Making the deals: amidst the merger and acquisition frenzy, many agencies believe the value of their businesses may never be higher. (Property/Casualty: Selling Insight).

Agency principals often ask me if the merger and acquisition frenzy is continuing. I tell them that this market continues to be robust and does not appear to be slowing down. Over the past five years, an average of 173 deals have been announced each year, with 45 announced as of April 2003. Today's M&A activity is driven by the hard market's higher revenues and profits. Many agencies believe the value of their businesses may never be higher. The competition among buyers also has generated more attractive offers and more creative structuring of deals. Smaller agencies are being driven to mergers or acquisitions by carrier pressures for volume and by carrier consolidation. And for many agency principals nearing retirement, selling is the best perpetuation option.

Public brokers--the traditional buyers--were for several years overshadowed by larger and better-capitalized banks. However, in 2003, public brokers have taken the lead in number of deals announced, accounting for almost 40% of deal volume, compared with 30% in 2002. Historically, banks have been interested in making acquisitions to increase fee income in order to offset interest rate risk. Their excess capital has allowed them to pay more than most public brokers. Recently, however, a more level pricing field has emerged. The public brokers have been able to attract more acquisition candidates to grow their revenues and maintain high price-to-earnings multiples. Small and mid-sized agencies also see acquisitions as a key growth strategy and necessary to maintain carrier volume requirements.

Acquirers look at many factors when determining value, such as mix of business, account longevity, retention rates, and average account size. Agencies experiencing exceptional growth tend to receive the greatest multiples. However, the most important factor is sustainable earnings capacity, indicated by pro forma profit. Two similar agencies with the same revenue could differ greatly in their ability to generate profits.

Conversely, sellers should consider price vs. after-tax cash flow when structuring their deals. For example, if the agency is a C-Corp and the buyer wants to do an asset purchase, there is double taxation to the selling shareholders. The agency will first pay tax on the gain from its sale of assets to the buyer. Then the shareholders will pay tax on the liquidating distribution from the agency. However, if the deal is a stock sale, the selling shareholder merely pays capital gains taxes--once. If the buyer will only structure an asset purchase, then the price should be adjusted accordingly.

Besides price, sellers should consider whether payments are made up front or retention-based as the highest price may not produce the highest value. Sellers want more of the payment upfront, while buyers like to delay payments as long as they can. Receiving a slightly lower purchase price but significantly more upfront would provide greater value. However, if the buyer structures a retention-based deal, there is less risk and the buyer should be willing to pay a higher price. If the seller is still going to be active in the business for the duration of the retention period, then a retention-based payment may make sense. However, if the seller plans to retire, then he or she should consider whether the new owner can retain the accounts.

Another factor to consider is stock vs. cash. In selling an agency for stock, capital gains may be deferred. If the acquirer's stock is undervalued, there may be an opportunity to gain greater value when the stock price increases. Employment contracts should also be evaluated as they have an effect on the purchase price. Some buyers want the seller to stay for a significant period of time, while others may not. Generally, the more favorable the employment contract, the lower the upfront payment.

Selling an agency is both a financial and personal decision. For many agencies, it is an opportunity to become part of a larger organization which can provide them with the resources or capital they need to grow, expand or diversify In going through this process, agencies should understand how they are valued and what a realistic price might be. It's also important to understand how deals are structured, what options sellers might have for payment terms, what tax implications the deal will have, and how sellers might gain the greatest value from the business they have worked many years to build.

Sharon Cunningham, a Best's Review columnist, is president of Business Management Group, a management consulting firm. She can be reached at [e-mail].