2021 Best Practices Study

Adapting to a Rapidly Changing Environment

Internal Perpetuation Best Practices

(principal and interest) covered by shareholder distributions or bonuses that the buyer receives. For example, if a buyer’s first-year payment is $100,000 in principal and interest and they receive shareholder bonuses or distributions of $70,000, the BCR is 70% ($70,000/$100,000). An agency with a BCR of 100% provides buyers with bonuses and/or distributions sufficient to cover 100% of the buyer’s principal and interest payments, albeit on a pre-tax basis. The Study concluded that agencies with BCRs of 100% or better were ideally positioned to perpetuate internally. In other words, equity proved to be generally affordable in the event an agency had a 100% or b etter BCR. In cases where an agency’s BCR fell below 100%, the Study concluded that buyer affordability would likely become an issue. Let’s look at an example of what has happened over the past decade to Buyer Coverage Ratios. The typical financing terms available to buyers in 2010 were a 10% down payment, with the remaining balance financed over eight years at a 3% interest rate. Below is a comparison of BCR ratios assuming the same financing terms were available to buyers in both 2010 and 2021. The meteoric rise in valuations over the p ast decade dropped this agency’s BCR from 101% in 2010 to just 73% in 2021; equity affordability decreased by almost 28%!

2010

2021

Value as Multiple of EBITDA

6.5x

Value as Multiple of EBITDA

9.0x

Down Payment

10.0%

Down Payment

10.0%

Years Financed

8.0

Years Financed

8.0

Interest Rate

3.0%

Interest Rate

3.0%

Profits Distributed

80%

Profits Distributed

80%

Pre-tax, First Year Buyer Coverage Ratio

Pre-tax, First Year Buyer Coverage Ratio

101%

73%

This huge leap in agency valuations and the accompanying compression of BCRs have put real pressure on internal perpetuation. Equity is materially less affordable to buyers. Without buyers, any internal perpetuation plan will collapse.

What happened between 2010 and 2021 that caused these seismic shifts in agency valuations? The typical agency or broker is not much different from a decade ago – profit margins and growth rates are about the same. As it turns out, external factors have accounted for much of the increase in agency valuations: •

• Tax laws changed in favor of agency owners • Public broker equity markets surged • The U.S. stock market strengthened significantly following the Great Recession • Interest rates remained at historically low levels

Investment capital flooded the industry from a variety of sources, most notably, private equity firms • Capital costs declined materially • Competition intensified from high-performing acquirers

For privately-owned agencies perpetuating with internal valuations at 8-10x EBITDA multiples (now the norm), several strategies may seem to be appropriate to address the buyer affordability conundrum. Increasing agency profit margins, hiring producers, and increasing down payments on buyer notes are often touted as mechanisms to increase affordability

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