2018 Best Practices Study

The most common profitability metric used throughout the Best Practices Study is pro forma EBITDA. An agency’s pro forma EBITDA is an agency’s reported Earnings Before Interest, Taxes, Depreciation and Amortization after normalizing (or pro forma) revenue and expense adjustments are made and discretionary expenditures made for the benefit of the owners are added back. Think of it as normalized pre-tax cash flow after accounting for operating anomalies and owner perk add-backs. An agency’s pro forma EBITDA expressed as a percentage of pro forma revenue is its pro forma EBITDA margin. Thus, an agency with $5M in pro forma net revenue (total revenue net of outside broker commissions and fees) and $1.2M in pro forma EBITDA is generating a 24.0% pro forma EBITDA margin ($1.2M / $5.0M).

In this year’s Best Practices Study , pro forma EBITDA margins averaged approximately 24.0% across all revenue categories. These strong profit margins enable Best Practices agencies to deliver superior shareholder investment returns, fund strategic investments, hire producers, fund perpetuation obligations, pay dividends, acquire agencies & producers with books of business and raise outside capital. The Best Practices Study provides a granular perspective from which to examine each of the four expense categories that drive an agency’s profitability: Compensation (payroll & employee benefits), Selling, Operating and Administrative expenses. High profit Best Practices agencies monitor each of the four primary expense categories. Doing so allows them to understand profitability issues at an actionable level – providing the basis for changes in compensation, staff usage, resource usage, etc.

Pro Forma EBITDA Margin

18.3%

>$25.0M

27.1%

23.1%

$10.0M-$25.0M

33.5%

22.1%

$5.0M-$10.0M

33.8%

27.5%

$2.5M-$5.0M

43.4%

27.7%

$1.25M-$2.5M

42.8%

26.6%

<$1.25M

42.6%

Of particular note in this year’s and recent Best Practices Studies is the impact of creeping compensation costs and

Average Top Quartile

value-added resource investments on agency profitability. In order to remain relevant in a marketplace defined by chronic shortages of available young talent (people) and ever-increasing customer expectations, increasing profit margin pressures are the rule rather than the exception and will likely remain so for the foreseeable future. Recognizing the well-reported aging of our industry, Best Practices agencies have responded by aggressively investing to attract young employees, particularly producers, to the industry. This is a very expensive proposition. Left unchecked and unexamined, these investments in human capital can significantly impair an agency’s profitability and long-term viability. In addition, client demands for value-added resources continue to accelerate in the middle-market, where most Best Practices agencies operate. Best Practices agencies face increasing competition from large and well-resourced national and super-regional competitors seeking to fuel their own growth by picking off under-resourced and under-served middle- market accounts currently controlled by smaller agents and brokers. As a result, Best Practices agencies are required to make ever-increasing investments in the resources demanded in the marketplace (think claims management, loss control services, account executives, ACA compliance, wellness, etc.). These investments must also be kept in check.

 22