Brokerage buyers paying top dollar for these 3 things

Brokerage buyers in Canada are looking to buy into growth, talent, and a mid-market business mix, a deal advisor tells brokers attending IBAOcon in Niagara Falls Thursday.

Brokerages that can show growth generated by young and successful broker teams will likely get the best value for their brokerage in a future sale, says Kenneth Pan, managing director and partner of Dowling Hales, an insurance-focused investment bank.

In his talk, Pan discussed common multiples seen in brokerage deals. The term “multiple” is an expression of what buyers are willing to pay for a brokerage before EBITDA (earnings before interest, taxes, depreciation, and amortization). He notes buyers are often willing to pay a premium for brokerages that have at least three certain characteristics.   

“Here’s what drives a higher multiple,” Pan said in response to a question from the audience. “Growth is huge. If you take two exact brokerages — same size, same mix of business — if one’s growing at 10%, and one’s flat, that firm that’s growing is going to get a premium to the market. And the one that’s flat is going to get a discount to the market.”

The age of brokers at the selling brokerage is also of interest to buyers.

“The other big factor, I would say, is also age — the age of the [selling brokerage’s] executive team, age of the producer force,” Pan says. “The younger and more productive you are, generally that gets a premium valuation.”

And then, as far as business mixes receiving valuation premiums go, buyers are looking for brokerages that show growth in Canada’s hot, mid-market space.

The definition of “mid-market” insurance varies, but it generally refers to brokerages catering to middle-market companies. These business clients are large enough to have complex risks, but they don’t have the staffing resources or tech infrastructure to manage them independently.

Such business clients often have annual revenues of between $25 million and $300 million, although some brokerages discriminate by other factors, such as premium size, for example, instead of revenues.

2X multiple days ‘way long gone’

Pan says the days of buyers paying two-times multiples for brokerages are “way long gone.” In the large-market M&A space, for example, he notes Aon bought NFP at a multiple of 19 times EBITDA. The multiples are lower depending on the size of the brokerage and its individual circumstances.

But Pan cautioned brokers in the audience not to focus too much on multiples, since the ultimate goal is to maximize value for the brokerage.

Profit margins, for example, can have a major impact on the value of two brokerages that may both sell at the same multiple.

“Selling your business at 13 times EBITDA at a 20% margin is completely different than selling of your business at 13 times EBITDA at a 40% margin,” he says. “All that matters at the end of the day. It’s not multiples, it’s dollars, right?”

The term “margin” is a profitability ratio. An EBITDA margin, for example, shows how much of a company’s revenue is converted into profit at different levels of expense.

Illustrating Pan’s point above, consider a hypothetical brokerage that has $10 million in revenue and sells at a multiple of 13 times EBIDTA. The multiple of 13 is applied to a profit margin of 20% times revenue. In this example, the brokerage’s profit margin would be $2 million (20% x $10 million revenue). Multiplying that by a multiple of 13 times EBITDA would result in the brokerage being worth $26 million (i.e. 13 x a profit of $2 million).

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Now consider the same brokerage at a 40% margin. Now the brokerage’s profit on revenue would be $4 million. Multiply that by 13 and you get a brokerage valued at $52 million.

Buyers are much more sophisticated these days, Pan says. And that means sellers can be more sophisticated as well.

He notes the difference, for instance, between “accounting EBITDA,” which focuses on the historical value of the brokerage, and “pro-forma EBITDA,” which accounts for the value of a brokerage’s forward-looking activities, such as new business to be added into the mix, new offices in new territories, etc.

Brokers selling nowadays will likely want to focus on the pro forma EBITDA, emphasizing to sellers what they plan to bring to the table in the future.

David Gambrill

David has twice served as Canadian Underwriter’s senior editor, both from 2005 to 2012, and again from 2017 to the present.