One of the most common questions we receive from agency owners is, “Why does everyone keep talking about EBITDA?” Whether they are preparing for a valuation, considering a perpetuation plan, or simply trying to understand what drives agency value, many agency owners encounter EBITDA without fully understanding why it has become the industry’s preferred measuring stick. At IA Valuations, we’ve completed more than 400 valuations, and EBITDA plays a central role in virtually every one of them.
At a high-level, EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. This method is used to analyze the true profitability of an insurance agency by eliminating the effects of financing and accounting decisions. EBITDA has become the preferred valuation metric for several reasons.
Why EBITDA Has Become the Industry Standard
First, it removes financing and tax decisions from the analysis. There is some variation in how insurance agencies are financed. Some are laden with debt due to merger and acquisition activity. Others could be owner-funded, and some carry earn-out liabilities. Regardless of how an agency owner chose to capitalize their business, by removing the interest and tax burden from the equation, a buyer is better able to compare the underlying operating economics of different agencies on equal footing – an apples-to-apples comparison, if you will.
Second, insurance agencies are not capital intensive like manufacturers and thus do not have heavy fixed-asset depreciation expenses on their books. However, many do have amortization expenses from prior agency acquisitions on their books. These are typically tied to intangible assets such as goodwill and expirations, like customer lists. And, since the amortization is tied to a non-cash legacy of a past transaction – and not a reflection of the current agency performance – removing it gives a clearer view of an agency’s actual cash-generating ability.
Third, EBITDA provides a reasonable proxy for cash flow. Because insurance agencies are largely commission based and fee-based enterprises with low capital expenditures, EBITDA tracks closely to the actual free cash flow available to agency owners or potential acquirers. In other words, “what can I expect this business to actually throw off per year,” on an ongoing basis or post-acquisition?
Finally, because most buyers are valuing agencies on EBITDA multiples, using EBITDA makes comparisons between transactions much easier. There has been a strong surge in merger and acquisition activity within the insurance industry over the last several years, especially by private equity-backed buyers. These buyers and these deals are almost entirely based on a multiple of EBITDA. Because this has become the de rigueur valuation method in this space, the use of EBITDA enables a valuation to be benchmarked directly against similar transactions.
Understanding EBITDA is only part of the equation. In practice, buyers rarely pay a multiple based on the EBITDA shown directly on an agency’s income statement. Instead, they focus on adjusted or pro forma EBITDA, which attempts to reflect the agency’s true ongoing earning power.
Adjusted or Pro Forma EBITDA Normalization
Typically, a valuation practitioner will base the valuation on a multiple of pro forma EBITDA. To arrive at pro forma EBITDA, the valuator will “clean up,” or normalize, the agency financials that are often full of extra, owner-specific expenses that tend to cloud up the agency financials.
To normalize the agency’s EBITDA, they will typically remove both revenues and expenses that are non-recurring in nature. On the revenue side, this could be income tied to lost accounts, a reduction of expected contingent payments or timing quirks, or one-time receipts of income from the gain on sale of certain assets.
On the expense side, these adjustments could include removing items like excess owner compensation and above-market rents paid to a separate owner-owned LLC. Additionally, this includes one-time expenses tied to legal or transition costs.
Lastly, the pro forma will remove any personal expenses that are run through the business that are not essential to the running of the business. Items such as country club memberships, sports tickets, family cell phone plans, and spouses’ vehicles will be removed from the financials prior to the valuation analysis. These types of personal expenses are not as common these days, but they are still seen on books and should be removed for the pro forma.
After the agency expenses are cleaned up, there are typically “add-backs.” These are expenses that are – aptly named – added back to the financial statements to arrive at a fully-normalized adjusted pro forma EBITDA. An example of this would be to add back the rent expense if the building is paid off and the owner is not paying themselves rent. A future acquirer would have to pay rent at the market rate, so this expense would be added in. Another example is if an agency is not paperless and does not have an agency management system, a valuator would add this expense as a future buyer would almost certainly move towards a paperless agency post-acquisition. The final normalized and adjusted pro forma EBITDA is what buyers will pay a multiple on.
The Lore of Revenue Multiples
If you have been in the industry long enough, you are certainly familiar with the old adage of “I am worth 1.5x revenue” or “We are worth 2x revenue.” At IA Valuations, we like to say that this is an expression of value, but not a calculation of value.
Any acquirer that would pay on a multiple of revenue is setting themselves up for a risky transaction, as revenue-based multiples do not allow for the kind of normalization explained above. Net income numbers are too distorted by various financing and tax choices to be a clean starting point in the overall value assessment.
Recap
Understanding EBITDA does more than help agency owners speak the language of buyers. It provides insight into what truly drives agency value and helps owners make better decisions about growth, perpetuation, acquisitions, and eventual succession. While industry folklore often focuses on revenue multiples, the market increasingly focuses on normalized EBITDA and the sustainability of future earnings. For agency owners who want to maximize value, understanding EBITDA is no longer optional; it is essential.
To learn more about your agency’s normal EBITDA, reach out to Craig Niess, Director of Business Planning & Valuations at IA Valuations, at craig@iavaluations.com or at (216) 288-8409. The IA Valuations team would be happy to help your agency better understand your value.
By: Craig Niess, CVA, MBA
Crag Niess is Director of Business Planning & Valuation for IA Valuations. Between his time with IA Valuations and MarshBerry, Craig has over a decade of financial and operational consulting experience with independent insurance agencies. He has advised many independent agency owners on their transition and perpetuation plans, created financial models to support an ownership transition, and developed producer hiring and business planning for agency growth. In addition, he has completed hundreds of valuations and consulting projects for independent agencies of all sizes. He holds a BA in Economics from Ohio Wesleyan University, and an MBA in Finance from the University of Iowa. He also earned the highest and most prestigious designation in the valuation profession – the Certified Valuation Analyst designation.
About IA Valuations and Agency Link – Founded in 2017, the IA Valuations team has performed over 400 valuations to independent insurance agencies across the U.S. Our advisors have 30+ years of experience guiding agency owners on maximizing their agency value, planning, and legal needs for ownership transition. In addition, IA Valuations has provided perpetuation planning, financial modeling and business planning for independent insurance agencies. Finally, IA Valuations has advised dozens of agency owners on selling their agencies through our Agency Link process. Agency Link is a platform that connects buyers and sellers together to further the growth and strength of the IA system. To learn more about IA Valuations, please visit IAValuations.com or contact@iavaluations.com.
The information provided in these documents is general in nature and shall not be construed as personal legal, tax or financial advice for your situation. Please contact@iavaluations.com to discuss your personal situation.
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