The retiring agency owner’s guide to EBITDA
EBITDA stands for "earnings before interest, taxes, depreciation and amortization."
“I bought this book of business for two times 25 years ago; I was just going to do the same when I’m ready to retire.” This is one of the most common quips IA Valuations hears from the generation of agency owners getting ready to retire, and we fear it could leave much on the table for owners’ retirement and their agency. You bought the book for two times what? Commissions and fees? Gross revenue? Net income? Did the owner in this example really understand the details of what their price was based on? Far too often, the answer to this question is only a half-hearted “yes.” When really, an agency owner or anyone interested in buying a book of business, should be able to confidently say “OF COURSE!”
In the market right now, prospective buyers or lenders are not determining the price they will pay or lend for an agency based on revenue alone, but instead on EBITDA. EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization, and it is expressed as a percentage of gross revenue. You may hear someone use the term “profitability margin” when referring to EBITDA and, while that is commonly accepted, they are not synonymous. Technically speaking, EBITDA is just one of many ways to measure profitability. One other measurement that is most visible to agency owners is net income or loss. The difference is simple:
EBITDA = Net income + interest expense + taxes + depreciation expense + amortization expense
In essence, EBITDA gets rid of the “noise” associated with expenses that aren’t directly related to operating the business. Interest expense, taxes, depreciation, and amortization are all expenses that can vary between businesses in the same industry based on levels of debt, tax circumstances, and the non-cash deductions from income.
Thus, EBITDA is often used by lenders or buyers because it strictly deals with the cash related to operating the insurance agency and none of the extra “noise” that can vary so much. Especially from a buyer’s perspective, the “ITDA” of EBITDA will change under new ownership, anyway! In a nutshell, that is why the agency owner should care about EBITDA, because the people that have the power to turn the value of your agency into cold-hard-cash care about it.
An important note we share with all of our valuation clients is that having the highest EBITDA is not always best. Your agency’s EBITDA should match the goals of the agency. Is your agency applying for a loan soon or are you selling the agency? If either of those things are true, then maximizing EBITDA is wise in preparation. However, there are many other phases in the lifecycle of a business where it makes sense to have a low EBITDA, for example, when a business needs to grow and doesn’t have the luxury of acquiring a book of business. To do so, an agency will likely have to invest in a new producer or increase other selling expenses that reduce EBITDA. The only time to be concerned about a decreasing EBITDA year after year is if it is unexpected. If it’s part of the agency’s business plan, then it’s a positive, because it means you’re taking action to achieve your goals.
Although we just shared that lower EBITDA is not necessarily bad, as an agency owner, you are likely still curious on ways to drive up EBITDA to maximize the value of your agency. Here are some ways to increase your agency’s EBITDA:
- Purchasing books of business: Upon purchasing a book of business, the agency is increasing their revenue, but if debt was involved to do so, the interest expense of said debt won’t reduce the agency’s EBITDA. The only reductions to EBITDA will come from increases in operating expenses it takes to run that acquired book of business, if any.
- Decrease operating expenses: This is no secret to business owners trying to drive up profits. IA Valuations has worked with some agency owners who operate their agencies with minimal margins so they can run lifestyle expenses through the agency, including cars, social clubs, etc. If this sounds like your situation and you plan to exit the agency in the near future, begin to think about ways you can start to decrease any unnecessary costs from your income statement.
- Increase policies in force (PIFs): While increasing revenue by any means possible is great, increasing your policies in force is the best way to do so. Smart buyers and lenders are wise to the industry’s hard market. Nowadays, growth is not the goal, but quality growth is. Is your agency’s top line increasing just because of rate hikes, or is it increasing because the sales culture within your agency is driving new policies throughout any rate environment? The latter is the stronger way to grow.
No matter where your agency is at in its lifecycle, understanding EBITDA is important. Knowing how to talk EBITDA will make you more comfortable negotiating your agency’s value, enable you to see your agency from the eyes of a lender or buyer, and help you measure if your agency’s actions match its goals.
Jarod Steed is a business planning and valuation analyst at IA Valuations.
This piece first appeared on the IA Valuations blog and has been republished here with permission. Opinions are the author’s own.