Another resounding yes. Based on the various data sources that we will share in this article, all indications point to the conclusion that as the agency ownership gets older, EBITDA profitability margin shrinks.
First, let’s define what EBITDA profitability margin is. EBITDA stands for Earnings Before Interest, Taxes, Depreciation, & Amortization. It is used to analyze the true profitability of an agency by eliminating the effects of financing and accounting decisions.
There are many factors as to why the profitability margin shrinks as the agency owner(s) age, of which it would take more data and analysis to thoughtfully draw conclusions. For that reason, we will not opine on the cause of why agency owner(s) advanced age leads to a reduction in EBITDA profit margin and instead will focus on the correlation of the data conclusions and opportunities to improve the results in your agency.
Over the past 3 years, we have completed over 120 valuations on independent insurance agencies and our data shows that the older an agency ownership is, the lower their EBITDA profitability margin, particularly for those agencies with 70+ agency owners.
As you can see in the graph below, the EBIDTA profitability margin for agencies with agency owner(s) in their 40s is highest at 23.6%. Agencies with ownership in their 50s, 60s and 70s all saw a reduction in their profitability margin in comparison to agencies with owners in their 40s ranging from 3.5% to 10.5%.
While the average of all agencies in this chart are showing EBITDA profitability, the strongest profit margins are with agency owners in their 40s. The drop-off is particularly pronounced with the 70+ agency owners.
While the youngest agency owner category (30s) showed lower profit margins as well, this is likely attributable to the investment expenses needed to grow and establish the agency. Whether the agency is a startup or established agency, often times agency owners in their 30s find themselves making significant technology, marketing and staffing investments to grow and compete.
So in real dollars, what does this mean to an agency owner? Let’s use the example of the average $700,000 annual revenue agency that operates at a 23% profitability margin versus a 13% profitability margin. The agency with a 23% profitability margin is generating $161,000 per year in profits whereas the agency with a 13% profitability margin is $91,000 per year.
This is a difference of $70,000! When you multiply this amount over 3 years it is $210,000, $5 years equals $350,000 and 10 years is $700,000 and that doesn’t include dollar cost averaging. The loss of earnings is profound when an agency fails to maintain a healthy mix of agency ownership and make the necessary investments to grow the business.
For many agency owners, $91,000 in profit is sufficient. It is a comfortable life and steady business. However, we caution just looking at this factor because it overlooks the significantly lower organic growth factor that we reviewed previously and the decreased agency valuations that we are going to review in the next article.
Big I National and Reagan Consulting Best Practices Study
As we reviewed the Big I National and Reagan Consulting 2020 Best Practices Study Update, we found similar results in the correlation between EBITDA profitability margin being highest among smaller agencies which happen to have younger agency ownership. For example, agencies with revenue below $1.25 Million had an EBITDA profitability margin of 31.9% and had an average owner age of 52, whereas the lower growth categories with the larger agencies all had agency owners that were on average older than 52 years old, particularly the mid-sized and mega agencies which were both over 55.
Again, it is not our intention with this series to drive older agency owners into early retirement, rather our goal is to encourage better planning to maximum agency value for your life’s work. Every agency owner will have to transition ownership of their agency at some point in their life, despite our best effort to drink from the fountain of youth, aging is inevitable.
In Ohio, our data shows $2.75 Billion of the $11.4 Billion of premium written by independent agents are controlled by 55+ year old owners, with an average age of 63. That means 24% of the premiums written in Ohio are controlled by agency owners withing 5 – 10 years of the traditional retirement age. In addition, we estimate that 10% of agencies are owned by agency owner(s) 70+.
While not all of this premium will change hands in the next few years, much of it will.
The bottom line, the better preparation and planning equals higher agency value. Here are some tips for how you can get started today:
- Complete a fair market valuation of your agency – to understand where you are going you must know where you are and where you have been. A valuation will help you understand your agency’s value, identify the risk factors in your agency, and develop a plan around each one to improve upon it. We encourage agencies to make an agency valuation part of their annual business planning processes to ensure that you always have a good barometer on the value of your agency and are working on addressing the risk factors.
- Develop a formal perpetuation/transition plan – every situation must have an exit strategy, particularly something as valuable as your agency. Whatever wishes you have for your agency - internal perpetuation or external sale - you must have a plan with your exit strategy. The more planning you do in advance the smoother the process and will likely lead to capturing a higher agency value.
- Establish a contingency buy-sell agreement – this is critical for every agency but particularly for those with single owners. The contingency buy-sell is insurance for your family, employees, and clients that if the unexpected happens to you, a structure is in place to preserve the agency and its value.
- Recruit and mentor young producers and agency staff with the potential of becoming owners – recruitment of younger producers and prospective future owners is key to maximizing your agency’s value. Even if you decide to sell externally, having successful younger producers will enhance the value of your agency.
Next week we will cover the impact of the agency owner(s) age on the agency valuation multiple. Please contact Jodie Shaw today to discuss your plans and how we can assist you in growing your agency value, solidifying your legacy and fulfilling your transition plans successfully.