Insurance broking: the black art of valuation
23 August 2019
It is a challenging time to be an insurance broker. In addition to the increasing consolidation, the insurance industry is facing a number of headwinds related to digital disruption, changing regulatory requirements, etc.
For many years the broking industry operated on a valuation model that was unique and different to most of the business world. Values were often quoted based on multiples of recurring income, and whilst the multiple itself would change to reflect the specific circumstances of the deal or other proxies (such as specialised products/services offered, client relationship…), the methodology itself was common across the industry.
However, the persistent infiltration of accountants and financiers into the industry has led to the industry re-appraising its approach to valuation and becoming more aligned to “cash-backed” profitability valuation methodologies (e.g. EBITDA multiple approach) applied in other trading business and industries.
The EBITDA valuation model has four key components:
- EBITDA is the first component and is essentially the profit generated by a business which is, in part, a proxy to cash generation. As reported EBITDA per statutory accounts might include non-recurring costs and income, they will often need to be adjusted when considering the true underlying profitability of a business or “Maintainable EBITDA”.
- Once a maintainable EBITDA is agreed it then needs to be applied to a multiple. Multiples move over time and are dependent on numerous factors including size of business, quality or volatility of its earnings, customer and employee dependency, etc. One size does not fit all and as with EBITDA, the appropriate multiple to apply will be subject to presentation, interpretation and negotiation.
- A multiple is applied to maintainable EBITDA to generate the Enterprise Value of the business. This is often the headline number which is quoted but is very rarely the actual sum that is received by the owners. Adjustments to Enterprise Value, the third component of the valuation, are extremely common but are not always considered upfront when first appraising the valuation of a business. In terms of the balance sheet, the common adjustments relate to cash and debt held in the business at completion and working capital requirements.
- Finally, valuation also might be impacted by what the accounts do not include such as contingent liabilities associated with taxation planning, potential property dilapidations, etc.
Arriving at a valuation is often a complex process that is subject to extended negotiation. A clear understanding of what is involved from the outset is essential for any seller before embarking on a potential transaction. Professional advice and transactional experience is vital in this regard. Often, it is a life’s work at stake.