Selling a business is no small decision, and if you’ve ever thought about selling your crop insurance agency or book of business, you’ve probably struggled with determining its value.
Whether you’re considering selling your crop insurance business now or in the future, this overview provides common valuation methods.
Business Valuation Basics
While the valuation of any business can seem like a complex venture, the purpose behind these calculations is to provide an impartial opinion of value. However, your business is unique and a potential buyer’s circumstances may increase or decrease its worth to them.
In purely economic terms, your crop insurance business is worth the present value of all free cashflow the buyer expects it to generate in the future. What does that mean?
Future cashflows are often estimated based on historical cashflows. Generally, in the crop insurance industry, simply subtract servicing costs from net commissions to get a reasonable estimate of free cashflows.
Net present value refers to the value of future cashflows discounted to reflect what a reasonable investor would accept today to give up future payments.
Calculating Cashflows
To form an estimate of future cashflows (FCF), a buyer will typically want to review your financial performance over the past three to five years.
Early in the process, self-reported numbers may be sufficient, but as negotiations progress, buyers will request documentation – including Approved Insurance Provider (AIP) commission and premium reports – to substantiate company financials.
A serious buyer will be willing to sign a non-disclosure agreement (NDA) before you provide sensitive information about your crop insurance business. With an NDA in place, be prepared to share the following:
- Base commissions – This is the largest portion of cashflow and likely the easiest to report.
- Processing bonus – If you receive a processing bonus, the buyer will want to evaluate and verify the processing bonus received. If the buyer intends to combine your business with their existing business, they will likely replace your current processing bonus with an estimate of the processing bonus they would earn when the business is converted to their servicing model.
- Profit share – Again, a buyer with an existing crop insurance business will probably replace this with an estimate of the profit share (if any) they could earn once the business is incorporated into their own arrangements with various AIPs. Additionally, the buyer will want to see the level of profit share you earned by each AIP you write with, including how consistently it was paid by the respective AIPs your agency writes with.
- Premium reports – A prospective buyer may have a different commission schedule than the seller, so the premium reports will help the buyer evaluate if their net cashflow will look different than what the seller has been receiving.
- Outstanding claims and obligations – A buyer will want to know of any outstanding claims and obligations, including any potential errors and omissions (E&O) claims for your agency that might reduce the cash flow of the agency.
It’s important to break all these numbers down by AIP and by insurance type (MPCI, Crop Hail, PRF, etc.), and by customer so the potential buyer can put them into the context of their existing relationships with AIPs and servicing models for various types of business.
Buyers will deduct an estimate of cash outflows necessary to service the customer base from the sum of commissions, bonuses and profit sharing to calculate net cashflow.
Providing products and premium by customer by AIP will allow a potential buyer to estimate servicing costs. It’s also important to document any outstanding errors and omissions (E&O) liability.
Net Present Value (NPV), Discount Rates and Multiples
Calculating the net present value of FCF can help potential buyers answer a simple question: Does the present value of all the money coming in over the life of the business outweigh how much money they must spend to acquire it?
In practice, valuation multiples are often used as shorthand for discount rates and complex NPV calculations. For example, a multiple of five would mean a buyer estimates the NPV of all FCFs as five times their estimate of the current year’s cashflows.
In the crop insurance industry, multiples typically range from 1 to 3. Keep in mind, multiples will change over time as interest rates and investment yields change. Often, the multiple is tied to base commissions, which are guaranteed, and generally does not include profit sharing revenue, which can be hard to estimate for future years.
Playing an active role in knowing which multiple or multiples are being used to value your crop insurance business will allow you to understand how they arrived at an offer and help you ensure productive negotiations.
