The downside of selling for 4 times multiple during COVID

Despite the economic disruption from the COVID-19 pandemic, some brokerage owners could sell their business for multiples of more than four times revenue, but there is potential downside to this, Ontario brokers heard Wednesday at their annual convention.

“About 15 years ago, the multiples that buyers paid to acquire brokerages were in the 2.5 to 2.75 range,” said Colin Clahane, national director and insurance head of Canadian commercial banking at BMO. “We are now in 3 to 3.5 for an extended period.”

Simply put, a “multiple” is the price that a buyer pays for the brokerage, divided by the brokerage’s annual revenues. The higher the multiple, the more the brokerage is valued by potential buyers.

Clahane shared his view of what brokerages are selling for these days during a keynote presentation Wednesday at the Insurance Brokers Association of Ontario’s annual convention, which was held online this year.

He told IBAO members there is wide speculation on the street that the COVID-19 pandemic will lead to a devaluation of assets, particularly downward pressure in pricing multiples for brokerage acquisitions.

“I have been a minority, I have been bullish on pricing,” said Clahane. “Believe it or not, we are starting to gravitate more towards (multiples of) 4.25 and up to 4.75. And I have even seen some of those five-times-commission-revenue deals sometimes cross my desk for the past couple of months despite the pandemic impact.”

But there is a downside to escalating multiples, Clahane warned. “We are starting to get to a point where multiples are so materially challenging that you may, by osmosis, be inadvertently pricing out future generations. Sellers, if you are looking to optimize the price, just be mindful of that concept.”

But he is not going so far as to advise brokerage to reject offers at these multiples.

“I can’t sit here and not advocate that a broker not get top value from the sale of a brokerage if they put their blood, sweat and tears into the enterprise to grow it,” he said. “But that is not the full end of the equation.”

Clahane suggests that sellers go through some “mental gymnastics” and consider how to reduce the up-front price that the buyer has to pay.

“The only thing we are cautioning is, collectively, there could be some thought process put into where we are headed,” he said. “I think that would be appropriate for all parties involved, be it buying or selling. Ultimately we need that localized community entrenchment. We need the independent broker distribution channel to be alive and well. Those small to mid-sized enterprises within our economy are the ones that churn and oil the businesses.”

For Clahane, the amount of deal activity is part of what is driving up the multiples.

“The average age of the broker in Ontario is about 57 years old,” he said. “There could very well be some prospective sellers listening to this discussion and thinking to themselves, ‘I am not sure how much more I want to stomach, from a macro shock point of view, this COVID thing. It is not a whole heck of a lot of fun. I may decide to drift off and this might act as a catalyst and push me towards my exit strategy.’”

Other factors driving brokers to sell could be their health or an opportunity to get a key employee or family member to take over the business.

“When we think about perpetuation or succession plan deals,” Clahane said, “there are going to be operating circumstances that trigger the need for these transactions to transpire, regardless of whatever adverse externalities are going on around us.”

Feature image via iStock.com/Kritchanut