M&A is top of mind for many in the industry, as F&I agencies are being acquired at a rapid pace. Over the past three years, at least 10 F&I agencies have been acquired by administrators, insurance agencies, and consolidators. These acquisitions are fueled by an influx of private equity capital and motivated by the need for acquirers to grow and lock in distribution channels.
The rapid pace of agency consolidation is not expected to abate for the foreseeable future. The F&I industry is stronger than ever. In 2018, franchise vehicle sales, excluding certified pre-owned, were 29.8 million vehicles, a 14% increase over 2015, and we expect 2019 to be commensurate with last year. Average new vehicle sales prices are at an all-time record of $33,319 for Q1 2019, causing buyers to turn to the used-car market.
Dealerships remain increasingly dependent on F&I income — it represents over a third of their profitability. These trends, coupled with the strong, predictable cash flow F&I agencies create have drawn private equity interest to the sector. The private equity universe is flush with cash with over $800 billion in the U.S. and Europe sitting on the sidelines waiting to be invested.
Challenging Competitive Dynamics for Small, Independent Agencies
The F&I agency universe is highly fragmented, with approximately 1,000 agencies in the U.S. with no single firm controlling more than an estimated 2% of the market. Agencies are typically local or regional players and few agencies of scale exist.
Many small agencies have built their books on a few dealership groups, which results in a lack of client diversification. Client concentration leaves the agency vulnerable to the vagaries of dealership owners’ actions and consolidation of dealerships themselves.
Dealership consolidation is the single biggest threat to a small F&I agency without a highly diversified book of business. Dealership M&A activity is at a record high level, with transaction volume increasing 20% in 2018. Over 1,500 dealerships have been sold since 2012. Importantly, there are 2,855 fewer owners than in 2008, thereby shrinking the universe of potential F&I relationships.
Small agencies often lose out when dealerships are acquired. To compete, small agencies need scale to produce the breadth of products and geographic footprint to be the winning agency.
To successfully compete, F&I agency owners may see more opportunities for long-term growth as part of a larger organization. Yet, in selling the agency and monetizing value, they would still like to retain the economic upside in future growth and some autonomy. Some acquirers will allow a seller to rollover a portion of its sale proceeds into equity in the acquiring entity.
Some owners prefer to exit altogether in a sale transaction. But after spending years, even decades, building an enterprise with their blood, sweat, and tears, how does an agency owner sell the company, retire, and walk away from the business?
Unless the owner has spent years preparing to exit the business by building a succession plan and having already transferred account relationships to the firm’s agents, it will not be possible for the owner to leave and still receive a good value for the agency. Typically, the owner will need to stay with the business for one to several years.
Valuation and Deal Structure
The enterprise value of an F&I agency is defined by its brand recognition, strength of relationships, new versus used mix, and diversification.
For example, if one agent is the key man for 60% of revenues, the agency has limited value to a buyer. If an agency is highly diversified in relationship ownership, dealership clients, and geographically, it is worth more. Generally, if any dealership group (note: group is common ownership of multiple stores) represents more than 20% of revenues or any three represent more than 40% of revenues, the agency is not sufficiently diversified.
To achieve that diversification and command the highest acquisition multiples, the agency must have scale of likely more than 15 salespeople. New versus used vehicle mix is as important, as new-car sales are forecasted to decline over the next few years.
F&I agencies are generally valued on a multiple of pretax earnings or EBITDA (earnings before interest, taxes, depreciation, and amortization. The purchase multiple range for agencies is significant at 5x to 11x, depending on size, diversification, and strength of relationships. Overall, F&I agency valuations have been increasing due to competition for good acquisitions.
Acquirers will often tie up sellers by linking part of the purchase price to future performance through an earnout and sometimes with ongoing equity participation. Both of these structures reduce the amount of cash for owners at the time of sale and defer a portion of the purchase price to be paid in the future. A typical example involves a buyer purchasing an agency for 8x and 5x is paid in cash at close and 1x is paid each year for the next three years based upon the agency hitting specific targets.
Since the value of an F&I agency is highly dependent on its sales agents, many buyers and sellers will motivate top sales agents with cash and equity rewards linked to future performance around a transaction.
F&I product administrators have been acquiring agencies to lock in distribution channels and take costs out of the value chain; however, this group of acquirers creates a high degree of financial and operational risk for the agency owner, depending on the deal structure.
As previously mentioned, the buyer will allocate some of the purchase price to an earnout and/or ongoing equity participation. For the administrator to realize the financial synergies in the acquisition, it will look to move the agency’s dealership clients over to its book of products, which may cause the loss of some dealership relationships.
With a resulting decrease in revenue, the agency will struggle to meet the earnout targets or find meaningful value for its equity participation. Additionally, the transaction may diminish the enterprise value and relationships built over the years. The agency owner will lose some control because the agency function is ancillary to the core business of the administrator, and some value-add services for dealership clients, such as recruiting and training, could be lost.
However, for an F&I agency in which the buyer is its primary administrator or for situations in which the earnout is minimized, the transaction could prove to be beneficial for the seller due to increased scale and relationship opportunities.
Insurance agencies, such as Confie Seguros and Brown & Brown, have been acquiring F&I agencies. Acquiring an F&I agency is logical for these consolidators of P&C insurance agencies, as the typical multiple is 12x to 14x for insurance agencies while F&I agencies trade for 5x to 11x. It is also a natural product extension; these firms are experts at acquiring and integrating smaller enterprises.
The drawback for the F&I agency owner is a loss of autonomy as part of a larger group. Additionally, rebranding may negate previous branding efforts and recognition. Importantly, the agency owner is less likely to participate in the equity upside of these larger enterprises, while future entity value will be created off the ongoing work of the seller. Typically, these types of acquisitions are structured with earnouts instead of equity participation.
Generally, private equity firms have not directly acquired F&I agencies due to the relatively small size and scale; however, they are the money behind many of the acquisitive administrators and consolidators. An exception is Southfield Capital, which, in partnership with management, acquired Vanguard Dealer Services. The agency had scale and a management team that could successfully execute a roll-up strategy in the F&I agency vertical. A few well-funded industry veterans are consolidating agencies under a different model, which marries both the financial strength of a private equity firm with the benefits of building and operating within a larger, independent F&I agency.
F&I agency owners need to plan ahead to sell their agency for the highest value.
As an F&I agency’s key asset is its people, employment agreements with non-competes should be in place with the sales agents long before the process. If the agency is a managing general agency with independent agents, the owner should consider bringing them onto payroll with employment agreements.
The monthly and annual financials should be reviewed or audited by an accounting firm.
The financials should be adjusted in a transaction for non-continuing expenses, a.k.a. “add-backs.” These are expenses that will not continue with a new owner, such as personal car loans, phantom employees, or excessive T&E. Remember, buyers pay a multiple on every dollar of earnings, so the agency should be positioned with the highest earnings possible.
If the reason for the sale is to retire, and the owner is important to the agency’s relationships, they should pick a retirement date and work back 3½ years to identify a kickoff date for the sale process and begin to transition key accounts. It will take three to six months to sell the agency. Then, if important to dealer relationships, the owner may need to stay as long as three years to earn full value.
The F&I agency should have control of its data and be able to easily report revenues and contracts sold by dealership store, dealership group, selling agent, administrator and product by month for the last three years. Strong data reporting and financial controls can improve valuation meaningfully.
Waiting to sell your company until the economy is in a slump is too late. The U.S. economy grew by 3.2% in the first quarter of 2019, topping expectations of 2.5%. This is the first time since 2015 that first-quarter GDP exceeded 3%. There is little concern of the Fed increasing interest rates in the near future. Buyers pay the highest prices when capital is available and when they forecast continued growth in the organic business.
Gina Cocking is a managing director at Colonnade Advisors, an investment banking firm that specializes in merger and acquisition advisory services for clients in financial services.