When you’re considering taking steps to grow your insurance agency, one of the biggest considerations is how to fund the expansion of your office space, upgrade your technology, hire more staff, or make other needed changes. And of course, you’ll want to know how much you can – and should – borrow.
The First Mid Bank & Trust Agency Finance team has the expertise to walk you through the process of determining how much you can borrow and the best options for increasing your access to capital. For more than 20 years, this specialized department has been catering to the unique needs of independent insurance agencies, Allstate agents and other captives.
Types of Capital
There are three primary types of capital — Senior Debt, Subordinated Debt, and Equity.
Debt financing normally allows the owner to retain full operating control of the business, without changing the ownership or structure. Senior Debt is any debt that takes priority over other debt owed and is normally secured by collateral (assets within the business, including commissions). Subordinated Debt is frequently associated with acquisitions and buyouts, like seller notes.
Equity financing is different from debt financing as it relates to ownership and control. Equity financing allows an owner to sell shares of their business. This creates an avenue for outsiders to secure an ownership stake in the agency; this can affect daily operations.
Your capital needs will vary, depending on the lifecycle stage of your agency. If you are new, you may be looking for growth capital. If it has been difficult to grow, you may be in need of marketing capital.
Your need for capital is dependent on your agency’s needs. How much you can borrow is very specific to your agency’s characteristics and financial performance. There are a few factors unique to insurance agencies that can help guide you in determining your debt capacity or the amount you can borrow. These include:
- Insurance product types
- Retention and loss ratios
- Personal and/or business credit scores
- Debt service coverage
- Debt to EBITDA
- Ratio of your desired loan amount to annual commissions
Products, Retention, and Credit Score
The product types, retention/loss ratios, and credit scores are qualitative factors that can impact the amount a lender like First Mid Bank & Trust is willing to lend to you and your agency. Product types with longer, more stable renewal income may allow a lender to advance more against the commissions.
Higher credit scores and retention in the insurance book are good indicators of stability of the borrower and related insurance commissions. It’s a good idea to request a copy of your credit report using at least one of the three major credit bureaus (Equifax, Experian, and TransUnion) prior to applying for a loan. This allows you to understand what your credit score range is and determine if there are any errors on your credit report that need to be fixed.
Debt Service Coverage
Your Debt Service Coverage (DSC) ratio is a good benchmark to work from in determining the ratio of cash flow to debt payments. DSC measures the ability to pay current debt obligations with available cash flow. The higher the ratio is, the easier it will be to gain access to lending opportunities.
The ratio is generally calculated by taking excess cash flow (net operating income) divided by total debt payments, measured monthly or annually. Included in the total debt payments is interest and principal on existing debt PLUS the new loan you are considering. Lenders vary on their requirements for DSC. Some lenders require a DSC ratio of at least 1.2 while others may require a DSC ratio of at least 1.5.
Debt to EBITDA Ratio
EBITDA is your Earnings Before Interest, Taxes, Depreciation, and Amortization based on your agency’s income statement. This measurement helps a lender, like First Mid Bank & Trust, determine an agency’s profitability.
Lenders compare debt to EBITDA by taking total debt divided by EBITDA. It’s important to note that lenders vary on their requirements for the ratio of debt to EBITDA. Some require that debt to EBITDA be no more than 3.5 while others may require a ratio of no more than 5.0.
Multiple of Annual Commission Revenue
Lenders have differing capacity limits for different insurance product lines. Products that have a more stable, longer vested commission value may allow us to loan more when compared to products that are more price sensitive and have lower retention rates or commission values.
We’re here to help!
Insurance agents should consider which types of capital will work for them based on their present and future needs. All capital is not created equal, so choosing wisely for your agency is of utmost importance. We are always happy to discuss your needs, goals, agency metrics, and capital requirements with you. Reach out to our team so we can share the insights we’ve gained during the last 21 years of providing financing to insurance agencies.
The information contained in this article is not intended to fully encompass the requirements that a lender may have for an insurance agency loan but is intended to help guide you in understanding some of the key components that may go into a lender’s decision.
