People who identify with the sandwich generation, the popular term for middle-aged individuals who care for their aging parents while supporting their own children, understand what it is like to be in a pickle.

Wedged between two challenging caregiving roles, “sandwichers” often have to juggle many different and difficult responsibilities.

In the insurance brokerage or agency world, a younger generation of owners and partners is experiencing its own version of a sandwich challenge when it comes to determining the future of their businesses. Young partners are sandwiched between the high cost of buying out retiring owners at historically high multiples and a strong pressure to invest in increasingly expensive talent and technology to be able to compete effectively.

Often, current agency owners who bought out their firms from the generation before assume the next generation will do the same. The problem is many fail to consider the unique challenges of today’s mergers and acquisitions environment.

Two decades ago, the typical agency sold for five times earnings before interest, taxes, depreciation and amortization [EBITDA]. Nowadays, in the highly competitive, private-equity fueled marketplace, the usual price is nearly 10x EBITDA. In addition to strong PE interest, a large supply of willing sellers, low-cost debt and the synergies in a growing economy are fueling a sustained run of transactions at exceptionally high multiples.

Also, a low personal savings rate and high personal debt mean many younger partners do not have sufficient financial means to buy out senior partners without incurring significant additional debt.

Given these challenges, current agency owners seeking to divest are forced to decide between structuring a buyout over an extended period of time and asking the junior partner to incur major debt. Either way, the cash flow required to buy out senior partners or repay the loan significantly restricts the ability of the junior partner to make much-needed investments in the business after the transaction closes.

Meanwhile, in the current, highly competitive insurance brokerage environment, the cost of operating a successful agency is substantially higher than ever. Keeping up with the competition requires more than a simple investment in customer service and staff. Significant funds are needed to acquire and maintain state-of-the-art technology and other specialized capabilities. These resource investments are critical especially for agencies aspiring to move “up market.” Amid the fierce competition to acquire new business, producers and account team members are also under pressure to deploy expensive analytical tools that can better address the needs of their sophisticated clients.

Case in Point

The story of the hypothetical Joe’s Insurance Agency illustrates this challenge.

Joe Sr. started an agency in 1960. Through hard work, he built the agency to a formidable presence in the local market. In 1998, the senior Joe and his son discussed a buyout strategy that would allow transitioning ownership to Joe Jr. At the time, the agency had annual revenue of $3 million and EBITDA of $600,000.

Through research, Joe Sr. and Joe Jr. learned that the market value of Joe’s Insurance Agency at the time was 5x EBITDA, or right around $3 million. The two agreed that, since Joe Jr. had been working and contributing for years, he would receive a credit that would allow him to buy out Joe Sr. for a total of $2 million, spread out over five years. Joe Jr. was able to satisfy this cash outflow from agency profit and still have $200,000 left each year to retain or reinvest. The plan worked out well, with Joe Jr. taking over the helm of the business and the senior Joe slipping into a joyful retirement.

Over the last 20 years, Joe Jr. built the agency by acquiring great talent and strategically investing in technology and resources to increase efficiency. The annual agency revenue is currently $8 million, with a 25% EBITDA of $2 million a year.

Then comes Joe III, who has also been working with his father for the last five years and is ready to start taking the reins. Since Joe Jr. and Joe III both pay attention to industry news, they are aware that valuations are at an all-time high. Agencies like theirs are selling for 10x EBITDA, or $20 million, a reality that creates a serious challenge for both father and son.

Although Joe III has some personal savings, he is reluctant to take out such a large loan against the business. He would prefer to do a buyout over time, just like his father did. However, in this case, a similarly structured deal would mean Joe III would allocate two thirds of agency profit toward a buyout and need 15 years to pay off the full value. If Joe Jr. did what his father did for him—granting a third of the agency value to Joe III—it would still take the youngest Joe 10 years to pay the full value, and Joe Jr. would need to give up almost $7 million to make the deal happen.

Meanwhile, Joe III, feeling less enthused at the possibility of this future, realizes 10 to 15 years is a long time to pay off the debt. Under this deal, he won’t be able to take out money for himself or, more importantly, fund new technology he knows the agency needs to grow further.

Over the last five years, Joe III has watched the market consolidate in his town, with most of the local firms he once competed against partnering with large national players to compete against him. Amid the fierce competition, Joe’s Insurance Agency is not winning new business as often as Joe III would like. A major source of frustration is the fact that Joe III’s competitors are using RFPs to search for service providers instead of choosing a local person they like to work with. When the RFPs are sent out, Joe III knows he doesn’t have what it takes to compete.

Joe III feels stuck—sandwiched between a father who would prefer to perpetuate internally and a staff that is desperate for more resources to compete effectively.

This is the reality of many agencies in today’s environment. As a result, many families and partnerships are deciding the best way forward is through carefully selecting an acquiring agency that can provide both a high value for owners and a great pathway for growth for the next generation. This may be the best path for Joe III and for many in the next generation: selling the agency to a thoughtfully chosen partner that will allow you to maximize the value of your hard work and leave a legacy of wealth to your family.

Kate Bang is the vice president of corporate development at USI Insurance Services.