Pro-forma modeling — building a number you can defend.

The number a seller hands a buyer is built to look as large as possible — owner perks run through the business, family on the payroll, one-time costs left in or taken out as convenient. Normalization is the discipline of rebuilding that figure into one that reflects what the agency will actually earn under new ownership. It's the foundation everything else rests on: the multiple gets applied to Adjusted EBITDA, so an inflated or sloppy normalization corrupts the entire valuation. Three categories of add-back do the rebuilding.

§ 01 · The three add-back categoriesWhat gets added back, and why.

Each category answers the same question — will this expense continue under the new owner? — and adds back the ones that won't. Compensation adjustments are usually the biggest: the owner's above-market draw, family members on payroll who don't work in the business, and producer commissions that need aligning to the buyer's splits. Discretionary and lifestyle expenses are the owner's personal costs run through the agency — vehicles, travel and entertainment, club dues, professional services, and related-party rent (which adjusts both directions, to fair market). Non-recurring items are genuinely one-time costs: the deal's own advisory fees, a past lawsuit, a major system migration. Added back together, they lift a modest reported profit meaningfully — a book showing $100K of net profit can normalize to roughly $128K of Adjusted EBITDA once the owner-specific and one-time costs come out.

§ 02 · Owner replacement costThe single largest add-back.

Owner replacement is where the most value is recovered and the most discipline is required. The logic is sound: a buyer won't pay the old owner's inflated draw, so the agency's true earnings should reflect a market-rate manager in that seat. But the add-back is only honest if the replacement salary is real — if the owner is also the top producer generating 40% of revenue, replacing them at a manager's salary understates what it actually takes to keep the book, and the add-back is fiction. The disciplined buyer sizes owner replacement against the owner's real functions, not just their title, which is the same forensic rebuild covered in normalized EBITDA.

§ 03 · The benchmark reality-checkDoes the pro-forma hold up?

A normalized number is only credible if it survives a comparison to how agencies of that size actually perform. Industry growth-profit-stability benchmarks give the bands: total compensation typically runs 55%–65% of revenue (higher for smaller agencies), administrative expense 15%–25% with rent alone 3%–6%, and pre-tax margin climbing from 8%–12% under $500K to 18%–25% above $3M. A pro-forma projecting margins above those bands needs documented justification — otherwise it's optimism, not analysis. Revenue per employee is another quick check: below roughly $150K signals overstaffing relative to peers, which is an integration opportunity rather than a red flag. And any revenue-synergy projection deserves a 5%–15% first-year client-attrition haircut, because some clients leave when ownership changes no matter how clean the transition. The benchmark check is what keeps a pro-forma from becoming a wish list.

§ 04 · Modeling the upside honestlySynergies and the shadow view.

The disciplined pro-forma also models the deal's real upside without overstating it. Two synergies recur in agency deals: converting brokered business to a direct carrier appointment lifts commission roughly five percentage points (a 10% wholesaler rate becoming a 15% direct rate is a 50% increase on that block), and aggregating premium volume across the combined book can reach a higher carrier profit-sharing tier — though that upside evaporates if the merged book's weighted loss ratio climbs above 60%, which can forfeit profit-sharing entirely and sometimes justifies ring-fencing the target's codes until the ratio improves. When an earnout is involved, a separate "shadow" view of the post-close P&L protects the seller's organic performance from the buyer's allocated overhead — and a fair convention caps that allocation around 3% of revenue rather than the 10%–15% a buyer might otherwise assign. Modeled this way, the pro-forma shows both what the agency earns today and what it can earn combined — honestly enough to defend. How that valuation translates into an offer range is covered in the initial valuation.

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