A buyer reading a seller's financials is looking for the gap between what's claimed and what's true. The seller isn't usually committing fraud — they're presenting an optimistic picture, leaving out the inconvenient, and stating retention numbers no one has checked. Seven patterns reliably surface the gap, and learning to spot them turns a stack of statements into a risk map. The most important of the seven is the one that catches the others.
§ 01 · The seven patternsWhat to look for.
| Pattern | What it signals |
|---|---|
| Revenue up, customers flat | Growth coasting on hard-market rate, not new business |
| Retained earnings ≠ profits | Reported profit the balance sheet doesn't support |
| Expense ratios off-benchmark | Routed costs, missing expenses, or hidden liabilities |
| Retention claimed, not shown | An over-stated number with no data behind it |
| Producer / carrier concentration | Revenue dependent on one person or one carrier |
| Triangulation failure | Revenue that won't reconcile across three sources |
The seven run from the obvious to the subtle. Revenue growth without customer growth — more than ~5% annual revenue-per-policy growth with no matching new-business production — means the book is coasting on hard-market rate increases, not organic performance, and the multiple should reflect that fragility. Retained earnings that don't match cumulative profits beyond a 15% tolerance demands documentation, or the normalized number gets reduced to what the balance sheet supports. Expense ratios outside benchmark — a total ratio materially below the normal 55%–70% — signal costs that aren't on the books. The remaining four are retention claims without data, producer dependency, carrier concentration, and the triangulation test, each covered below.
§ 02 · The triangulation testThe verification backstop.
The triangulation test is the backstop behind every other flag: revenue must reconcile within 3% across three independent sources — the management-system production reports, the carrier production reports, and twelve months of bank statements. A variance above 3% requires line-by-line reconciliation. And a seller's refusal to share carrier reports or bank statements isn't a red flag to price around — it's a stop sign.
Triangulation is what converts a seller's claimed revenue into verified revenue. Three sources that should agree — what the management system records, what the carriers report paying, and what actually hit the bank — are cross-checked, and a variance over 3% means something doesn't add up and needs reconciling line by line before the number can be trusted. The distinction between a red flag and a stop sign matters here: a 5% variance is a flag to investigate and price; a refusal to provide the source documents at all is a refusal to be verified, which is a reason to walk, not negotiate. Triangulation is the same evidentiary discipline behind a proper quality-of-earnings review.
§ 03 · The concentration flagsOne person, one carrier.
Two concentration flags decide how much of the revenue actually survives the sale. Producer concentration is the people risk: top-3 producers generating more than 40% of revenue is a danger threshold, and an owner personally producing more than 40% means the book shrinks materially when they leave. Worse, any producer above 10% of revenue without an enforceable non-compete or non-solicit is a "free agent" — they legally own those relationships and can walk with them, so that revenue is modeled as at-risk. Carrier concentration is the supply risk: 40% of commission from a single carrier is the danger threshold, but severity depends on context — a long-tenured, low-loss-ratio, fully-appointed carrier at 40% is manageable, while a short-tenured, high-loss, limited-appointment carrier at even 18% is the real exposure. The deeper read on concentration is in revenue concentration risk.
§ 04 · Retention and the cluster ruleOne flag prices, four flags walk.
The retention flag is the highest-friction one because sellers chronically over-state it. The rule of thumb: a retention rate verified by management-system data above 92% earns a premium multiple; below 85% takes a material discount; and a retention claim with no management-system report behind it gets the claimed rate discounted by at least 5 points until diligence verifies it — the verified number is the only number that counts. Beyond the individual flags, the most important discipline is reading them together. One flag is a negotiation data point — it adjusts the price. But four flags clustering — say, off-benchmark expenses, unverified retention, producer dependency, and a triangulation gap all at once — is a systemic-problem signal that shifts the question from "what's the right price?" to "is this deal worth pursuing at all?" A data-backed price reduction during diligence is an ethical retrade, not a tactic; a cluster of unresolved flags is a reason to pass. How these flags feed the multiple is covered in risk-adjusted multiples.
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Terminology on this shelf
- Seven red-flag patterns
- Revenue/customer mismatch, retained-earnings gap, off-benchmark expenses, unverified retention, producer dependency, carrier concentration, triangulation failure.
- Triangulation test
- Revenue reconciled within 3% across management-system reports, carrier reports, and bank statements.
- Free-agent risk
- A producer above 10% of revenue with no enforceable non-compete — their revenue is modeled at-risk.
- Carrier concentration
- 40% of commission from one carrier — severity modulated by tenure, loss ratio, and appointment status.
- Retention discount
- An unverified retention claim discounted at least 5 points until management-system data confirms it.
- Ethical retrade
- A data-backed price reduction justified by diligence findings — not a predatory tactic.