From Zero to 200 in 5
Len Kline and his business partners, the private equity firms Parthenon Capital and Century Capital Management, had an ambitious goal when they created Kansas City, Mo.-based Ascension Insurance Inc. in late 2007. They would grow Ascension from zero revenue to $200 million in five years by acquiring select agencies in dynamic areas of the country.
Kline, the company’s president and CEO, readily admits that the drastic economic downturn that occurred after Ascension made its first acquisition in January 2008 has added unexpected challenges in reaching that goal. But so far the company is on track. Its tenth agency acquisition in July 2009 — 18 months or about one-third of the way into the projected timeline — brought the company’s revenues up to $70 million, or approximately one-third of the way to the monetary goal.
Kline, who is a third-generation insurance broker, hails from Kansas City. His family sold its Kansas City-based agency in the ’70s to the Marsh & McLennan operation there and Kline ran the Marsh office for a number of years. He subsequently left Marsh and moved to Houston to start up the Compass Insurance division of Compass Bank. He led Compass Insurance for about four years, during which time it grew from a zero to $70 million operation.
At that point, Kline figured Compass was unlikely to “grow much past that size because of the limitations that we had relative to the bank footprint,” and was eager to apply what he’d learned at Compass in building his own insurance operation. “I was lucky enough to run into some people from Parthenon and Century Capital who wanted to do kind of the same thing I wanted to do, which was build an agency through acquisitions that does not have a limiting geography or footprint,” Kline explained.
Ascension was created to bring together premier middle market insurance agency operations from around the country. The company acquired four agencies in 2008 and purchased six more in 2009. Kline says they are currently looking at four other agencies.
He said he and his partners don’t limit themselves to specifics when they are looking at potential agencies to acquire. “We’re looking for agencies that have management that do not want to go away after the purchase,” he said. “That want to continue to grow out of the footprint or the market that they are in, using our capital and our expertise. And we would like them to have some type of a specialty business if that’s possible. Because we find that business in many, many cases is more profitable and has better retention. …
“And we’d like them to be in dynamic areas — areas that grow faster than the national average and who have other opportunities for us to consolidate.”
He added that for a hub operation they look at agencies that have somewhere between $7 million and $40 million in revenue. Many of their acquisitions so far have been in California and the Southeast, and Kline says they will continue to look in those markets.
“We’re also going to be looking in the Texas market. I think Texas is a great market and I think Arizona is a great market. We presently have a small operation in Yuma, but it would be great to have something in Phoenix. And Texas is a very exciting market. There’s a lot of opportunity there,” he said.
A Change in Agency Valuations
Economic hurdles during the past two years have slowed down consolidations somewhat, but Kline believes the rate of mergers and acquisitions in the insurance industry will increase in 2010. One thing that has changed during the past couple of years, Kline said, are the expectations of agency owners who are interested in selling their businesses.
“Until about a year ago a lot of the owners were under the perception that they could still get seven to eight times earnings, or EBITDA (earnings before interest, taxes, depreciation and amortization),” Kline said. “That perception is now down closer to five to seven. And most of them now understand that the market has moved.
“Now that the big banks have stepped out of the picture from an acquisition standpoint, compounded by the fact that most of the large consolidators, like a Gallagher, or a Hub or a Brown & Brown, have really slowed down their acquisitions, the supply has outpaced the demand. And so those multiples have come down and most of the owners now understand that,” he said.
“There’s a perception that if they want to get a larger multiple they either have to perform very well on their earn-out or they have to perhaps wait for quite a long time,” Kline added. “I don’t think those multiples are moving up in the very near future. And I think in 2010 … again, that supply will outpace demand.”
One reason for that, he explained, is that agency owners may have concerns about taxes on capital gains, “which will probably change January 1st of 2011.”
No Fixer Uppers
Kline said most of Ascension’s purchase agreements are structured with an up front cash amount and an earn-out component based on a pre-determined performance matrix. Ascension, he said, makes it clear to agency owners that “we’re going to help them grow their operation. We’re going to expect certain degrees of responsibility and cooperation. We want them to be part of a larger operation and contribute to building the operation, and to share expertise with other owners.”
While Kline and his partners bring a lot of capital to the table to help agency owners grow their operations, the culture of the company is driven by the agencies that join it.
“When someone joins us we pretty much allow those owners to run their operations pretty much how they did in the past. And that’s a huge plus for people.”
Plus, he added, “We do not buy fixer uppers. We [look for] operations that were running successfully when they joined Ascension.”
A Stable Agency Pool
While Kline believes mergers and acquisitions will continue to occur at a steady pace and that 2010 may see an increase in the rate of M&As, that doesn’t necessarily mean the number of independent insurance agencies in existence will diminish.
“There are about 40,000 insurance agencies in this country,” he noted, “and there have been around 40,000 insurance agencies for the last 10 years.”
Despite the high rate of consolidation that occurs each year, there also is a lot of annual “re-birthing of the business,” Kline said, with people continually leaving larger firms and starting their own operations.
“It’s really quite amazing. And if you think about our business, our business is not very capital intensive. It doesn’t take much capital to start an insurance agency. It effectively requires a little space, some computers and a little payroll. And that’s all,” he said.
It doesn’t take a huge amount of capital to get going and “a good producer with a good book of business could just as easily work out of his house as work out of somebody’s office,” Kline explained. So a producer that starts his or her own agency this year could have a two, three or four million dollar agency in five years — which is the kind of agency Ascension seeks.
“Over the last 10 years, until 2009, there’s been pretty stable M&A activity — somewhere between 200 to 225 agencies, year in and year out,” Kline said. “And those are the larger agencies that are recorded, maybe not the smaller ones. So if you figure you only have 250 agencies that are merged every year, there’s a lot still out there. And all those are growing, hopefully.”
Keeping a lid on non-essential expenses, having a strong sales culture and showing year-over-year growth are a must for agencies that would like to enhance their attractiveness to a potential buyer. With the current economic and rate pressures those standards are difficult maintain but doable, Kline said.
Agencies that have good retention and a good sales culture are probably doing pretty well. After all, insurance is “not going out of style,” it’s a product that people have to buy, he said.
Best Agencies, Best Markets
Although Ascension is still on track with its goals for growth, Kline acknowledged that the slow economy and soft market have put pressure on the company to operate as efficently and effectively as possible.
“It’s more important now than before, although it was part of our plan before, that we go out and buy the best agencies in the best markets. And not do what some other people have done that have gotten themselves into trouble, and that’s just to go out and buy assets wherever you can buy assets. We’re really making sure that we keep our focus on what our original plan was.”
The company remains very selective with its acquisitions. “We see two or three deals a week,” Kline said. “We turn a lot of them away. Because they’re not in the right market. They’re not of the right size. They don’t have a management team that wants to stay around and help work with us. Or the dynamics just aren’t right.”
The key, he said, is to keep focused and to make sure that the businesses you purchase have all the qualities you identified as being essential for contributing to long-term growth.