Is Private Equity Investment in Insurance Agencies Always a Good Thing?

It takes a lot of capital for an insurance agency to grow, acquire, merge or partner with another agency, and increasingly, private equity firms are stepping up to the plate to supply that funding.

Although the number of reported mergers and acquisitions in the insurance distribution system in the U.S. and Canada fell slightly last year — from 456 in 2015 to 449 in 2016 — both years represent an increase from 2014 when 359 agency/brokerage M&As were reported, according to Chicago-based Optis Partners, which specializes in investment banking and financial services.

A report issued in January by Optis Partners, its “December 2016 Agent/Broker Merger & Acquisition Update,” shows that more than half of the transactions in both 2015 and 2016 involved private equity investment. The report covers only agent/broker M&As that were publicly reported and recognizes that not all such transactions are reported.

This widespread investment activity by PE firms has driven up both demand for agency acquisitions and the amount being paid for them. Whether or not that’s a good thing depends on whom you ask.

“Recently private equity firms have driven the demand in the marketplace, which has had a positive effect on the multiples in the industry. Their involvement has contributed to the increase in the average multiple paid on deals over the last five years,” said Phil Trem, senior vice president at the Ohio-based consulting firm, MarshBerry.

However, the higher multiples, which may run as high as three times revenue, can make it tough for agencies to compete if they are looking to expand through acquisitions and don’t opt for the private equity route, said Chris Burand, principal at Burand & Associates in Pueblo, Colo., and a faculty member of the Academy of Insurance, an Insurance Journal affiliate.

“The amount that private equity is paying is so much higher than what a regular agency can cash flow if they were to buy an agency that it’s created a very disparate marketplace. And that’s really an issue in the industry on many levels,” Burand said.

“Let’s say the agency down the street wants to do a merger with a friendly competitor. They cannot cash flow three times, so a dilemma is created there. Does somebody sell to private equity for three times or do they keep things friendly and local, and take care of all their employees and clients, but for a much, much lower price tag?”

MarshBerry’s Trem also acknowledged the competitive stress that PE investment has placed on independent agencies.

“Agencies are in a very tough spot right now. They cannot compete on price in the M&A environment and they are in the midst of a softening property and casualty rate environment,” he said.

Still, private equity firms bring a lot to the table.

“Some of the equity players really do invest quality money in agencies that they buy in the sense that they invest in IT and they invest in high quality people and they invest in higher quality of services to the clients,” Burand said.

The model works especially well for agencies seeking to expand through acquisitions or consolidation.

Grand Rapids, Mich.-based Acrisure is one such company that has benefited from PE-backed funding. Genstar Capital acquired the firm in 2013 and worked with Acrisure’s management to expand the agency’s geographic footprint, along with its product and service offerings. Announcing a management-led buyout of the company from Genstar last year, Acrisure reported that under Genstar’s ownership, it acquired more than 138 retail insurance brokerages and generated industry-leading organic growth.

Confie Seguros, a large, national personal lines and commercial insurance broker based in Huntington Beach, Calif., has worked with two private equity partners since its inception in 2008 and has completed more than 120 acquisitions so far. Co-Founder and Chairman Mordy Rothberg said Confie currently is partnering with Abry Partners in Boston, and has set the goal of completing 35 more acquisitions in 2017.

“When a company is looking to raise capital there are various different forms of capital and the reason why we prefer private equity over going public, as an example, is that when you partner with private equity, instead of managing the business quarter to quarter they have a longer term approach to the business,” Rothberg said.

Typically, private equity investors are not interested in operationally managing the business. Instead they partner with the agency’s senior management to add value, he said. “With the right partner, the private equity model works really well.”

Ryan Clark, president and managing director of the private equity firm, San Francisco-based Genstar Capital, said the insurance distribution sector is attractive to private equity investors for a couple of reasons.

Insurance agencies and brokerages “are fundamentally good businesses. By that, I mean they have high levels of recurring revenue. They have strong profitability and good cash flow characteristics. The credit markets like insurance brokerages as well, so there is ample debt available for growth.”

Another thing that makes the market attractive is that it’s so fragmented.

“Private equity firms seek out fragmented markets where there are consolidators,” he said. “With our capital and with a strong management team we can act as one of the consolidators or aggregators in the marketplace to build a market-leading business.”

Private equity builds the financial relationships and capital structures that allow the firms in which they invest to make acquisitions they might not otherwise do if the money were to come out of the owners’ pockets, Clark said.

While PE investment in insurance distribution channels can result in a great outcome for many agency owners who want to grow their firm quickly or just cash out, it’s not appropriate in all cases, some say.

Private equity “has its place but it’s certainly not for everybody,” said David Macknin, president and CEO of the Chicago-based brokerage Alper Services.

“It makes sense in a lot of situations … those being if the agency principals are looking to generate the highest return on the investment they made in the business regardless if they’re a founder or a PE buyer who’s now a seller, or a consolidator who’s now a seller. If the motivation is maximizing return for whomever, the PE play makes perfect sense,” Macknin said.

It works well for agencies like Confie Seguros that want to grow through consolidation, Rothberg said. But “an agency that’s doing two to three million dollars of EBITDA (earnings before interest, tax, depreciation and amortization), that might not be somebody that wants to start a private equity backed company,” he added.

Macknin said there are agency operators, and he counts Alper Services’ management as one of them, who have no interest “in having outside money impact how we conduct our business.”

He said an agency that seeks to grow without using private equity dollars should “should look at the medium and long term, not just at the short and medium term. One needs to have a focused strategy for your growth, and then explain it and live it.”

A profitable agency would presumably have retained earnings that could be “clearly deployed and reinvested” into the agency and the existing personnel, and to bring in new people, he said.

When it comes to mergers and acquisitions between agencies, “I would say you absolutely need to have a strategic plan as to what you’re trying to do, who you’re trying to bring in. The characteristic that I believe should drive it is culture. Culture, culture, culture. … It cannot be overstated. … It’s got to be something you live. Your culture should be defining you, how you carry yourself as an individual as part of a firm,” Macknin said.

For Burand, it’s not clear that private equity is the solution for achieving organic growth.

“In the majority of cases that I’ve seen I don’t think private equity achieves organic growth,” he said. “If an agency wants to achieve organic growth it has to invest in a growth strategy. There’s a number of those out there. But they involve hiring quality people that can make sales and making those people accountable for that. That’s the real key. You’ve got to invest in people that can actually get out there and make sales. And hold them accountable for doing so.”

Both Macknin and Burand advocate internal perpetuation plans for agencies that want to grow organically.

“If they plan it out, if they use foresight, the owners can still make a lot of money upon retirement. And they can do so with the knowledge that their people and their clients and their legacy will live on,” Burand said.

However, it takes a considerable amount of planning — operationally and strategically — to make it happen. “What I see occur way to often is that planning doesn’t happen until it’s way too late,” Burand said.

Likewise, MarshBerry’s Trem said agencies should relentlessly focus on “predictable, profitable, organic growth.” That strategy will not only enhance the firm’s valuation, it will “position them to have a choice for their long-term perpetuation.”