August 19, 2014 by Regan Reid
“There’s been a dramatic change in Canada, compared to the US,” says Larry Lineker, president of Canadian operations at Hub International. He’s talking about the mergers and acquisitions market in Canada. In the U.S., Hub’s main competition for purchasing brokerages is mostly other brokerages. But here, Hub’s up against the insurance companies.
“In Canada, the real difference is this development of insurance companies acquiring brokerages to protect and grow their distribution base,” he says. “It feels like Canada is moving to somewhat of a semi-direct marketplace, where an insurer acquires brokerages and through that model finds ways to drive—as much as possible—the premium dollars that are inside that brokerage into their underwriting platform.”
Though few insurance companies would admit to such a scheme, it’s no secret that they’re not just window-shopping, but looking to buy. It’s also a well-known fact that the cheap capital and friendly terms offered by these insurers have contributed to a steep hike in brokerage prices (it’s now common to see operations valued at seven times EBITDA). But Mike Berris, practice leader at insurance advisory and valuations firm Smythe Ratcliffe, says that this seller’s dream market may be shifting ever so slightly toward equilibrium. “[Buyers are] paying a price sometimes where they’re looking at nine or 10 years out before they get their money back on an after-tax basis. So they’re really being more careful now than they were before.”
So if you’re a brokerage looking to sell, what can you do to woo purchasers who are getting pickier? And when you’ve done everything you can to get the best price for your business, who do you decide to sell it to? We have the best advice for you from brokerage purchasers, evaluators and financiers.
How to Sell
The most important piece of the acquisition puzzle differs depending on whom you ask. But there are certain essential things all acquirers look for in a business and a few key things sellers can do to get the best price.
First things first: get your house in order. Buyers will pay the most money for brokerages that have prepared for a sale. “The easier the brokerage is to buy, the better the price is going to be,” says Berris. Before putting the business up for sale, he suggests you cut unnecessary expenses, focus on efficiencies, try to get labour costs below 50 percent of expenses and clean up the markets you deal with. “I look at the commission volume. I look at how much of this business is being placed directly, rather than through MGAs. I look at wage cost and revenue per employee, because that tells me about the efficiencies. That gives me a clue that the operation’s well run.”
Sue Loomer, managing director at Campbell Valuation Partners and a member of the board of directors of the Canadian Institute of Chartered Business Valuators, suggests you should also have your financial statements audited or reviewed by an accounting firm. “When a buyer’s looking at purchasing a business, one of the first things they’re going to look at is your financial statement, and if they’re audited or perhaps reviewed by an external accountant, that gives the buyer comfort that these are good numbers that they can rely on.” Investing in good broker management and information systems is also key. She says that due diligence is usually conducted by a buyer when they are acquiring. So if a buyer asks you to pull up information on revenues, historical profitability or the company’s top producers, being able to do this quickly and easily will only help your cause.
Next, ensure you have the right people in place. “Ultimately, in the insurance business, the assets are the people that work for the business,” says Hub’s Larry Lineker. “You want to make sure, if you’re acquiring a brokerage, that you’re acquiring one that has a leadership team that’s solid, has an understanding of how to grow a business, has a desire to continue to be in the business, and has [people] that are engaged.” Are you willing to stick around for a period of time to ease the business transition? Do you have an effective management team in place? Do you have strong non-competition and non-solicitation agreements with your current producers and employees? These things will be critical to the success of the acquisition.
Of course, an efficient brokerage and a solid team mean nothing if your business isn’t profitable. Generally speaking, the higher the profit of the brokerage, the higher the value. “The good purchasers, they’re looking at the number of policies, the average premium per policy, the average premium and commission per customer,” says Mike Berris. “So they want volume. Sales volume is king.”
He’s seen some brokerages go on big marketing kicks before selling their operations in an attempt to bring in more business, and therefore up the value of their businesses. “They’ll sometimes bring in [another] producer, and it tends to pay off in terms of a sale price. Perhaps it shouldn’t, but it does tend to pay off.”
Sue Loomer does caution, however, that purchasers aren’t looking for a brokerage on a hot streak; they’re looking for consistent profitability. “They don’t want a one-trick pony that had one good year last year, but then all the other years were inconsistent or had poor performance. They want to see a good trend of profitability in the past as an indicator of what to expect in the future.”
These things will help all sellers get a better price for their business. But the fact is that some brokerages are in higher demand than others. “The businesses that do best find a way to specialize in areas where they actually have a defined value differentiation compared to that of their competitors,” says Lineker. “There’s something that they do better, that they understand more of, they have some sort of specialty or expertise in.”
If you have a specialist brokerage, it’s of more value than a generalist one because— the rationale goes—you’re likely to have less competition, it’s expected that you can handle more volume, and so you’re more profitable. Commercial brokerages are also more likely to fetch a higher price. “Commercial brokerages are in very, very high demand because a) it’s hard to develop a commercial book, and b) the premiums and profit per customer should be higher,” says Berris.
Some areas of the country, too, can be easier or more attractive to purchase in than others. Berris uses British Columbia as an example of how different the markets are between provinces. There are a limited number of Autoplan appointments (licenses required to sell auto insurance in the province) available, and they sell for between $900,000 and $1 million— creating a significant barrier to entry for smaller players. Additionally, provinces with good economic growth are understandably more attractive markets than their sluggish counterparts. Alberta, of course, remains a primary market for many acquirers. Lineker says that, given the size of its population, Ontario is another attractive market to his company. “With our scale and capabilities, we would like to be larger in Ontario. Ontario today, for us, is not as large as our BC operations and yet Ontario’s population base is dramatically larger.”
Enter the Buyer
You’ve shaped things up, you’ve made your business attractive… But you don’t want to be wooed by just anyone. You have to decide who to sell to. Insurance companies and large brokerages, though not the only buyers, are two of the major players in the M&A space—and surprisingly, both have a similar take on the value they offer to independent brokers.
For Hub’s Larry Lineker, if you’re looking to sell your brokerage but want it to remain a “brokerage,” there’s really only one option. An insurance company has a distinct advantage, because “they’re able to not only acquire the business based on its financial performance, but they’re also able to think about how much business they can direct from that brokerage into their own underwriting platform. They kind of get two bites of the apple. I think that’s an inherent conflict as a brokerage, as it may sometimes require you to act more as an agent for the carrier than a broker for the buyer of the insurance.”
Lineker says a brokerage principal should ask himself: What is it that I want my business to look like? Do I want to be an insurance broker that truly represents all of the markets? “If they do, I think we’re a perfect option for them.”
Though there are insurance companies (that shall remain nameless) that purchase brokerages outright, others provide loans or investment to help a broker purchase another business. Aviva Canada, for example, provides minority equity investments. “We generally look to invest 19 percent equity in a brokerage,” says Krista Franklin, vice-president and director of corporate development and broker investments, at Aviva Canada. “So we are not taking control, we are not directing the day-to-day business of the broker the way some other insurers are doing when they make majority investments. By allowing the brokers to have an alternative to that, and making that very clear to them, they can weigh their options. They don’t necessarily feel like they have to go out and sell to one of these other insurers.”
Franklin says the purpose behind these investments is to help sustain the independent broker channel. In return for the investment, an Aviva representative will sit on the board of the brokerage as an observer. “What we’re really trying to do… is to provide value to the broker.”
SGI Canada also provides financing and support to brokers looking to buy—and the company is not shy about discussing its motivations. “We have threats coming from direct writers and different distribution models, and this is a way that we can help our brokers and [SGI Canada] protect the business that they have,” says Morgan Boyle, manager of national business development at SGI Canada. Boyle is adamant that when a brokerage obtains financing from SGI Canada there are no strings attached—or, at least, relatively few. “We don’t have a first right of refusal on the terms of the loan. We don’t have specific premium targets that they have to hit. That being said, we’re providing a financing option to a broker, so we do look for there to be a strategic alignment. We do look for there to be support, but it is not written into a contract that you have to give us X amount. We don’t believe that’s the way to do it.”
Copyright 2014 Rogers Publishing Ltd. This article first appeared in the June 2014 edition of Canadian Insurance Top Broker magazine.
This story was originally published by Canadian Insurance Top Broker.