What’s selling hotter than real estate these days? Brokerages

Buyers are paying up to double-digit multiples for Canadian commercial lines property and casualty brokerages, while pricing for smaller retail brokerages has softened, a P&C industry consulting firm has observed.

“Some of the prices being paid for larger commercial brokerages have been surprising,” British Columbia-based Smythe Advisory said in its 2021 Property & Casualty Insurance Brokerage Report, released last week. “We have observed pricing as high as 14x earnings before interest, taxes, depreciation, and amortization (EBITDA).

“Ultimately, while a typical broker should not expect to receive a 14x EBITDA multiple, there is certainly an opportunity to get high multiples if the conditions are right and multiple parties are bidding,” the report said. Smythe Advisory added it “cannot say if this pricing is sustainable.”

A “well-balanced portfolio with a substantial commercial book” is one of the components identified by Smythe Advisory for successful brokerage sales ranging from eight to 14x EBITDA. In addition to this well-balanced portfolio with a substantial commercial book, brokerages that achieve the higher end of the range generally perform well in the following areas:

• Consistent growth in policy count and revenue
• Retention over 90%
• Total revenue over $5 million
• Good loss experience
• Operating profit greater than 30%
• Continuance of management
• Expense discipline

Strong competition exists — and higher prices are being paid — for commercial brokerages and specialty lines brokerages, the report’s 2020 M&A update section noted. Conversely, pricing and demand for smaller retail brokerages with revenue under $1 million has softened.

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“Three years ago, we were seeing smaller brokerages regularly selling for 4x revenue to national consolidators,” the report said. “Today, those same purchasers are passing on these opportunities for a couple of reasons.”

One reason is that smaller retail brokerages tend to have a mixed book of business focused on personal home and auto business rather than on commercial business. Also, acquiring a small brokerage “can be almost as much work” as buying a large entity; the time and effort to close a deal might not be worth the volume of business they are acquiring.

“That is not to say there isn’t still demand for smaller brokerages,” Smythe Advisory said. “They just need to be marketed differently and sellers need to be both creative and flexible when putting together deals.”

The consulting firm found that consolidators are accounting for most of the reported transactions. Most consolidators are either: 1) larger publicly-traded or private equity-backed brokerages, or 2) insurance underwriters.

Growing through M&A remains a popular strategy for expanding digital offerings. “Those brokerages with scalable online capabilities are being richly rewarded in prices being offered,” Smythe Advisory states.

In December 2020, Smythe Advisory surveyed 70 brokers and industry executives from across the country. The firm asked respondents for their views on the impact of digital insurance distribution, hard market conditions, the long-term impact of COVID-19, and brokerage management.

One question asked respondents if they thought the M&A market demand for brokerages, books of business, and MGAs would remain robust for the next two years.

About four in 10 respondents (42%) thought market demand would stay about the same. Nearly the same percentage (40%) thought it would be somewhat stronger. Fourteen per cent thought market demand would be much stronger, while just 3% predicted it would be somewhat weaker and 1% said much weaker.

“We would agree with the participants that the M&A activity will continue to be the main focus for brokerages that wish to obtain scale,” the report said.

Overall, demand for Canadian P&C brokerages continues to be strong, with private equity-funded brokerages leading the way, the report concluded. “In closing, we want to be clear that we are confident the brokerage distribution channel is strong and will continue to be so in the years to come.”

Feature image via iStock.com/FARBAI