Being bought by a private equity firm may be an attractive option for brokerages looking to sell, said veteran P&C industry advisor and consultant Mike Berris, a partner with Smythe Advisory.
“Their offering can be attractive in that they often do not require the brokerage to change its name, they leave most of the internal systems in place and they give the brokerage owner the opportunity to roll some equity into the PE fund with the expectation of a second payday,” Berris wrote in a recent blog post, 2020 M&A Trends in Canada’s P&C Insurance Industry.
PE-owned brokerages have been active in the marketplace for a number of years, Berris noted. They are aggressively competing with other buyers for a shrinking population of available brokerages as they execute their roll-up strategy.
A typical PE approach is to buy a business, improve management systems and then grow the bottom line through sales initiatives, bolt-on acquisitions and efficiency improvements, with the end goal of selling in four to seven years, Berris wrote. The increase in value comes from improving total earnings before interest, tax, depreciation and amortization (EBITDA) and increasing the scale of the operations.
PE firms active in the Canadian P&C space are all following the same playbook, with the exceptions of not requiring the broker to change its name, leaving most of the internal systems and place and giving the brokerage owner the opportunity to roll some equity into the PE fund with the expectation of a second payday.
“With a shorter investment horizon, it makes sense that the focus would not be on making longer-term investments in the brokerage,” said Berris. “The goal is squarely focused on increasing EBITDA and scale.”
This strategy requires that the PE firm buys at the right price. “There is a perception that PE firms pay the highest prices, which we think is incorrect,” Berris wrote. “PE firms are disciplined purchasers and their strategy depends on buying at the right price to ensure an appropriate return on exit.”
2020 M&A Trends in Canada’s P&C Insurance Industry included observations on three main issues that are having an impact on industry M&A based on divestiture processes Smythe Advisory has been engaged with, discussions with other industry advisors, brokers and underwriters recently involved in transactions. Besides private equity, the two other issues include online distribution and family and/or management buyouts.
Family transition and management buy-outs
The orderly transition of a brokerage to either family members or existing management is “one of the most exciting and growing areas of our practice,” Berris wrote. “One of the changes in the industry that has allowed more management transitions to take place is the increased availability of capital. As banks and other lenders have become more comfortable with the underlying value of an insurance book of business, they have been more open and are actively offering loans and other forms of financing to facilitate these deals.”
Brokers who use online distribution as part of their service offerings (and provide the consumer professional advice if needed) will be in the best position to both grow and protect the enterprise value of their businesses. Smythe Advisory said it has recently seen some “impressive online platforms that work well with a broker distribution model. But it’s still an open question as to how these online platforms will interface with insurers in a standardized manner.
“In closing, we would like to stress that there continues to be great opportunities for brokers in P&C insurance distribution. Yes, there are changes to distribution channels and how brokers transition to new owners, but the fundamental need for insurance products remains and the reliability of cash flow will continue to fuel demand for well-managed books of business.”