Friends With Benefits
There’s a lot of new cash flowing into the brokerage business these days, and a lot of it traces back to the big-money world of private equity. From Blackstone to Morgan Stanley to Goldman Sachs, some of the biggest names in business have been placing bets on the brokerage industry in recent years.
With the economy perking up, they’re helping to fuel a wave of consolidation, launching new brokerages and helping big players to grow bigger.
Today, three of the nation’s 12 largest brokerage firms—Hub International, USI and Alliant—are backed by private equity. A flock of second-tier firms is tapping streams of private capital to expand their turf. And in March, Chicago-based private equity firm GTCR launched its own platform agency, putting $250 million behind a pair of former Brown & Brown executives to start buying smaller firms and build a company.
Private equity has long been a player in the brokerage business, says Brian Deitz, a partner at Reagan Consulting in Atlanta, but lately it’s become a much more active one.
“They’ve probably quadrupled their activity over the last four or five years,” Deitz says. And this raises some interesting questions. What does it mean when you put up a “For Sale” sign and private equity comes calling? What does it mean to go into business with them? What do they mean for the industry?
From private equity’s perspective, the appeal of a brokerage is pretty straightforward. It represents a safe, low-cost investment with steady cash flow—all those commissions and renewals rolling in—and low overhead.
“You can make a lot of margin with not a lot of capital,” Deitz says. “You don’t need a warehouse. You don’t need mountains of inventory. You don’t need some massive R&D expense.”
Scale helps. Rolling up a few firms and centralizing their back offices can boost margins. It’ll boost leverage with providers, too, helping you get better rates. Then there’s market timing. Premiums have been falling for years, but if that ever changes—and a growing number of experts think it soon will—the value of brokerages will climb fast. That’s pulling even more investors into the business.
“The future looks promising compared to where it’s been,” says Leader’s Edge contributor Rob Lieblein, a partner at Dowling Hales in Harrisburg, Penn. “There’s a lot of opportunity.”
There’s also a lot to think about for people who are looking to sell.
Traditionally, agency owners have had two options: A bank or a bigger brokerage, some publicly traded, some privately held. Either way, they’re in the insurance business.
Now the market includes investment bankers—or bigger firms already owned by investment bankers. They’re a slightly different animal: more Wall Street than Main Street, though they typically use teams of brokerage veterans to run their new assets. Their aim is clear.
“Good, bad or indifferent, they only have one goal, and that’s to make money,” says John Wepler, president of MarshBerry in Willoughby, Ohio. “Their highest priority is driving a return to their investors.”
That means they run lean, and they make sure their new acquisitions do, too. They’ll wring out extra costs and look for room to grow, says Jack Windolf, chief executive of Bollinger Insurance Services in Short Hills, N.J., which sold a 51% stake to Evercore Capital Partners in 2008. But they’ll likely leave you in place to manage it.
Evercore, Windolf says, “doesn’t want to run the insurance agency. They want us to run it.” But, he adds, there can be changes. “If you’re not well organized on the accounting and administrative side and you have a private equity partner come in, that’s definitely going to change,” he says.
That’s probably true of most acquiring companies, Windolf says. Everyone wants to make the most of their new acquisitions. The biggest difference with private equity firms is that they don’t plan to own you forever.
“They buy firms with the intention of selling them,” Deitz says. “You can’t escape that. That’s how private equity makes money. They buy firms, run them and sell them.”
For sellers, he says, that presents an intriguing opportunity: a second bite at the apple. Unlike other buyers, private equity firms will often take less than a 100% stake in their acquisitions, leaving the original owners with, say, a 30% share after the deal. If things go well and the firm grows in value, that 30% can be worth a lot more than it was when private equity entered the picture. When the agency gets flipped again, the original owner can cash out too.
“You’re going to have to be willing to share some control,” Deitz says. “But if you go along, you’re going to share in that payday.”
Still, like any ownership model, private equity can have its downsides. Some warn that a partner with a short time-horizon and purely economic interests can be less concerned with customer service or talent development than companies that are in it for the long haul.
Misunderstandings can crop up, too, if there are different visions of life after the deal. If an owner thinks his new partners will fuel a string of acquisitions but the capital isn’t there, conflict can arise. Conversely, someone might expect a cushy, quiet gig after they sell, only to find the new bosses want growth.
“Most private equity firms want a really aggressive, active owner,” Wepler says. “Sometimes when people sell their business, they’ve got one foot in retirement. Then the private equity firm says, ‘We need the best leadership we can get,’ and they’re out.”
But for the most part, observers say, selling to a big equity-backed firm isn’t much different than selling to any other big operation, be it private, publicly traded or a bank. After years of running the ship yourself, there’s a new hand on the tiller. And that can take some getting used to.
“It’s tough to transition a true entrepreneur from being a leader to being an employee,” says Kevin Donoghue, managing director of Mystic Capital Advisors Group in New York. “But people find a way to make it work. They’re monetizing their assets, so they’ve got something to work for.”
One person making that transition is Peter Davis. A principal at Davis & Graeber Insurance Services in Redlands, Calif., Davis sold his firm to Hub at the end of 2010. He’d had some lingering concerns about succession at his family-owned firm, and about generating enough volume and growth at the $4 million-a-year agency to keep insurers satisfied.
“We just saw Hub as a really good fit to meet those concerns,” Davis says. The buyer’s ownership structure didn’t much concern him. Aside from a few to-be-expected hiccups, like switching health insurance plans, the first few months have been pretty seamless.
“It’s been very much, ‘Do what you do,’” Davis says. “The only shift is that, in running your own shop, you can have the ultimate say with personnel. You can be as flexible as you want. That’s not to say Hub’s not flexible; it’s just a little different.”
For most of its 13-year history, Hub has grown through acquisitions. Lately it’s been on a tear, closing 10 deals in the fourth quarter of 2010 and 19 so far in 2011. The company has been publicly traded and backed by private equity, but the philosophy hasn’t changed, says Hub chief executive Martin Hughes. When the company went private in 2007—purchased by Apax Partners and Morgan Stanley for $1.8 billion—most of the management team stayed in place. That’s important, Hughes says.
“We’re not sitting here in some ivory tower in Chicago telling people what to do without completely understanding what it means to do it,” he says. “We were all producers at one point.”
That not only helps the integration process, it can also ease the minds of potential sellers worried about private-equity ownership. Hub can point to a long list of successful deals. Still, Hughes acknowledges, that concern comes up.
BOTTOM LINE MANAGEMENT
“One of the things we’ve had to deal with from time to time is that private equity has some kind of a reputation, and it’s not always the most alluring reputation,” he says. “Some people fear they’re going to come in and change management, take a meat axe to the place, and then sell it. That clearly has not been the case with us.”
If anything, says Windolf, a bottom-line-oriented firm can thrive with private-equity investment. When Evercore came in, he says, they gave Bollinger more resources to keep growing. The private capital bought out Bollinger’s employee stock ownership plan, taking a big unfunded liability off the table. That freed up room for new credit facilities, which helped finance more expansion.
“Since Evercore came in, we’ve done 10 acquisitions,” Windolf says. “That’s worked out very nicely. We would not have been able to do those without them.”
In a few cases, private equity investors are building firms from scratch. In March, GTCR became an instant player when it announced plans to put $250 million behind Jim Henderson and Tom Riley to buy firms for a new brokerage. The new firm, Assured Agencies, is out shopping now, says Henderson. He hopes it will make its first acquisition this year, and it sees a lot of opportunity.
“There is a pent-up demand out there because of the economy,” he says. “Sellers probably had some interest in the last three or four years, but earnings were unstable. Today it’s a more stable economy.”
Assured’s plan, Henderson says, is to build up a solid group of brokerages, boost their performance, and perhaps go public in eight or 10 years. That’s a fairly long time frame for private equity, Henderson says, but it reflects a long-term faith in the business.
All this investment, Deitz says, speaks to an underlying optimism in the future of the brokerage industry. Private capital, after all, can go wherever it pleases. Real estate. Energy. Tech companies. A good chunk of private capital obviously sees value in insurance brokerages.
“You’ve got a bunch of people whose job it is to invest money for a living,” Deitz says. “Increasingly, they’re investing it in our space. That’s great.”
In particular, it’s good for potential sellers. Private equity gives them another option, a whole cohort of potential buyers beyond the traditional big brokerages and banks. That can drive up competition, and prices.
Still, few expect this private-equity surge to last forever.
For one thing, the two biggest private equity-backed firms, Hub and USI, are nearing the end of their private run. They’re widely expected to go back into the public markets within a couple of years, a prospect that Hughes says “is being discussed internally.” That alone will tilt the merger tables away from private equity. Smaller players, too, are likely to join forces so they can go public or sell to a bigger firm and cash out their investments.
“I think you’re going to see a lot of the names and faces with private equity-funded firms change over the next two or three years,” Wepler says.
And the fundamentals that make right now an especially attractive time to buy—low valuations coupled with the hope of a hardening market—will eventually play out. As firm values rise, the big names like Blackstone and Goldman will sell and take their profits elsewhere. As public brokerages see their stock prices rise, they’ll have more cash to work with. Some new source of funding will emerge to fuel deals, and it will ripple out through the industry as private equity has been doing.
“All you know,” says Hughes, “is that you’re going to have change.”.