Many agency owners see two options for the future of their business: sell for the highest price or stay independent … [T]here are other capital restructuring options to consider.
AGENCY FINANCIAL MANAGEMENT
Looking beyond the usual methods
can result in a successful restructuring of capital
By Paul J. Di Stefano, CPA, CPCU
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Many agency owners see two options for the future of their business: sell for the highest price or stay independent … [T]here are other capital restructuring options to consider.
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When it comes to agency ownership, many think of it simply as a black and white issue. Many agency owners see two options for the future of their business: sell for the highest price or stay independent. In many cases, merging is unfortunately discounted once the question of control rears its ugly head. However, Harbor Capital’s experience clearly indicates that there are other capital restructuring options to consider. Deciding on the specific option becomes a function of the goals of the various agency shareholders.
In situations where there are multiple agency shareholders with one controlling shareholder, a sale of the agency may be one of the first options considered. While in many cases minority shareholders may express a desire to buy out the shares of a retiring principal, our experience is that, in the final analysis, most of these shareholders participate in the sale. Although, a sale may not be a bad option, all of the partners should evaluate all of the available options. There may be alternatives that will prove to be much more attractive for those minority shareholders than simply attempting to buy out the principal shareholder. Those options typically can revolve around both strategic and financial investors.
Strategic investors
An example of this can be seen in a transaction recently handled by Harbor Capital. In this case, the principal shareholder expressed a desire to retire and offered his equity to his much younger minority partner. The minority partner declined the offer and, in this case, decided that strategically it would be a better move to sell the agency and continue on as part of key management. While this position might have seemed to make the process easier, the reality was that it would be difficult to meet the minority shareholder’s financial expectations in a sale. The acquirer would either have to come up with an exorbitant purchase price in order to satisfy the minority partner’s financial requirements or leave the minority partner’s equity stake in place.
To solve the dilemma, Harbor Capital introduced a Bermuda-based company that wanted to enter the U.S. market. The company was more than happy to leave the minority shareholder’s equity stake in place while buying out the principal shareholder. The deal worked for several reasons. The acquirer believed that the minority shareholder had added significant value to the transaction by having taken over most of the agency management during the course of several years, and the minority shareholder was very confident that the new partner would add great value to the financial success of the agency.
In situations where the exiting shareholder has a minority interest, an alternative solution to having the agency acquire the minority stake would involve having a third party acquire the selling shareholder’s equity position. In most cases, that would entail having the third party assume a minority position in the agency. While many investors would be reluctant to be a minority shareholder, there are strategic investors that prefer to take a minority position in the agency.
One Harbor Capital transaction involved a client that had passive minority partners who wanted to be bought out. In this case our client’s buyout option was structured on very favorable terms that would have consummated the buyout. However, at the same time that the buyout opportunity arose, our client happened to be in final discussions with an underwriting market regarding a new program. To cement that new underwriting deal, our client offered to let his new underwriting partner assume the buyout deal. The equity interest acquired by the underwriting market actually became an important factor in the sale of the agency several years later. The fact that this market became a key underwriting facility for the agency and, in addition, held an equity position made the ultimate acquirer feel extremely comfortable with the transaction.
Recently, a Harbor Capital client agreed to sell 50% of the agency to a strategic partner who ran a prominent nonprofit affinity group. The sale accomplished two goals: (1) the majority shareholder was able to exit with an all-cash deal and (2) the agency’s younger shareholders were now affiliated with a major affinity player that would have a significant impact on growth.
Financial investors
However, not all investors are strategic investors. Some are financial investors who see an opportunity for attractive returns on their investment. Several years ago, one of our clients partnered with a group of Asian investors who desired to provide acquisition capital. Our client has utilized that source of capital and is now one of the largest agencies in the country.
A group of financial investors that is becoming more and more important is private equity funds that, in turn for acquiring a controlling financial stake in an agency, will provide capital needed to grow the agency. A high-profile example was the original formation of USI Insurance Group. The venture resulted from an investment by a leveraged buyout organization that wanted to do a roll up.
Stretching the envelope even further, a number of situations come to mind where clients starting new ventures have actually given equity interests to carriers as an additional incentive to establish an underwriting relationship. Clearly there can be significant benefits to selling equity for below-market value or, in some cases, giving equity to a strategic partner.
Many agencies see underwriting opportunities as a result of their specialization in the marketplace. One such client in the West recently put together a deal with a group of financial investors to create an insurance company. Our client contributed his agency to a newly created highly capitalized insurance holding company in turn for an equity stake in that holding company. Our client was so confident of the underwriting opportunity that he was willing to make that dramatic move despite having turned down a number of buyout offers. What closed the deal in the end was our client’s willingness to have “skin in the game.”
In summary, as you can see, strategic and financial investors can run the gamut from private buyout funds and insurance carriers to affinity groups. While not all agencies will be attractive candidates for these investors, Harbor Capital’s experience would indicate that these opportunities are not the exclusive purview of the largest agencies. It certainly takes some “thinking outside the box” to identify and pursue the more creative solutions, but that is what “stretching the envelope”’ is all about. Identifying and structuring these types of transactions is by no means a simple task. Having an experienced financial advisor who can help guide you through this process is a necessity. *
The author
Paul J. Di Stefano, CPA, CPCU, is the managing director of Harbor Capital Advisors, Inc., a national financial and management consulting firm that offers services to the insurance industry. Services include agency appraisals, merger & acquisition representation, strategic and management consulting. Harbor Capital Advisors, Inc., can be reached in New York at (800) 858-2732 and its Web site can be visited at www.harborcapitaladvisors.com.