by Kevin Stipe, March 2011

National Underwriter

During the agency acquisition frenzy of 2007-2008, privately-held brokers were often left out in the cold.  They wanted to get in on the buying action, but in many cases were unable to compete for deals.

My how things have changed!

Following the economic meltdown in late 2008, deal activity slowed to the lowest level in a decade.  Banks nearly stopped acquiring altogether, as many had serious liquidity concerns in their core banking operations.  Public brokers also slowed their buying activity, as their valuations got reduced and their access to capital became limited.

Enter the privately-held acquirer.  After years of coming in a distant 3rd place to banks and public brokers, in 2009 they surged to the top and then actually widened their lead in 2010.



 But can they stay there?  Deal activity is expected to continue to accelerate in 2011.  Will privately-held acquirers continue to lead the marketplace in deals closed?

Trying to pick the winner of any competition beforehand can make one look foolish.  But sometimes a competition can be broken down to some key areas.  If a team can put together a complete performance, in which it plays well in each of the key areas, then the chance of success is high.

In the agency M&A game, there are four key areas that drive a seller's decision.  Successful buyers find a way to effectively compete (although not necessarily win) in all areas.  For privately-held buyers to succeed in 2011, they will need to make a strong showing in each of the four areas:

1. Price.  Of course, price (or valuation) is the main thing in agency M&A.  There is no quicker way to lose than to be non-competitive when pricing a deal.  During much of the last decade, privately-held buyers frequently failed to get anywhere close to the valuations being offered by banks, public brokers and private-equity backed players.
   Yet over the past couple of years, the pricing disadvantage of the private acquirer has shrunk as many banks scaled back their acquisition activity and public brokers slightly reduced their pricing multiples and became more selective.  Today, with bank stock prices recovering and with public broker market capitalizations hitting their highest EBITDA multiples since 2006, acquisition valuations are on the rise.
   
   Competing will certainly get tougher for privately-held brokers.  They need to continue to focus on local fold-in opportunities where they can match (or even exceed) the valuations of others by consolidating a local peer into their office.  Blindly hoping to find sellers willing to take a significant "home-town discount" will prove as unsuccessful as it does with free-agent sports figures.
   
   An alternative for privately-held brokers is to find an agency whose principals have a strong desire to remain independent but want to take some, but not all, of their chips off the table.  In these situations a friendly merger can work, with the sellers retaining shares in the privately-held partner they have selected.
    
2. Resources.  A key reason why agencies sell to 3rd parties is to gain access to resources they need to be competitive.  For sellers of smaller agencies, the resources they need tend to be pretty simple:  more insurance carriers, better automation, more sophisticated client support, and dedicated agency management.
   
   For mid-size and large agencies, client-facing specialty resources are becoming increasingly important and costly.  Clients are increasingly demanding service that is customized to their particular industry.  As agency owners look to continue to grow their business, they are evaluating the quickest, most efficient way to deliver what clients are demanding - and sometimes that means aligning themselves with another agency that already possesses the resources they need.  Public brokers frequently have a powerful advantage here, but sometimes struggle to make their best resources available locally.
    
3. Culture.  Most agency owners are very proud of the culture they have built and want to take reasonable steps to preserve it going forward.  During the peak of their acquisition activity, many banks were able to use this issue to their advantage, which may seem counter-intuitive given the significant cultural difference between many banks and insurance agencies.  However, in offering a "hands-off" philosophy of agency autonomy, the banks were able to attract sellers that wanted to get in first and have their agency's culture define that of the bank-agency operation.
   
   Of the four key areas, culture is the one that provides privately-held acquirers the strongest natural advantage.  Many agencies that sell to, or merge with, a privately-held peer say that preserving the benefits of a privately-held culture was a major driver of their partner selection process.
    
4. Greenfield Opportunity.  This is a situation where a seller is provided a chance to exploit a new, untapped opportunity existing within the buyer.  It could be a personal opportunity (such as a chance for leadership in a larger organization) or it could be a collective opportunity (such as the chance to cross-sell insurance to a bank's customers).
   
   A Greenfield Opportunity gives the seller a new and exciting challenge that can lead to greater enthusiasm among employees as they evaluate what life-after-the-deal will be like.  And if there is an earn-out, the ability to capitalize on the Greenfield Opportunity can ultimately result in a material enhancement to the deal pricing.

Conclusion

Regardless of who comes out on top in 2011, competition for deals will likely continue to heighten.  If privately-held buyers want to extend their recent wins to a 3rd straight year, they will need to focus on building a winning combination of price, resources, culture, and, where possible, Greenfield Opportunity.  For those able to do so, the future continues to look very bright.