Private equity firms are paying high prices for well-managed wholesale brokerages and managing general agencies, but that doesn't mean they are a quick or easy way out of the business for retiring specialty producers, merger and acquisition experts warned.

"Private equity is not necessarily an exit," said John Kraska, managing director for Hales and Company in New York, who assists in such transactions.

Brokers often begin discussions with him saying, "I hear private equity pays a lot. Should I sell to private equity?" he reported, going on to reveal that what PE firms really provide for specialty firms is not an immediate solution for a broker without a succession plan, but partial liquidity for business growth at the time of the deal.

Those brokers that go the PE route should understand that "achieving good value means partnering" with the PE firm to build the business, rather than selling out and walking away. "The real money comes at the second exit," he said, referring to the point when the original PE firm turns over its investment to another buyer.

That means specialty brokers looking to partner with PE firms need to think about their five- to 10-year plans, and how they'll work to grow their businesses, he added.

"Is capital really what you need" to achieve the results you're looking for, he asked, during a panel discussion at the midyear educational conference of the National Association of Professional Surplus Lines Offices.

In agreement was Matthew Kelty, a principal for Allied Capital Corp., a Washington-based PE firm. Too many times, brokers think about transactions backward, asking, "What's my EBITDA? What can I add back? What are the multiples?" he said, referring to the fact sales prices are typically expressed as multiples of earnings before interest, taxes, depreciation and amortization.

"That's really the last five yards. The important part is [figuring out] what's your plan [and] who's your partner," he said.

"We're less sensitive to valuations going in, if all the other things fit," and if the go-forward business plan makes sense for everyone, Mr. Kelty added. As a buyer, "you're not getting a deal by paying a multiple less than the market if [you] wake up a year later and you're going to be strange bedfellows" with the broker.

Mr. Kelty explained that having a five- to 10-year business plan helps the broker to decide whether to strike a deal with a strategic buyer, such as an insurer or a larger wholesaler, or with a PE firm.

Once you have a plan, then you should ask, "What's going to get us there?" he said. Is it a situation where a very good, small niche organization is looking to continue to grow, and where combining resources with a bigger organization will get you to what he called "the promised land?"

"That's a very different...set of inputs than saying, 'If I could just find a private equity partner with capital, then in three years, we can do A, B and C,'" he said.

Mark Watson, chief executive officer of Bermuda-based Argo Group International Holdings Ltd., a specialty insurer, said his outfit is similar to PE firms in focusing on the management teams of target companies, and generally looking to partner with them and "help them grow their franchises as they become part of [Argo's] franchise."

Mr. Kraska told brokers "the reason why Mark [Watson] would want to buy a business is there may be opportunities for him to cross-sell products or...find other avenues to do business together and start to do some other things. With private equity, you're not getting that feature."

With private equity, "you're certainly getting expertise," Mr. Kraska added, but "it's not like you're getting another product set to go add to your tool case."

In addition, Mr. Watson noted that unlike PE firms, Argo can offer an exit strategy. He went on to highlight his firm's access to capital as a public company and its ability to handle transactions in a more simplistic way than PE deals, which can be complex.

Gerard Vecchio, a managing director with Century Capital Management, a Boston-based PE firm, said PE partnerships work well for wholesaler brokerages and MGAs led by entrepreneurs who want to go back to their roots of taking "calculated risks" to jumpstart business growth.

In particular, Mr. Vecchio described companies started by one or two people that "built their businesses up from scratch" with perhaps $100-to-$200 million of seed capital, and now sitting with multimillion dollar businesses.

"In the early days, they took educated bets [or] calculated risks, and it didn't matter if they lost the money because they really didn't have that much invested," he said. "Today, however, they've stopped taking those risks because they have so much invested in the business that they changed their perspective from building to maintaining."

From the PE perspective, "what we've found is if you give those entrepreneurs partial liquidity--so they know that if everything else goes wrong, they've got their little nest egg--they go back to taking those calculated risks, and again you see a J-curve uptick in the business," he said.

While the experts spent most of the panel discussion trying to help wholesalers and MGAs understand the expectations of PE partners and distinguishing between different types of PE firms, Mr. Kraska began the session reporting that deal prices for brokers have soared in recent years.

Noting that Hales has advised on $1.6 billion worth of transactions during the last three years--with 31 deals last year and six already this year (three involving MGAs and wholesalers, and three involving sales to PE-owned businesses)--he said shops that sold for six-times or 6.5-times EBITDA for a business just a few years ago are now getting seven-to-eight-times.

"You're starting to see the real marquee firms--the firms that really have a strong management team and good growth pattern--getting nine-, 10-, or in some cases 11-to-12-times multiples for their businesses. In the last year-and-a-half, it has been very much a seller's market," he said, adding that PE ownership in insurance brokerage has strengthened dramatically.

"If you go back five years ago, private-equity-owned insurance brokers controlled about $325 million of commission revenue," he said, referring mainly to the retail side of the broker business. "Today, that number is close to $2 billion," he added, noting that on the wholesale/MGA side of the brokerage business, many of the large players that used to be public companies are now owned by PE firms.

During the session, Argo's Mr. Watson suggested that the upward trend in multiples is set to reverse, pointing to a change in financial buyer appetites as one factor. "I'm not sure if the top hasn't come off of some of those lofty multiples," he said.

"If it hasn't happened, I think it happens in the next six-to-12 months," Mr. Watson said, also predicting that the crisis in the credit markets will have an impact because many PE deals are financed with debt, which has become more expensive.

The consequence may be that some deals don't get done--or if they do, there won't be enough funds left for the PE firms to deploy to help grow acquired brokerage businesses, according to Mr. Watson.

Mr. Vecchio argued that the impact of the credit crunch on broker deals might not be immediate because PE firms still have funds with cash available--"dry powder"--to complete transactions.

Mr. Kelty and Mr. Kraska said the near-term impact might be stronger differentiation between good, strong target companies and weaker ones.

During an interview at NAPSLO, Alan Kaufman, CEO of Burns & Wilcox, told NU that while his firm has always been active in looking for acquisitions, in the last couple of years the independent Farmington Hills, Mich.-based wholesaler and MGA has made only a few small acquisitions because the environment has been so competitive.

"Our business has changed in the sense of ownership. A lot of the ownership today is not family ownership, [but] public companies, private equity, banks--and we have been competing with those firms for acquisitions in [an insurance] market that was relatively strong," Mr. Kaufman said, predicting that financial buyer appetites will change as the market grows softer.

Special Reports /

Private Equity Deals No Automatic Exit For Sellers Of Wholesale Brokerages

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