A panel of experts representing agencies, insurers and investors discussed M&A trends and how to strike a successful deal at the eighth annual summit meeting of the Target Market Program Administrators Association (TMPAA), held Oct. 13-15 in Tempe, Ariz.

The panelists were:

o William Kronenberg, chairman, Professional Underwriters Corporation
o Art Seifert, president, US Risk Underwriters
o David Jordan, senior vice president, AIG
o Archie McIntyre, senior vice president, business development, Meadowbrook Insurance Group
o Chris Lalonde, principal, Century Capital Management
o Moderator: Kevin P. Donoghue, managing director, Mystic Capital Advisors Group LLC

Although the number of completed deals declined 10 percent since 2007, there is more interest than ever in M&A activity, said panel moderator Donoghue. However, each deal is unique, and many pitfalls await if the deal isn't carefully thought out and structured.

Years of experience

Art Seifert started a program company from scratch, then borrowed capital from a carrier to buy out his partners. He subsequently sold this business to US Risk Underwriters, and now runs the division as Lighthouse Underwriters and The Lighthouse Companies. "There's never a right or wrong time to do a deal,obCrLf but there will be many variables, including the seller's age and how much he or she wants to work in the future, he said. "No deal will ever end up looking like the way it was first presented,obCrLf he added.

David Jordan spoke from the insurer's perspective. As senior vice president and COO of Risk Specialists Companies (RSC), a surplus lines broker subsidiary of AIG that produces and underwrites business for AIG entities including Lexington Insurance Co., he knows what MGAs face in the transaction process.

Archie McIntyre has spent 20 years of his career at Meadowbrook, which started as a privately owned agency that evolved into a programs business. Today, acquisitions are a key part of its future. Meadowbrook has recently completed three transactions, acquiring program administrators with underwriting expertise including Century Surety, a $220 million deal.

Representing private equity, Chris Lalonde assured the audience that in spite of the economic crisis, deals are still getting done. "However, big deals are frozen because if you went to the investment bank for debt, they're not lending,obCrLf he said. Because of this, the time frame for securing debt for a deal has increased. Much of Century Capital's debt comes from traditional banks-another frozen source-but with the $700 billion government bailout in the wings, Lalonde believes these sources should be loosening up soon. Debt funds are also available as a more expensive alternative to traditional lending, but which should be considered in light of the deal's growth potential. Companies and large pension funds are also looking for good places to invest

The elements of attraction
Buyers and sellers are attracted to different yet similar qualities in a potential partner. Buyers primarily seek underwriting expertise, which is critical to carriers, followed by program profitability within the book of business, and a good cultural fit - essential when merging two or more entities, Kronenberg said.

The people involved in the deal are vitally important, especially if the principals will be staying with the business, Seifert added. "A poor cultural match is frequently why a deal doesn't work,obCrLf he said. It's also important to understand business processing from an IT standpoint and to be able to merge two different IT systems, he added.

Similarly, company buyers seek "intellectual capital of the entire organization, not just the principals,obCrLf Jordan said. Business sustainability, margin improvement and underwriting profit are also essential.

Private equity firms agree about the importance of the "peopleobCrLf component. "The management team is key because we don't go in and run the business for you,obCrLf Lalonde said. Century Capital is also attracted to businesses with a competitive market advantage, such as great technology, as well as a high-quality distribution system, underwriting expertise, and a stellar reputation within the industry.

When insurers acquire MGAs, it's frequently a defensive move to squelch a competitor, Jordan noted. And buyers are shifting from domestic carriers to players from London or Bermuda, he said. "Our view is colored by underwriting results and projections, which are very important to us,obCrLf he said. "Deals that didn't work out are usually because of a poor cultural fit."

Problems can also arise if a transaction changes the original business's distribution system. "Distribution is the lifeblood of the business, so it must be clear when acquiring a company how this will be handled,obCrLf Meadowbrook's McIntyre said.

For example, an acquired business that is converted into a product portfolio will change distribution, and ultimately, earnout - "the trickiest part of the deal,obCrLf according to Seifert.
Earnout can also be affected if a business loses good program managers in the process of being sold, he said.

One recipe for failure is relying too heavily on bank financing to the point the bank is calling the shots, Seifert said. "Bank financing can be cheap, but there are usually strings attached to that cheap money,obCrLf he said. "The market cycle affects earnings and thus earnout. You could end up running a business to please the bank.obCrLf

Another consideration is the direction and alignment of financial interests, Lalonde said. For example, does the buyer's management team hold common stock, while the seller's team has preferred? It's something to consider.

Non-compete agreements
Parties in M&As have long relied on non-compete agreements to "put handcuffsobCrLf on the seller-an element so essential to the transaction that it falls under the category of "Deal 101,obCrLf according to Kronenberg. In fact, even if the principal agrees to stay after the acquisition, it's still a good idea to keep him "tied upobCrLf in some way, such as restricting his sales activities to a product line or niche. If the seller's principals are staying, it's also important to establish upfront what their day-to-day responsibilities will be, he added.

From the buyer's perspective, non-compete agreements are a must, along with confidentiality and non-solicitation agreements as a separate agreement from the asset purchase agreement, Jordan said.

However, jurisdictional views of non-compete agreements vary by location. For example, the California Supreme Court recently invalidated non-compete agreements, although they may be easier to enforce if they are separate from the rest of a buyout, Seifert said.

The non-compete issue is less of a concern to private equity firms, although Century Capital uses them as part of the deal package, especially if there will be management transition, Lelond said. Contract length is typically two to three years.

Seller pricing in the current M&A market has been hotly contested by industry experts. Panelists varied on their estimates, with Lelond saying that four to six times EBITDA is typical for private equity firm all-cash transactions. Seifert added that sellers can expect higher multiples for "bolt-onobCrLf businesses-six to eight times EBITDA-because the buyer is only purchasing the book of business, not the firm's management.

The panelists were divided on the wisdom of program administrators owning or creating carriers or captives. Kronenberg's firm created an offshore reinsurer years ago, but the regulatory climate was less restrictive at the time, he said. "For the average program administrator in a tough credit market, this isn't a good idea, because it's hard to raise the money needed to start up,obCrLf he said. "You're also committing that the money will be there, which totally changes the game.obCrLf Increased responsibility on filings and regulations makes such an undertaking extremely labor intensive, added. "Being a carrier is very different than being an MGA-it's a big boy's game.obCrLf

Meadowbrook formed an admitted carrier in 1986, which subsequently went public, McIntyre said. "But it's a long horizon; the idea must be very well thought out,obCrLf he said. "Some program administrators run captives, but I would generally discourage it.obCrLf

At this point, RSC would probably not be interested in acquiring a program administrator that was in the risk-bearing business, Jordan said. The capital and regulatory requirements are intense, and risk bearing would be a deterrent to the deal.

Basic M&A terms:

Fixed price: Refers to payment at closing and guaranteed payment after closing

Earnouts: Variable future payments based on premium, net revenue or earnings

EBITDA: Earnings before interest, taxes, depreciation and amortization

Net revenues: Gross commission revenues, less outside brokerage

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