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The Rough Notes Company Inc.



November 28
09:38 2017

Acquisition Acumen

It’s important to make sure financing is in place before approaching a potential acquisition target

Developing strategy, originating transactions and vetting culture are always hot topics when one is looking to acquire an independent agency. This is all predicated on the fact that you can afford to purchase an agency. When providing a letter of intent or a formal offer letter, potential buyers generally indicate how they intend to pay for the acquisition. When a buyer states that the deal is contingent on obtaining financing, the seller likely will view this as a risk to the deal. When a buyer has financing in place, this not only reduces the risk for the seller but also can help reduce the work necessary for a buyer’s staff to get the deal across the finish line.

As you embark on a strategic acquisition program, take the time to consider your funding strategy up front.

When setting up a financing program for an acquisition strategy, buyers have four basic options: cash on hand, third-party debt, seller-financed debt and equity.

Cash on hand

It has a thousand slang names, but regardless of what you call it, cash is king.

Cash is often the first order of business when one is looking to fund a deal. It is generally the cheapest capital available, especially when it’s already in your business and no one is clamoring to get it out. In the current interest rate environment, the yield on liquid investments is low (check your savings account statement if you don’t believe me), and the cash is likely sitting in an account with minimal returns. The cost of capital here is most often measured in opportunity cost, which represents the value of other things the cash could be used for (e.g., that new boat you’ve been dreaming about).

Maintaining a war chest full of cash reserves, or “dry powder,” should enable you to move quickly on a potential transaction that requires significant cash as either a complete or partial source of funding. A well-run agency should generate EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization), a proxy for free cash flow, of 25% of net revenue, meaning that a steady source of capital should be available. The key to maintaining available funds is restricting distributions to members or shareholders over time as a means of building reserves.

We believe this is far easier than asking shareholders to put funds back into the agency on short notice and that it should be an integral part of the long-term planning and acquisition strategy.

Third-party debt

The use of third-party debt to finance brokerage transactions is fairly common, although it has not always been this way. Traditionally, debt was used to finance large fixed assets—items that are capital intensive and can be used to collateralize the loans. Think factories or airplanes—assets that can be taken back and sold if the loan goes into default. The recurring nature of brokerage revenue appeals to educated lenders as it provides ample cash to repay the loans despite the fact that all of the assets are intangible.

The benefits of using debt are based largely on the low current interest rates and hence the lower cost of debt capital relative to equity capital. Notably, a buyer should be able to borrow against its total EBITDA, not just the EBITDA of the firm it is buying, thus giving a mid-sized buyer more capacity to acquire small firms. Using debt facilities set up in advance can allow the buyer to move quickly and effectively pay cash up front (from the seller’s perspective) for an acquisition. The drawbacks come in the form of covenants built into the loan agreements that may restrict the borrower’s flexibility in managing the agency.

Seller-financed debt

Asking sellers to fund their own buyout is an intriguing concept. The buyer pays the seller with notes rather than cash, and the buyer pays off those notes over time, with interest. In theory, the rates on this debt should be market based and therefore neither cheaper nor more expensive than comparable third-party debt. The difference between seller notes and bank debt is in the covenants. Ordinarily few covenants are imposed on the borrower (the buyer in this case) as the lender (i.e., the seller) is likely not a sophisticated financial institution.

Some seller-financed deals have contingent or variable features, where the loan could be forgiven if certain projections are not met, but it would be inappropriate to consider this a financing option; it is really a purchase price adjustment that is achieved by means of the notes.


Financing a deal with equity involves issuing stock to a seller and making that seller a partner in the combined firm. If you have a well-run, high-growth firm (perhaps greater than 7% growth per year), using equity as a funding source can be an expensive proposition. The seller would benefit from any growth of the acquiring firm and would dilute the ownership of the current owners. On the positive side, financing with equity requires far less cash and aligns the interests of the buyer and seller. Using equity to purchase part of the business from a partner who is nearing retirement does not make sense. Using equity to align the interest of a young, hungry new partner, however, could be well worth the ownership dilution. The key to understanding the costs and benefits of this approach lies in the projected growth of the new partner as part of the combined firm.

As you embark on a strategic acquisition program, take the time to consider your funding strategy up front. A professional advisor can help you evaluate the benefits and risks related to each funding source in your specific scenario and help you craft the appropriate strategy for your firm. Additionally, licensed advisors can help you obtain capital and make sure that it is available in advance of your need. Doing this may help avoid a closing crunch, allowing you to use the cheapest capital options and providing you the flexibility to make unrestricted offers free from financing contingencies, which may make the difference in winning a deal.

The author

Brad Unger joined Marsh, Berry & Co., Inc., in 2015 as a vice president on the mergers and acquisitions team. In addition to his M&A advisory responsibilities, Brad also is involved with the firm’s financial consulting business. MarshBerry helps insurance agents, brokers and carriers maximize their value through a variety of industry-specific services. Contact Brad at

Market Update

Year-to-date (YTD) activitythrough September is up roughly 7% from last year, with 357 total announcements vs. 334 announced transactions for YTD 2016. Nearly half the transactions announced in YTD 2017 have been property and casualty agencies, and over 85% of all announcements have involved traditional retail brokers.

Acrisure, LLC remains the most active buyer in the marketplace, having announced 30 transactions for YTD 2017. Hub International Limited is a close second at 27 YTD announcements, with BroadStreet Partners, Inc., and Arthur J. Gallagher & Company a close third and fourth at 23 and 21 YTD deal announcements respectively.

During September it was announced that KKR & Co. L.P. was selling its minority interest in Alliant

Insurance Services, Inc., to company management. It is estimated that KKR made 2.5 times its original 2012 investment on the sale, with the original value of the business at $1.8 billion and current valuation at $4.5 billion. Private Equity company Stone

Point Capital, LLC continues to have a stake in Alliant.

It also was announced in September that OneDigital HealthandBenefits will be taking over as brokerof record on an estimated 8,700 Zenefitsinsurance accounts, following severalyears of controversy at Zenefits regard-ing investigation into its brokering of insurance in California, among other internal disruptions. Zenefits is confident this will create less channel conflict with brokers in the insurance space and allow it to better serve its broker customers.

Securities offered through MarshBerry Capital, Inc., Member FINRA and SIPC.

Disclosure: All deal count metrics are inclusive of completed deals with U.S. targets only. Scorecard year-to-datetotals may change from month to monthshould an acquirer notify MarshBerry or the public of a prior acquisition. Please feel free to send any announcements to M&

Source: S&P Global Market Intelligence, other publicly available sources, and MarshBerry Opinion & Experience.



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