Acquisition Acumen

By James Graham

NOW IT’S TIME TO PAY FOR IT

Consider three things while contemplating potential tax changes

It has been over one year since COVID-19 hit U.S. shores and began devastating communities, and just now things are starting to get back to “normal.” The vaccine roll-out is in full swing and COVID-19-related health ordinances seem to be in retreat.

Thankfully, for those in the insurance industry, swift actions taken by the federal government to shore up the economy during the coronavirus crisis have so far been effective in staving off a financial crisis.

Last spring, many thought that merger and acquisition (M&A) activity would have halted and many insurance agency and brokers were expecting revenue reductions in excess of 15%. However, in large part due to the federal government’s massive stimulus spending, many firms did not experience a decline in revenue and M&A activity in the insurance distribution industry exceeded pre-pandemic expectations.

If this [tax] increase happens, a firm would have to grow I5% per year for three years to achieve the same after-tax value as they have today.

While the federal government seems to have sidestepped a financial crisis, it comes at a steep price tag of over $4 trillion. The question now becomes—who pays for it?

In addition to the stimulus directly related to COVID-19 relief, the Biden administration also plans to spend another $2 trillion on infrastructure spending. Unlike the COVID-19 stimulus packages, President Biden desires spending to be revenue neutral, meaning he plans to match the increased spending with increased taxes. While the jury is still out on which of his proposed tax increases will be enacted, his proposed increase on capital gains from 20% to a pending increased ordinary income tax rate of 39.6% for income earned over $1 million is already affecting the M&A market.

As shown in the table below, this proposal would effectively result in a doubling of the current capital gains rate. If this increase happens, a firm would have to grow 15% per year for three years to achieve the same after-tax value as they have today.

The potential for the largest capital gains tax rate increase in history has been well known to the market since Biden was named the Democratic nominee for president. Even before the November election, the pending threat of this tax increase drove sellers to the market in record numbers during the second half of 2020 and through Q1 2021. When contemplating this tax change, and the rush of M&A activity, agencies should consider the following:

1. Firms exploring the sale of their business over the next few years should factor in potential tax changes. Going to market now could result in materially more after-tax proceeds than selling in subsequent tax years.
2. With a rush of activity, potential sellers should understand that individual buyers have limited buying capacity each year. It may seem that buyers have the potential for limitless deals, but this is not the case. Firms have financial and operational limits on the number of transactions that can be completed each year. While capital or operational constraints should not be an issue for the wider M&A ecosystem, there are some individual buyers who may have a full pipeline by mid-year. This means a firm coming to market in Q3 and Q4 may have fewer options or may have to delay closing to Q1 2022.
3. Working with an advisor is more important than it has ever been. The complexities in the current M&A market are such that anyone selling unrepresented is likely getting a subpar deal. An advisor will not only be key in helping firms find the best combination of fit and value, they will also help ensure that deals are completed on time.

The author

James Graham, CVA, joined Marsh, Berry & Company, Inc. (“MarshBerry”) in 2015 and currently serves as a senior consultant in the California office. James’ activities include merger and acquisition services, preparing valuation reports, creating perpetuation plans, providing business planning and general consulting. James is also a relationship manager for MarshBerry’s Connect Networks. Prior to joining MarshBerry, James was a senior consultant with Deloitte Consulting LLP. While at Deloitte, James provided financial analysis work on a wide range of consulting projects.

James currently maintains the FINRA Securities Industry Essentials (SIE®) Exam in addition to the Series 62, 79 and 63 FINRA Registrations through MarshBerry Capital, Inc., the affiliated FINRA-registered Broker/Dealer of Marsh, Berry & Co., Inc. He earned a bachelor’s degree in finance from Azusa Pacific University and a Master’s in Business Administration (MBA) from George Mason University. He is also a Certified Valuation Analyst (CVA). Contact him at James.Graham@MarshBerry.com or (949) 272-0351

MARKET UPDATE

As of March 31, 2021, there have been141 announced M&A transactions in the United States. This represents a 24.7% increase compared to 2020 at this time. This is encouraging for 2021 in total, as deal activity is anticipated to ramp up even more in the second half of the year.

Private capital-backed buyers have accounted for 98 (69.5%) of the trans-actions through March, while independent agencies made up 20.6% of the total. There is more activity in the marketplace by independent agencies; this is presumed to be driven by spending restrictions being eased and more confident financial outlooks being forecasted.

Hub International Limited, Broad-street Partners, Inc., and Integrity Marketing Group LLC are the top three most active buyers in the U.S. in 2021, contributing a combined 24.8% of the 141 total transactions. The top 10 most active buyers completed 68 of the 141 announced transactions (48.2% of total).

Two large acquisitions were announced in the first quarter:

• Integrated Specialty Coverages (ISC) announced on March 4 that KKR is acquiring a majority stake in the firm. ISC currently writes over $300 million in specialty premium across a number of areas, including property, construction, transportation, and hospitality. Sightway Capital is retaining a minority position in ISC after the transaction.
• On March 5, AmWINS Group announced its acquisition of Worldwide Facilities. AmWINS and Worldwide are the largest and fourth largest wholesale brokers in the U.S., respectively. The addition of Worldwide will result in the combined firm having more than 6,000 employees and $24 billion annual in placed premium.

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Disclosure: All deal count metrics are inclusive of completed deals with U.S. targets only. Scorecard year-to-date totals may change from month to month should an acquirer notify MarshBerry or the public of a prior acquisition. 2021 statistics are preliminary and may change in future publications. Please feel free to send any announcements to M&A@MarshBerry.com.

Source: S&P Global Market Intelligence, http://www.insurancejournal.com,http://www.businessinsurance.com/and other publicly available sources.