Jeff Cappel is chief executive officer of Hales & Company, a national investment banker and consulting firm that focuses exclusively on the insurance industry.
Perpetuation. Consolidation. Merger. Acquisition. Buyout.
If you're an independent agency owner, these are the words that dance in your head when you close your eyes at night--and when you drink your morning coffee, review your balance sheet, or talk to the producer who just came on board.
Your agency may be the strongest and most profitable in its market now, but whether you're 30, 70, or somewhere in between, you know that today's success is no guarantor of tomorrow's. In the challenging terrain of the new millennium, the bridge between the present and the future isn't a gossamer fantasy of wishes, hopes, or assumptions. It's a solid, durable structure firmly supported by concrete, realistic plans, with just enough "sway factor" to keep it flexible when the waters swirl or the wind rises.
At the merchant banking firm of Hales & Company, this kind of bridge building is both art and science. Focusing exclusively on the insurance industry, Hales offers strategic planning expertise and capital investment to firms that seek guidance in shaping their future. To learn more about the specific resources Hales & Company offers its independent agency clients, we'll speak with its chief executive officer, Jeff Cappel. First let's briefly review the organization's history and structure.
Born at the right time
Established in 1973, Hales & Company opened for business at a time of significant dislocation in the insurance marketplace. Stock insurers with long, stable histories were being bought up--and in some cases plundered--by hungry investors from outside the industry. Old, traditional mutual companies were forming "downstream holding companies" to acquire the insurers and their assets, and to permit the formation of subsidiaries. The auto insurance markets in states such as Massachusetts and New Jersey were collapsing, in part because regulators refused to grant rate relief to loss-ravaged carriers. And independent agencies that for generations had conducted business the same way suddenly found themselves swirling in a tidal wave of change for which they were neither responsible nor prepared.
Helping agencies be prepared is what Hales & Company is all about. Hales is a financial advisory and merchant banking firm that specializes in the insurance industry. Originally formed as an adviser on ownership perpetuation to independent property/casualty agents and brokers, the company has expanded to become a multi-faceted investment and merchant banker with particular expertise in middle market transactions. From five offices located throughout the United States, Hales offers insurance distributors, underwriters, and service companies assistance in a variety of corporate finance and private equity areas. About 50% of Hales' business is conducted with independent agents and brokers; the other 50% of its clients are underwriters, service companies, and life/health/benefits providers.
Hales today operates as the Merchant Banking Group of Arch Capital Group Ltd. (ACGL), a publicly traded diversified financial services firm based in Bermuda that has assets of more than $500 million. ACGL's primary emphasis is on the insurance sector, where it owns and intends to acquire insurance-related entities such as intermediaries, underwriting agencies, service providers, and insurance companies.
Meeting to discuss strategy are (from left): Tony Cummings, vice president; John Kraska, managing director; John Lathrop, managing director; Jeff Cappel, chief executive officer; Steven Nigro, managing director; Aaron Mason, associate; and Patty Parker, office manager.
"Soup to nuts"
"Three segments of our company are applicable to agents and brokers," Cappel says. "First is the Corporate Finance Group, which works with either buyer or seller on merger and acquisition transactions, as well as with firms that are seeking to grow by acquiring multiple agencies or brokerages. We offer 'soup to nuts' advisory services: we can work with someone from the time they start thinking about selling or buying, through due diligence, all the way to the closing of the transaction." Also part of this group's portfolio is raising capital for clients. "That includes finding equity capital through strategic or financial partners, and securing bank debt or debt from strategic partners such as insurance companies. We help clients obtain capital for acquisitions or for perpetuation planning and buying out existing shareholders," Cappel explains. A third function of the group is valuations. "We work with private firms to support buy/sell agreements, employee stock ownership plans, perpetuation planning, and acquisition activities. We use Valuation Reports as a basis to assist clients in the development of strategies to improve the long-term value of their company."
Investment partners
The second segment of Hales & Company is the Private Equity Group. Hales manages Distribution Partners Investment Capital, LP, which provides equity capital to insurance distribution, technology, and outsourcing organizations. "Through Distribution Partners, we make principal investments between $1 million and $10 million in organizations we think have excellent growth prospects, strong management, or a unique position in a market," Cappel says. "Many clients look to us for capital to allow a management team to buy out a business from existing owners (MBO), or existing managers may take us on as a partner to continue to build the firm and create greater value for the shareholders."
The Distribution Partners fund has $51 million in committed capital; and with a lower investment limit of $1 million, Cappel points out, Hales & Company is unique in its class. "We can make investments as small as
$1 million, whereas most private equity funds would think that's too small; it's not worth their time," he remarks. "For us, in this segment of the market, that can be an appropriate investment. In addition, we understand the distribution, outsourcing, and technology sides of the insurance business, and we are able to quickly get our arms around the business prospects. We're willing to invest in a sector that a lot of other equity firms just can't. They're not geared to look at deals the same way we are," he comments. "We think we're a fairly unique source of equity capital in the market today."
"Of the various segments of the insurance business, we believe distribution is the key component going forward."
--Jeff Cappel
Like its parent, Arch Capital, Hales & Company is committed to supporting the distribution side of the insurance business. "Investors made a number of attempts to develop technology, a lot of which was intended to disintermediate agents and brokers," Cappel observes. "These investors found out that the relationship between the agent or broker and the client is a strong one, and a lot of the business generated by agents and brokers is meaningful to carriers. You can't simply develop technology that's going to disintermediate that group. I think that element of the business will get even more valuable over time. Of the various segments of the insurance business, we believe distribution is the key component going forward, and that's why our fund is really looking to make investments in this segment."
Consulting practice expands
The third segment of Hales & Company that provides services to independent agencies and brokerages is the consulting practice, which offers merger and acquisition advice, information services, and compensation design. "We've been the publishers of the Hales Report for 27 years, and prior to 1995 were actively engaged in consulting," Cappel says. "We're now looking, through either recruiting or acquisitions of other firms, at building out our consulting practice as part of our overall offerings, and expanding our information services business. We particularly want to broaden our reach to smaller brokers and provide more services in that area."
The expanded consulting practice also has its sights set on a major target: the alternative market. "With our parent company, we'll be in a position to provide insurance and alternative risk transfer services to rent-a-captives and other facilities," Cappel says. "One of the reasons we're building our consulting practice is so we can provide a broader range of insurance services to a wider number of agents and brokers--not simply the traditional consulting services. We're able to offer agents and brokers markets and services related to their needs."
A relationship business
With its myriad of services and diversified insurance industry clientele, Hales & Company knows that its success ultimately depends on building rapport and trust with its clients. "We view our business as a relationship business," Cappel says. "We do a lot of our work and thinking up front. With both clients and potential clients, what they think they want to do may look good on paper, but it isn't always the best alternative. Our first step with them is to think about what all the options are. Then they can make a decision with great confidence in what they've chosen. Once that's done, we can work with the client to execute the transaction, whether it's a merger, an acquisition, or obtaining financing to expand their business. So we really want to get a lot of work done up front and build that relationship. Then we look at outcomes to be sure we've helped the client meet objectives."
To form a clear picture of Hales & Company in action, we asked Cappel to provide some examples of the firm's work with independent agents. He responded by presenting two case studies involving Hales clients.
Case Study #1. "We worked with an agency's management group in the Northeast that wanted to buy the agency from its parent company, which had owned the agency for a long period of time. This group, which was composed of producers, believed if they owned the agency themselves, they could build it much more efficiently by operating it independently from the parent. They came to us with a plan to buy the business using funds borrowed from the parent company. They didn't believe they had the resources to do it themselves. As we worked with them and with the parent company, it became clear that the parent would welcome the opportunity to sell the agency to the management group, but the management group was going to have to finance it themselves. The management group was discouraged because they thought they couldn't do it, and we worked with them to explore all the different alternatives.
"As we went through the process, we discovered that, if the management team expanded from a handful of people to a broader group, the group in fact could raise the money needed to buy the business. As a first step, the group agreed to use resources such as their 401(k) and pension plan balances to invest in the agency. We were then able to arrange the bank financing, and the combination of those resources allowed us to make an offer to the parent company that it found very attractive and was happy to accept. If we had followed the path the management group originally chose, we think the agency would have been sold to a third party. We really had to think creatively about how we were going to make the transaction happen and how we were going to get the ownership in the right hands. Since then the company has tripled in size and has gone through two additional rounds of financing at higher valuations. It's a very successful story, and it's a situation in which, by moving ownership to the people who produced the business, we were able to help the business really flourish."
At Hales & Company, Jeff Cappel says, a key first step is helping clients explore all their options so they can make decisions with confidence.
Case Study #2. "A West Coast agency came to us with a classic dilemma. The selling shareholders were in their early sixties, and the young producers who wanted to buy the business were in their thirties. Over the last several years, they'd done a very good job of transitioning the business from the older group to the younger group, but not a very good job of transitioning ownership. The older group was at a point where they felt compelled to sell the company in order to diversify their asset base, but the younger group didn't have enough of an equity stake in the business to acquire it, and they thought they had to own the agency to develop it. The original idea was for the younger group to buy the agency from the older group at a price that reflected the amount the older group needed if they had sold the agency in the open market. There was really no financing for that, and all the financing would have had to come from the older group. When you do that, you have a big problem. There's not a lot of actual risk transfer at that point. If the agency doesn't perform, then the selling shareholders really haven't diversified their risk; their money is still at risk in the agency. With that big an economic stake, they would have wanted to have control and cut the younger group free.
"What we were able to do in that case was look at sale alternatives, and in that process we found a nontraditional buyer for the agency who really understood the differences between the needs of the two groups. We put together a transaction under which the current value of the agency would be distributed to the older group, and the growth in the value was heavily weighted to the younger group, because they felt very confident there was going to be a lot of growth. So the younger group was able to take the lion's share of the growth, and the older group got the value of the agency up to that time. The best solution was reached when the two groups worked together to resolve the issue instead of having a standoff where one group felt taken advantage of by the other. That's a common issue, because a lot of people fail to transition ownership appropriately even when the business has been transitioned."
The Hales "advantage"
Although Hales & Company's particular mix of services is unique in the insurance industry, the firm doesn't lack competition. "We compete with different people in different markets," Cappel says. "We have a wide geographic spread through our five offices around the country: Hartford, New York, Chicago, Seattle, and San Francisco. So we maintain as close a local presence as we can. In this sense we're unique, because a lot of the firms that serve agents and brokers tend to be in just one location."
The 15 professional staff members of Hales have a virtual alphabet of letters behind their names, each attesting to a high level of achievement in a relevant field. "It's a group that has a wide range of skills," Cappel notes. "We have seven CPAs, five MBAs, two JDs, and one actuary. Five of our eight senior partners have over 20 years' experience in the insurance industry; the other three have over 10 years. Four of our senior partners have also been chief financial officers of national or regional brokerages. Of our seven junior partners, two have 20 or more years of industry experience, and the others have five years or more. We offer a combination of industry knowledge, financial expertise, and transaction skills that we don't think anyone else can match." The chairman of Hales is Marty Becker, who was formerly chairman and CEO of Orion Capital Corporation.
Trends and challenges
What trends seem to be having the strongest impact on independent agencies and brokerages in today's market? First, Cappel observes, "The market is hardening to varying degrees around the country. On the one hand, this can be a positive development for agents and brokers in terms of increased income on their commission-based accounts. On the other hand, access to markets is becoming much more of an issue. How do you get to markets? Also, the use of alternative markets is increasing. That's one of the reasons we're developing the consulting practice and are able to help agents deal with that issue. The other long-term trend that I think affects agents is that this segment of the business remains undercapitalized. There just isn't a lot of capital available for independent agents and brokers to support their business plans. There's always a need for access to equity and debt capital, and that's an area we've been involved in for many years. That drives a lot of the M&A activity and capital raising activity as well. We see this trend accelerating, not decelerating."
With its high-powered professional team, depth and breadth of experience, and exclusive industry focus, Hales is poised to anticipate key trends in the insurance business and to help its agency and brokerage clients succeed by taking advantage of those trends. *
For more information:
Hales & Company, Inc.
New York City, Phone: (212) 592-5700, Contact: Steven Nigro
E-mail: snigro@halesgroup.com
Chicago, Phone: (708) 358-1100, Contact: Jeff Cappel,
E-mail: jcappel@halesgroup.com
Hartford, Phone: (860) 293-3541, Contact: Gordon Pratt
E-mail: gpratt@halesgroup.com
Seattle, Phone: (206) 236-6153, Contact: Bob Seda
E-mail: rseda@halesgroup.com
San Francisco, Phone: (415) 461-0505, Contact: Vince Trapani
E-mail: vtrapani@halesgroup.com
For more information:
Ajasent, Inc.
Web site: www.ajasent.com
E-mail: mparrish@ajasent.com