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Agency Financial Management Private equity capital—is it for you? Growth of private equity investors boosts agency prices, but it pays to study their agendas By Paul J. Di Stefano, CPA, CPCU While private equity capital investments in insurance agencies have been around for a number of years, starting with the investments in USI and Acordia years ago, a new round of investments has begun in both wholesale and retail distributors of insurance products. The proliferation of hedge funds and private equity funds over the last several years has been a driving force behind the expanded interest in the financial services sector. However, dealing with private equity investors is no simple task, and frankly the odds of success are not high considering the fact that these firms look at numerous opportunities before pulling the trigger. In addition, one must understand that different funds have different parameters for making investments. On the wholesale side, as most readers are probably aware, private capital groups were on the buy side in the divestitures by Aon of Swett & Crawford, Marsh of Crump, and Willis of Stewart Smith. One of the more recently announced private equity transactions on the wholesale side was the acquisition of Arrowhead, one of the largest MGAs in the country, which is headquartered in California. Investments have also been made in some of the larger retail brokers, the most recent of which was the acquisition of Genatt Associates by a group of private equity firms. Having participated as the investment bankers representing Genatt Associates in that transaction, Harbor Capital Advisors is in a unique position to understand how the private equity community evaluates these transactions and what parameters need to be in place in order to successfully consummate such a transaction. One of the greatest concerns that our clients routinely express when they consider selling a controlling stake in their agencies to a private equity fund is understanding what the ultimate exit by the funds might look like and how they will be impacted by it. While most firms have a time frame for their investments ranging from five to seven years, what happens at the end of that period of time will vary since the reality is that there are a number of possible exits for these investors. One exit strategy could be a sale to a strategic partner such as a bank or public broker while another could be a sale to another equity fund. Going public is another viable strategy, as in the case of American Wholesale, which recently filed with the SEC for its initial public offering. A high-profile example of a transaction between private equity funds was the case of Alliant Resources. The Alliant rollup was originally funded by a private equity group out of Chicago, which exited within the last year with a sale of their investment to another private equity fund out of New York. While most private equity funds prefer to acquire voting control when making an investment, there are a number of funds that will actually take a minority investment position. The reason more firms are not willing to take a minority investment is that they will not have financial control of their investment. The other side of the coin, justifying a lack of financial control, is the fact that what the private equity investors do have are partners in the form of existing agency shareholders that will keep their skin in the game with their continuing equity stake. Thus all parties have a common interest in continued success. There are two levels of investments that private capital is typically willing to fund. One is the initial platform agency, which will act as a base for future acquisitions. This is typically a larger agency with critical mass. The second level of investment will be in the form of other geographic hubs and/or roll in acquisitions for the acquired platform. One of the reasons that many agencies prefer to be acquired by private capital is that they remain fairly autonomous; for those who value autonomy, private capital investment may be the perfect partner. Agencies that have been looking to grow by acquisition but have been stymied by the lack of available capital may well be attracted to this model. The issue to be weighed is whether or not private equity capital can be used effectively. If capital can be efficiently deployed, it can increase the return for investors as well as agency shareholders. However, for those that are not comfortable growing through acquisition, private equity capital may come with a culture that is not compatible with that of the agency. Keep in mind that private capital marches to its own set of drums. The reason that money is pouring into private equity and hedge funds capital investments is that private equity capital investments typically provide higher rates of return for their investors. Those higher returns are only achieved by faster rates of organic growth and acquisitions. Our experience is that, on average, existing shareholders retain approximately one-third or less of the outstanding equity of the newly capitalized company. However, keep in mind that there may be different classes of equity including a preferred equity with enhanced rights along with common stock. With more and more acquirers with private capital entering the space, acquisition prices are being driven higher and higher. If the goal of selling shareholders is to take some money off the table and continue to participate on the upside, private capital opportunities should be explored. The good news is that the gamut of opportunities for agency principals is greater today that it has ever been in the past. * The author |
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