For those of you who have not been paying attention, private-equity backed brokerages have taken over the M&A world. They completed 316 announced transactions in 2017, which represented 57% of the total announced deal activity for the year.
The demand that continues to drive activity within the industry seems to be endless. And it has led to more investor diversification, creating a new category of investor—private capital.
The typical private equity structure includes funds that deploy capital raised from multiple sources. The PE firms focus on a strong return that is created through earnings growth and an exit strategy typically three to seven years long. Private capital includes traditional PE players, and it extends to other sources, including family offices, pension plans, sovereign wealth funds and independent capital. These investors, who typically are investing directly into PE funds, are recognizing the value of buying into the insurance brokerage space: recurring revenue, stable performance, a must-buy product, relatively low risk. They are making the decision to bypass the PE fund and are investing directly. Additionally, many of these private capital investors bring a long-term perspective to the table. For example, when BroadStreet Partners aligned with the
Ontario Teachers’ Pension Plan, it was told an average hold was 18 years.
How are these new private capital players partnering with insurance firms? What opportunities are they providing in the industry, and how do they complement private equity as we know it? The deals that follow showcase the different types of private capital.
The Long View
USI Insurance Services
“We wanted to get off the treadmill of trades that happened every three to five years,” says Ed Bowler, chief financial officer at USI, an insurance industry leader that started in 1994 as a single office of $6.5 million in revenue and 40 associates and today is approaching $2 billion in revenue with more than 7,000 associates in 150-plus offices.
While the ongoing buy/sell cycle with PE meant a “mark on the equity,” Bowler explains that it also can be distracting, time-consuming and expensive. “We had been hearing about more permanent capital, or evergreen capital, coming in, so we took it upon ourselves to reach out in the marketplace.”
USI interviewed pension plans and long-term equity funds that put capital out over a 10-year period—double or more what USI had been experiencing with traditional private equity.
Then, the KKR/CDPQ proposal came forward. KKR had accumulated a healthy sum on its publicly traded balance sheet that it wanted to invest long-term. It created a joint venture with Caisse de dépôt et placement du Québec (CDPQ), and their core private equity partnership (including KKR’s funds and CDPQ’s pool of capital) allows for attracting investment opportunities with a longer duration and lower-risk profile.
This was exactly what USI was seeking—a partner that could support strong management and long-term strategic business building. And for KKR/CDPQ, the insurance industry and USI were enticing because of the stability of the industry and USI’s history of high performance. “We reached out to them and had the discussion and really liked what they had to say,” Bowler says.
In March 2017, KKR/CDPQ acquired USI from Onex Corporation. “This is the final owner of USI, as far as I’m concerned—and we’re real excited about that,” says Bowler, who has been with the firm through seven owners.
The long-term investment means internal rates of return (IRRs) are not as important, Bowler says—it’s more about “money on money.” Bowler points out, “I can’t spend IRR; I can spend money on money, so I’m happy with that focus and growing that capital.” While IRRs are critical to traditional PE funds for raising capital for the next fund, “they are less important to pension plans,” Bowler says. “And with what KKR has on its balance sheet, they were looking more for multiples of money over time.”
What will change at USI with a longer-term owner? With new acquisitions, will those owners have equity in the deal, and what does liquidity look like for management and future leaders in the firm?
After five years, there will be a potential for internal trades. But, Bowler says, “most of our people aren’t selling their shares, and we don’t have the cry for liquidity now. We will likely have an internal process not dissimilar to what an employee stock ownership plan does if people do want to cash in and gain liquidity.”
If USI meets its goals, it will begin paying out dividends five to six years out from the time of the trade. “Assuming we achieve our plan, this will be a dividend-performing stock because of the cash flow,” he says. “So, if you hold your shares, you are going to start getting chunky dividends in years five, six, seven and so on.”
The business will prosper as it continues strategically growing without being on the “PE toll road,” which results in costly trades every few years, Bowler says, noting that he envisions more pension plan and long-term equity opportunities for the insurance industry. “They like the insurance brokerage world for all the reasons we know—the recurring revenues, it’s a product that needs to be bought and there isn’t the obsolescent risk.”
Greg Williams believes that Acrisure is unique. And as co-founder and CEO, he wanted to keep it that way. But the rolling ownership of PE made that difficult. In early 2016, when the company’s private equity partner Genstar Capital had decided to exit, Williams began discussing ownership options with his operating partners. The company had acquired 150 agencies over a three-year period, so a prosperous and meaningful exit was contemplated by all parties.
“I asked two simple questions,” Williams says of his conversation with his agency partners: “Are you interested in rolling equity assuming we secure a new capital partner that supports our objectives? And if so, how much equity would you be interested in rolling?”
Williams was pleasantly surprised when 99% of his agency partners said yes—they were in. And he was thrilled their aggregate equity roll was approximately 60%. So Williams did the math and figured that, with a slightly higher equity roll, he could present to a new investor a capital structure that would result in Acrisure’s management team and its operating partners becoming the majority shareholder of the business, including governance control.
“I felt strongly if we had majority interest and board control, it would help us grow from an M&A perspective, given there would be permanence in our capital structure. This permanence would ensure our unique and highly appealing operating model would not change, and our agency partners would not have to concern themselves with another sale of the business. We would be officially off the private equity train,” Williams says.
The value proposition was important, as Williams later had to go back to his operating partners with a specific request—he needed 75% of equity. For two and a half weeks, Williams and Acrisure’s chief acquisitions officer, Matt Schweinzger, did a “road show” for the company’s top 60 shareholders individually. They hit four or five cities a day, holding personal meetings. “We laid out a proposed capital structure if we rolled 75% of our equity,” he says.
It was a highly attractive scenario with a very positive reaction. “It gave me the opportunity to then go to potential investors in the market and say, ‘Look, we are more of a buyer than a seller. We are rolling approximately $700 million in equity.’” Williams offered a preferred equity position in exchange for governance control. “I received a number of interested parties,” he said of third-party investors. What resulted was a $2.9 billion management-led buyout. Today, the management team and its operating partners own 82% of the common equity, with outside investors owning 18%. Further, “we control the governance of the company, which is translating to comfort internally and externally because current and prospective partners don’t have to worry about that flip in three years,” Williams says.
The ultimate objective: “We want to own 100% of the business—and we are well on our way to achieving that.” Ownership and governance control is a competitive advantage in the marketplace, Williams says. “It makes us unique—it’s the private equity model turned upside down,” he says. “Value creation benefits owners, so our operating partners benefit from our growth at a disproportionate rate as compared to our competitors,” Williams says. “And, given our international expansion, our story is now being told in different parts of the world,” he adds.
Acrisure will continue to build the business both organically and through M&A, driven by a great deal of enthusiasm with its operating partners. Williams added “the excitement for being part of Acrisure is very high, evidenced by the number of employees that desire to become shareholders. We have an internal market that allows employees, based on certain criteria, to register to buy shares. Currently, the number of registered buyers to sellers is 10 to 1,” Williams says.
Looking at the value of the Acrisure stock today compared to 2013 when Genstar acquired the firm, the operating partners have realized over 11 times multiple on their equity, Williams says. “This has created wealth beyond their wildest dreams.” And, because of that dynamic, there is “extreme enthusiasm to continue growing the business both organically and inorganically,” Williams says.
Head of the Class
For more than five years, BroadStreet has been aligned with the Ontario Teachers’ Pension Plan (Teachers), the largest of its kind in Canada, with more than $200 billion in assets. As an investor, Teachers provides BroadStreet with a long-term capital base that has helped drive consistent, high growth for the company.
It all started in 2012 when BroadStreet began exploring alternatives to support its growth plan, says Rick Miley, who founded the business in 2001. At that time, State Automobile Mutual Insurance Company (State Auto) was BroadStreet’s primary partner, and its funding appetite was not as strong as BroadStreet’s desire to grow. Both agreed that a change was necessary in order for BroadStreet’s model to flourish.
With State Auto’s support, BroadStreet began to explore a number of options, which included meeting with several private equity firms. “We had upwards of 10 individual PE companies come visit with us and discovered that they weren’t a good fit,” Miley says. The three- to five-year investment time frame was not appealing to BroadStreet, which was looking for a more stable capital base. “We needed a financial partner, not an investor with a pending flip date. Our business is based on a co-ownership model, which gives our core agency partners the freedom to run their businesses independently. In order to do this effectively, we needed a financial sponsor with a long-term outlook.”
Then, Teachers approached Miley. “They said they wanted to get involved in the insurance distribution business, and we connected—and that connection developed into them buying out State Auto’s interest,” Miley says. As for taking on a pension plan as a financial sponsor, “they think in decades rather than years,” Miley says. “We found out that their average hold time for a direct investment far exceeded the typical private equity time frame, and that was music to our ears.”
Teachers’ long-term investment horizon has made all the difference. “Alongside our core agency partners, we are developing this business knowing that Teachers has a desire to hold it a long time,” Miley says. “They encourage our core agency partners to bring on new producers, and they support capital expenditures in technology and scalable resources. They are averse to high amounts of debt and leverage, so we have a lower leverage ratio than most of our peers. In turn, our core agency partners generate significant free cash flow, and we use this cash to fund acquisitions, distribute dividends to our core agency co-owners and reinvest in the business.”
BroadStreet’s co-ownership approach is an important distinguishing feature of its model that aligns interests and pairs well with a long-term view of the business. Importantly, BroadStreet creates and encourages liquidity for co-owners. “Our business thrives when ownership transitions among core agency leaders. Having an available market for our core agency partners to enter and exit equity holdings is critical for succession planning and reinforces the culture of ownership at our core partners,” Miley says.
Looking toward the future, BroadStreet anticipates a continued long-term relationship with Teachers and continued growth, which includes supporting its core agency leadership teams and creating opportunities to develop the insurance brokerage industry’s next generation of talent.
All in the Family
Baldwin Risk Partners
Aligning with a family office to provide long-term capital has given Baldwin Risk Partners a “forever partner” with multi-generational investors and complete control over their business. “We are insurance entrepreneurs and want that freedom and flexibility,” says Trevor Baldwin, president.
The model is a significant differentiator in the marketplace, according to Baldwin. “We want to build an organization that is a true partnership,” Baldwin says. “So what we have created is the best of both worlds: we have the operating environment and flexibility of a boutique privately held firm with the economic engine of a PE-backed business that allows us to create liquidity for partners and supercharge returns on the business.”
Baldwin Risk Partners’ share price has increased 450% during the last five years. “That doesn’t include the dividends we paid, which were substantial,” Baldwin says. “Factor that in, and you’re looking at close to a 700% return in five years, which you’re pressed to find anywhere. We expect that in the long-term, over the next five to 10 years, we can continue to generate annual returns in the 30-50% range for our shareholders.”
Baldwin says the ultimate goal is to be recognized by clients as a firm that delivers industry-leading innovative advice, ideas and solutions. When the time came in 2015 to bring in additional capital, they had to think outside of the box. Baldwin joined the organization in 2010, when the business was about four years old. He led a restructuring, the formation of the Baldwin Risk Partners holding company and the plans for strategic growth. “We were at a point of raising third-party capital, and we spent the next few years preparing for larger-scale growth—building out infrastructure, recruiting the right talent.”
Baldwin Risk Partners’ capital-raising efforts were not at all focused on liquidity, Baldwin says. “In fact, no shareholders of the business received any liquidity when we raised capital—it was all about growth, expansion and the creation of scale,” he says. The company recognized it was at a point where it needed to sell into the wave of consolidation happening in the industry or consolidate itself, “because scale was, and is, increasingly important,” Baldwin says. “We needed the ability to invest in and afford the type of resources necessary to remain relevant and impactful to our clients, and we needed the scale to access capital markets in a manner where we could leverage our balance sheet to create value for current and future shareholders.” What Baldwin did not want was a five-year turn.
They approached a number of capital providers—pension funds, sovereign wealth funds, family offices, and money center banks. The firm ultimately chose to partner with a family office for a couple of reasons: (1) it had an ability to provide continued capital; and (2) Baldwin Risk Partners could maintain control over the business. “The family office investor is essentially a passive investor,” Baldwin says.
The company accomplished its partnership with the family office in 2016 in the form of a preferred equity security that offers a fixed-rate return investment for the family office investors as well as some minority equity that vests over time. “It looks and feels a lot like debt but is structured like preferred equity as far as how it sits in our capital stack,” he says.
This tool gives Baldwin Risk Partners the flexibility to use leverage in a way that provides economic parity to its private-equity backed peers and the freedom to operate the business as a long-term independent brokerage firm, Baldwin says. “It’s the best of both worlds.”
Unlike private-equity peers, Baldwin distributes annual dividends. “Our capital is such that we don’t need to reinvest that into M&A, so our partners continue to get dividends on the equity they roll into the business, which is a nice way to access continued cash flow and makes the experience of ownership feel like what they’re used to as a sole proprietor or closely held private agency,” Baldwin says.
Last year, Baldwin Risk Partners’ organic growth was approximately 25%. It’s expecting similar growth this year. Baldwin says, “By being insurance-entrepreneur owned and controlled, we can generate great returns and create terrific results and outcomes for our clients.”
A True PE Partnership
In 2013, NFP embarked upon a pivotal $1.4 billion go-private transaction with Madison Dearborn Partners (MDP), a leading PE firm. This provided NFP with significant opportunities for future growth. In 2016, just three short years later, NFP had been so successful in executing on its five-year plan that a second PE firm decided to invest. The interest from a second PE sponsor was a gratifying validation of NFP’s strategic approach. “We were extremely proud of what we had accomplished. In particular, the real proof of our success occurred when other PE suitors came knocking at our door so soon after the initial go-private transaction,” says Adam Favale, senior vice president of M&A at NFP.
The company was prepared for the quick turn typical of PE investors when it entered into an agreement with HPS Investment Partners, a global investment firm, in which HPS assumed a substantial minority investment in NFP. MDP maintained a controlling stake in NFP alongside its management and employees.
Rather than the traditional PE-backed arrangement with one investment firm in the picture, NFP has two PE players at the table, and each brings valuable perspectives, says Carl Nelson, executive vice president of M&A at NFP. “They really act collaboratively,” Nelson says of MDP and HPS. “We feel fortunate to have two exceptional sponsors that are constructive, thoughtful and supportive partners,” he adds.
At NFP, employees and management, including the entrepreneurs that sold their businesses to NFP, own approximately 20% of the equity. “So we have a pretty big stake,” Favale says, noting that the remaining PE partners own the rest of the shares.
What about entrepreneurs who sell to NFP in the future? Many of them will become equity owners of NFP in connection with the sale of their businesses, and the equity is all one class of stock. This means it’s the same for all investors, employees and executives. “The single class of stock is important,” Nelson says. “It’s the same valuation, same terms.”
Nelson relates how NFP has built the business for the long term and maintains that point of view with liquidity. “We don’t have a view on the timeline of a future liquidity event,” he says. “If you build the business for the long term, liquidity will come at the right time and place.
Favale adds, “We have enjoyed partnering with like-minded investors. MDP and HPS have fully embraced our vision on how to grow the company, which allows us to execute on the strategic business decisions that not only align our employee and client interests but also reinforce the values that are core to our company philosophy.”
The New Faces of Private Capital
Whether an agency is planning to sell or perpetuate, these new private capital players are making a marked impact on the industry, and we believe they’re here to stay. They provide more options to sellers, and they will challenge firms that are perpetuating to constantly raise the bar, evolve and build value. It continues to be an exciting time in M&A, and we expect the momentum to continue in 2018 and beyond with a range of private capital getting involved in the insurance industry. As you consider your new partner, make sure you understand the capital structure and what type of reinvestment opportunity is available to you. More importantly, understand how you can monetize the asset. There are pros and cons in each structure. It is becoming increasingly more important for you to understand not just the business plan your future partner has developed but also how that ties into their long-term capital structure and your liquidity options.
Trem is EVP at MarshBerry.