What consolidators look at before buying a brokerage

Buyers of Canadian P&C brokerages are becoming more selective in their M&A targets, with an increased focus on future profitability, Vancouver-based advisory firm Smythe LLP told Canadian Underwriter.

Purchasers are still quoting high revenue multiples and prices aren’t necessarily decreasing, but acquirers’ criteria for what they’re willing to pay for is narrowing, said Alex Wong, partner at Smythe LLP and the practice group leader for its transaction and valuation advisory group.

“So, a brokerage that may have a big top-line revenue number but isn’t overly profitable, you’re not going to get a high offer price for it,” Wong said. “Along those lines is, does the acquirer see a path [to] grow that profitability once they take it over?

“A lot of these themes existed before, but acquirers are getting disciplined now and really paying a lot more attention to it.”

What consolidators want

Consolidators have long looked for cultural, value and strategic fits. And now they’re also focusing on client quality and demographics, as well as an understanding of markets, Wong said.

For example, some commercial brokerages or smaller brokerages lean heavily on MGAs — which have a lower commission rate — so acquirers may look to move some of that business from MGAs to be able to offer a higher commission.

Insurance brokerages, and businesses in general, also tend to look for companies that can provide extra layers of expertise to their current operations. But does that mean brokerages are looking to become specialists?

“I wouldn’t necessarily say ‘specialist’ because it’s not as though they are focusing only on certain industries at the expense of others,” said Wong. “But they really want to hone the expertise in specific areas.… They’re looking for acquisitions that complement those areas [and that’s] going to be a big focus.”

Not every brokerage is looking for specific expertise. Some seek an all-around mix of auto, personal and commercial lines, for example. “But there’s definitely…more of a movement in that [specialist] direction,” Wong predicted.

Today’s economic environment is a wild card. Wong doesn’t think higher capital costs sparked by rising interest rates will dampen the M&A appetite in the brokerage sector. But “it’s going to make acquirers more disciplined and more selective,” he said.

Selective appetites

Pete Tessier, vice president of innovation and strategy with ONE Insurance, shares Wong’s perspective. He said current economic conditions will not slow brokerage consolidation; rather, it will make deal appetite more selective.

Tessier, formerly CEO of BSI Insurance, was part of the merger between BSI and ONE Insurance in late June. The merger is expected to close by early 2024, with both companies operating under the ONE Insurance brand. The new entity will be the largest Manitoba-owned brokerage network with more than 200 employees.

In the case of the ONE-BSI merger, Tessier said the nature of the deal minimized the impact of capital costs. BSI was owned by three mutuals, and so money wasn’t coming onto the table to buy one entity, he said.

“We have a unique opportunity here, where money isn’t necessarily changing hands as much as diversifying ownership percentages,” said Tessier. “This is about bringing the brokerages together because the owners are essentially the same, the third being a minority one, and they’re simply reducing ownership stake.

“This is a great merger because it literally does not require intensive capital to do.”

Are other brokerages looking at different methods to diversify their ownership structures or minimize the impact of capital costs?

A few deals Smythe LLP’s worked on in the past few months involved sellers retaining some ownership of the brokerage, Wong reported.

“In order to reduce the amount of cash they had to fund on closing, [acquirers] wanted the owners to retain a bigger equity stake,” he told CU.

Another emerging trend, albeit a small one, involves earnouts. Here, sellers ‘earn’ part of the purchase price based on the performance of the business post-acquisition.

“So, part of that purchase price [is] paid a couple of years down the road, only if the company is able to hit certain targets,” Wong explained. “We’re starting to see that a little bit, but it’s still not overly common in multiple-offer situations.”

This story is excerpted from one that appeared in the August-September print edition of Canadian Underwriter. Feature image by iStock.com/metamorworks