By: Robert Pettinicchi
Recently, private equity (PE) firms have slowed their rapid pace of insurance agency acquisitions and some buyers have even hit the pause button. It is unknown if this is a case of indigestion or lack of capacity, but the slowdown is clear.
The slowdown relates to increases in interest rates. In March, the Federal Reserve made its ninth hike to interest rates in the last year. The unintended consequence of the increases is that asset values determined by the capitalization of future cash flows—like your agency and technology stocks—have been negatively impacted.
The other impact is that with rate increases, it costs more to pay the interest on debt used to buy an agency. This is why PE buyers, who use borrowed money—and a lot of it—are having a case of acid reflux from their recent purchases. They might be realizing that they may have paid too much, overestimated synergies or cost savings, or didn’t buy agencies that were very special.
With many PE buyers now taking a pause, some agency owners might wonder if they can still sell their agency and get a good price. While it’s a legitimate concern, unless an agency principal is actively seeking to sell the firm for retirement or other reasons in the very near future, there is no cause for alarm. The agency owner is still very well off owning and running the firm with continuing good cash flow.
Yes, valuations of independent agencies might have leveled off in the current interest rate environment. But owners can get a good price for their business if they have attractive cash flow and other positive attributes. Even with fewer prospective buyers, demand is high for larger and specialist agencies and always strong for those that are exceptionally well-run and growing.
Additionally, there’s a silver lining: the PE pause has created potential opportunities for agency owners to acquire another agency that otherwise might have been out of reach.
Strategies Outside of a Sale
An agency with reliable cash flows and a promising future will always be attractive, which means the first strategy outside of selling is to increase cash flow. Agency owners who place a strategic emphasis on growing cash flow by running an effective, efficient operation are adding to agency value while broadening their tactical options over time. Cash flow drives the vitality and viability of a firm, funds its operations, and generates cash for future investment. It’s also the source of compensation and wealth for the owners.
Cash flow is the most-revered financial measure for lenders and buyers alike. Agencies are attractive investments because they generate reliable, recurring cash flows and offer future growth prospects.
Other strategies for agency principals are to seek out acquisition opportunities. Less competition for an acquisition could bode well for principals who become timely buyers. A nimble, financially ready agency principal can become an agency buyer. Additionally, buying a book of business, particularly one that adds a specialty, can make sense for increasing market share, adding a growth platform and building cash flow.
Also, a side effect of the flurry of PE buyers over the past several years has been upheaval for producers now working for PE-owned brokers. Some producers might be less comfortable in their acquired agency environment than they were before it was purchased. This talent may be good candidates for principals to recruit to their firms. And, rather than selling your agency, a staged perpetuation may be a great option to consider.
While borrowing has presented challenges for PE brokerages, agency owners should not be afraid to borrow—even at the current, higher interest rates—if the use is for productive purposes such as acquiring an agency or a book of business. Refinancing debt at a floating rate provides an opportunity to borrow. There may be an opportunity to fix your interest rate to one that is lower, saving interest and improving cash flow.
Increasing interest rates might have put a pause on PE buyers, but they have also created an opportunity for agency owners with vision and the courage to act.
Robert Pettinicchi is the executive vice president and chief lending officer for InsurBanc, a division of Connecticut Community Bank N.A.
The article was originally published on iamagazine.com.
Original article: https://www.iamagazine.com/strategies/private-equity-takes-a-pause-what-it-means-for-agency-owners