|
|||||||||
|
|
Home :
Research & Resources :
BEYOND THE TOASTER: How the right bank came up with the bread to save a growing firm's buns. There really is a Santa Claus for agency capital.Leader's Edge, September 2006 FAST FOCUS
We all know the dilemma that both private and publicly held agencies face today in wake of soft product rates: How can I grow my agency? But the real question goes much deeper: If I do not grow, what will happen to me?
For public companies, the question can be boiled down to how to keep shareholders and Wall Street happy. For privately held agencies, the issue is much more critical: If I do not grow, how can I remain independent?
Fortunately for public companies, access to capital for growth is normally not a problem. However, privately held agencies are faced with the necessity of growth merely to ensure survival. Yes, survival. While some agencies can operate on the status quo, they are really just dragging out their ultimate demise.
On one thing, everyone agrees: growth is the key. But that begs the next question: Do I grow organically by hiring producers or do I go out and acquire another agency? The answer is not easy, as both routes are filled with traps. Unfortunately, most privately held agencies rely on hiring producers because they do not have the capital to fund an acquisition. I could place the blame on this situation by preaching, “I told you that you should have reinvested your profits back into the agency instead of giving yourself that nice fat bonus or distribution each year.”
Well, we will not go there. Instead, let’s discuss a successful agency with an owner who’s come to the time of life when the question arises of passing on the business.
Organic growth, acquisitions and succession planning are tough enough when times are good. But today we’re talking about soft markets and low organic growth rates, and many firms can’t get past the first questions about simply staying afloat. You may say, “That’s not me. I am a successful agency owner, my firm has continued to grow at 15% per year and I have an excellent management team.” But if, like our hypothetical agency owners, you are 60 years old with no desire to sell the agency to a public broker or bank, you’ll be wondering how to perpetuate without having to personally hold a note and get paid over a 10-year period.
Regardless of your situation, whether it is capital for growth or for perpetuation, the ultimate question is: How do you obtain financing to solve your business issue? Luckily, the answer is not as difficult as you may think.
All Lenders Not Created Equal
It is true that most banks do not lend to insurance agencies beyond just the minimal amounts. You show them you are profitable, you show them your own personal balance sheet and, lo and behold, your bank—the same one that told you it was a “relationship bank” and made money from holding all your trust account funds for 10 years plus—is willing to give you a $100,000 line of credit, personally guaranteed by you, the owner. Well, that may be fine if you are an agency that does $500,000 in commission revenue, but what about the $5 million commission revenue agency?
This example is not far-fetched. I have seen Top 100 brokers who have a hard time obtaining any meaningful amount of debt capacity. The reason is simple: the bank sees very little in hard assets and does not understand the value that could be obtained from the agency’s renewal rights and its associated cash flow. For the typical agency owner, the thought of an acquisition or perpetuation at this point is given up as impossible. But a creative agency owner does not give up just yet.
Luckily, as the insurance distribution industry has evolved, so has the banking industry. Today, there are a select few lenders who specialize in the insurance distribution industry. These are the lenders who truly understand the value and risks associated with an insurance agency. They understand the value of renewal rights (book of business) cash flow, and they understand the majority of value in an agency is not in tangible assets but in intangible ones.
True Story of Hasta
Let me tell you the true story of Hasta Rasta (names have been changed to protect the innocent!), and maybe you, too, will believe in Santa Claus again.
Hasta Rasta is the owner of a $5 million commission revenue agency that was generating $1.5 million in pro forma EBITDA (earnings before interest, taxes, depreciation and amortization).
In July 2003, Rasta had come to realize that, at age 58, he needed to seriously think about perpetuating his agency. He’d already come to the conclusion that an outside sale was not for him or his agency. Knowing that he had a strong management team that was interested in ownership, he approached them about buying him out. The meeting was great, and Hasta Rasta promised that he would get things moving quickly and that, by the end of the year, his perpetuation issue would be resolved.
The logical place to start was his local bank president, Joe Traditional. Hasta and Joe had a great relationship, and Joe had even provided a $250,000 working capital line of credit to help fund growth several years earlier. Prior to the meeting, Hasta sent Mr. Traditional his financial statements and tax returns for the past three years and a brief memo on what he wanted: an $8 million loan to be amortized over 10 years so he could sell 100% of his shares to his employees. He would have the agency guarantee the loan and he himself would provide a secondary guarantee. If there was ever a simple loan, this was it—or so thought Hasta.
Well, the meeting began as you would expect. Pleasantries were exchanged about the families, golf games and recent vacations. When it was time to get down to business, Hasta came in for the shock of his life. Mr. Traditional dropped a bomb on our agency leader. In summary, here is what he said.
“You have to be kidding me!” said an astounded Rasta, who quickly became frustrated by the inability to make Joe Traditional understand his agency’s value. The meeting ended with Joe saying he was really sorry and maybe the best thing to do was just to sell the agency as a way for Hasta to get his liquidity out of it. Angered and confused, Hasta left the meeting and started to reflect. Maybe I should not have done this by myself, he thought, maybe I should have hired an advisor to think through what to do and how to do it. He could not go back to his loyal employees and give them the bad news. At that moment, he made the decision to hire the right people to get this done properly so he and his employees could reach their goals and objectives.
To accomplish this, Rasta interviewed an insurance agency financial advisory firm that specialized in accessing capital for agencies. Within two months, he found himself fully engaged and moving forward with the perpetuation plan. The primary goals of the plan were:
After weighing the attributes of key man loans (loans written by banks to Hasta Rasta himself and to his team individually to enable the buy-out), Hasta Rasta and his advisors decided that a leveraged employee stock option plan (ESOP) was the optimal financing vehicle to use. It would not only align the team with the agency’s future success, but it would allow the team to build enterprise value more quickly because the leverage used to fund the ESOP would, over time, legitimately save millions of dollars in funds that would otherwise go to federal income tax. He initially would sell 60% of his shares to the ESOP, and the ESOP’s structure would provide a ready platform for him to sell the remaining 40% of his shares at a later date. Also, the ESOP’s tax advantages would allow the management team to acquire other agencies if they desired to do so. Finally, and maybe most importantly, under the ESOP structure his loyal team would not be forced to borrow money personally to buy stock in the agency they were building. The agency and the ESOP would be obligated, and they would receive stock over time as the agency became successful.
The advisors and Hasta worked closely together over the next two months to prepare the proper information to send out to banks that truly understood insurance distribution financing. The process went smoothly, and as Christmas 2003 was approaching, Hasta was visited by Santa Claus in the form of several commitment letters with the following terms:
For Rasta, his decision not to give up and to instead hire experts, allowed him to achieve the goals and objectives for both himself and his employees. In the end, he received the greatest holiday gift of all because that step confirmed that his decision to proceed with perpetuation strategy was right on the money.
Fast-forward to Christmas 2005. When Santa arrived two years after the ESOP, here is what he left under the tree for Hasta Rasta and his team:
As a side note, what was Joe Traditional doing by Christmas 2005? As you might expect, Mr. Traditional did not like change, his bank did not perform well as interest rates rose, and now his title, is Joe Traditional, regional senior executive vice president. Yep, Joe had to sell his bank and was reassigned as a regional head of a much larger organization. The reality is, he’s probably heading to retirement by the end of 2006. Pardon the pun, but it is safe to say that was “a Tradition well served!”
Bank of Santa Claus
There really is a Santa Claus out there for insurance agencies looking to access capital for growth or perpetuation. His name may not be Kris Kringle, and he appears in the form of one of those banks that specialize in serving the insurance distribution industry. The bank’s profile may look like this:
So, no matter what your needs are, do not despair. There is a lender that can help you solve your capital problems. You would be surprised at how much they will lend, how creative they can be, and how flexible they are in providing solutions to your most difficult business issues.
Lieblein is a contributing writer and managing principal of WFG Capital Advisors. rlieblein@wfgca.com |
||||||||||||
© Copyright 2007 WFG Capital Advisors LP. |
|||||||||||||
|
|
|
|
|