Peter and Doug are joined by Sam Patterson of Springtree Group to discuss how to execute an acquisition as a buyer or a seller, when to bring in third party facilitators (lawyers and accountants, for example), when acquisitions tend to happen through a normal year, the impact that COVID has had on the M+A market and pricing, and the outlook for the insurance industry in a post-COVID world.
Peter and Doug are joined by Sam Patterson of Springtree Group to discuss how to execute an acquisition as a buyer or a seller, when to bring in third party facilitators (lawyers and accountants, for example), when acquisitions tend to happen through a normal year, the impact that COVID has had on the M+A market and pricing, and the outlook for the insurance industry in a post-COVID world.
Doug 0:14
Welcome back to Insurance Agency Insights, where we are committed to helping small and medium sized insurance agencies achieve their business goals.
We're your hosts, Doug Burke, investment banker and advisor to the insurance agency industry; and with me is...
Peter Friedman, CEO and president of AgileCap, a specialty lender focused exclusively on the insurance agency industry. Over the last 20 years, through the the ups and downs of the US economy, AgileCap has advised insurance agencies on their acquisition and funding as they continue to grow their businesses. Every other week, we'll bring you interesting insights on the insurance agency world and how we can help you grow your business.
Doug 0:54
Today's episode is a continuation of our conversation on mergers and acquisitions in the insurance agency industry. We're very fortunate to have Sam Patterson of Springtree join us for this conversation, as we discuss how to execute purchases and what are some of the trends in mergers and acquisitions, pre-COVID-19 and post-COVID-19. Welcome, Sam.
Sam 1:16
Well, Doug and Peter, I am founder and CEO of the Springtree Group. We're a business-to-business M&A company exclusively involved in the insurance agency space. Springtree Group is focused on the market segment below $5 million in total deal size, much the same target market as Peter's group, AgileCap. We live in this space because this is where over 90% of the agency firms in the US are also involved, and our services are much needed. We started this organization back in 1988. And our work involves finding agency sellers, matching those sellers up with vetted agency buyers and then conducting the M&A mechanics of the transaction, which of course includes facilitating the financing for a given transaction. We are agnostic as it relates to the type of agency we work with. So everything from standard P&C shops through Life and Health, MGH and such, with our average deal size around $1.2 million.
Peter 2:23
Yeah, Sam. Following up on our episode of last week, where we kind of talked about what is M&A, some of the things going on in the market, how you would think about mergers and acquisitions... I'd like your insight on how someone executes an acquisition. How do they find something to buy? What's the first step in this process? Where should they look? What should they be looking for? Things of that nature. As you see this every day, what's your opinion on that?
Sam 2:50
Sure, Peter. Deal origination and target identification is the critical onboarding function of what we do. This is job number one. With the average age of an agency owner being 59 years + - and it's increasing - it's estimated that 75% of the current independent insurance agencies in the US will have some type of a transition ownership event in the next 10 years. These events can take many forms: family perpetuation, of course, partner buyouts, mergers, book purchases, divestors, and the actual sale to an outside firm of course. Unique for this space, it is estimated that 90% of the sellers do not publicly communicate their desire to sell. General public knowledge can have a negative impact to the seller's book of business, the employees, and their insurance carriers. If the competition has knowledge of the potential sale, a raid of the book or of critical employees can happen. You know, sellers are in an odd place, where they may want to sell but cannot openly communicate about it. This is where we step in. We have several tools and processes that protect both the seller and the buyer.
Our deal resources for agency listings include our in-house research team, and we produce outbound telemarketing from that crew. We have relationships with many sell-side intermediaries that are not knowledgeable about the insurance space. We also have a network of consultants, attorneys, CPAs, lenders like Peter. Department of Insurance, private equity group, direct outreach from our staff, agency owners, and the big one is broken financing. Broken financing deals are the number one reason why deals fail. So this is fertile ground for us to work because it really relates to both buyers and sellers.
Peter 4:50
Yeah, Sam, so if you have a target identified, and you're a buyer - for a myriad of reasons, you can be a buyer, we talked about that prior. How do you start this process of acquisition? What are the things you got to be thinking about? It's probably your first one. Because if you've done this multiple times, you kind of know the rhythm. But if you're a first time buyer, what are the things that you have to be thinking about that lead to success in an acquisition? Because, look, to be honest, whatever the size of the acquisition is, it's a lot of money. And there's a lot of risks there. So how do you mitigate that risk? And what are the things that you as a buyer should think about?
Sam 5:27
Sure. When we bring the two parties together, first and foremost, we have previously vetted the seller; so when we're bringing a buyer to the table, we vet that buyer. The two most difficult tasks are finding the appropriate target, and then the second is figuring out how to finance the deal. So I know I'm kind of talking around your question, but we are consistent with buyers in helping them understand that financing is the number one reason that transactions fail, as I mentioned. We work for buyers and sellers to help them logically think through how transactions work and the financial mechanics behind the process. This is not rocket science, but there's basic math that goes into it that we have to instill on both sides for them to make this thing work.
To that end, on the seller side, our role is to make sure that we have solid and logical financials to work with.
On the buyer side, we're consciously working towards understanding, "Are the buyers credit worthy?" And do they have the current cash flow liquidity to make a transaction happen? instilling the understanding about what free cash flow is, and how that stacks up against debt service - or the cost to borrow money to complete the transaction - is a critical part of what we do. So, Peter, there's a laundry list of touch points to clear in an M&A transaction like legal, customer information, technology platform matchups, marketing programs, employees, operational infrastructure, contracts with the insurance markets, and so on. But at the end of the day, if the cash flow math does not work, the deal typically does not happen.
Doug 7:16
Hey, Sam, what should the seller be thinking about? Often these insurance agencies are owned by someone who's spent their life building the practice, so it's almost like their children that they're parting with. And they have a very personal relationship with their customers, in many cases, and want to make sure that they're taken care of properly. What should sellers be thinking about?
Sam 7:40
We have pre-sale interviews with sellers. We go through that. And we understand that this is typically a once in a lifetime decision for a seller. This is something that they have spent 30 or 40 years building, developing, nurturing, loving, and this is a traumatic event. It's almost like a death in the family. So we work with them. Intellectually, they have to get over it; they have to understand that, like retirement or like anything else, times do change. And so they need to get best prepared as they can. But it is helpful in those conversations, to get them to transfer this feeling and this emotion about what is going to happen - that their life is going to change - and how do we get from where we are today to a transaction with a buyer that gets them not only the financial rewards that they want, but also not do any undue harm to the book of business or their employees. Okay? So it is important to a buyer that they hear this and appreciate this from the seller.
The buyers modus operandi, post-close is, "How in the world do we take this book of business, that is in this other firm's hands, transition it to our hands with as little damage as possible done to it (meaning we don't have a fall off of the block business). So, we talk through that. Sometimes it means keeping on employees from the seller. Sometimes it means having a consulting contract with the seller to continue on in an advisory role. The transaction process that takes place post-close, where the buyer and the seller join hands and go to their clients, as well as the carriers, to say, "Listen, this is a friendly transaction that's going to be good for the current book of business. It's going to be good for our employees. And it's going to be good for you, too, Mr. or Mrs. Carrier". You see that there? We understand there is a point to get through. And we have to work together between the buyer and seller to make sure that transaction processes is as smooth, gentle, kind, and courteous as possible.
Peter 10:17
You mentioned a lot of advisors to help along the way. Accountants, lawyers, investment bankers - like yourself - financiers, who all charge fees. What kind of fees can someone expect for, you know, your size deal, range-wise, because you know, it is going to cost some money to get a transaction done.
Sam 10:39
Yeah, we view that - again, in the space that we're talking about here - we're seeing transaction costs, somewhere in the 5 - 11% range of the first year's revenue. So, to some people, they go "Oh my goodness, that's that's a lot of money", but it's a one time cost. You need to bring - we totally believe - you need to bring experts to the table. Typically, as we mentioned, this is typically a once in a lifetime deal for the seller. And if he or she doesn't use the best talent available to execute that appropriately, you never know what's going to happen. So we always advise people: spend the money, buy the best talent you can. It's going to cost you just average around 10% of the first year's revenue to get this thing done. A bunch of it is going to go to Springtree Group. This is what we do. This is what we've been doing for years. Some of it's going to go to your attorneys - which you're going to be glad, years down the road, when something comes up, that you had good counsel. Some of it may be an issue of cleaning up accounting problems, which should have been cleaned up before, but now we see what it is and we're getting those things fixed.
So, you know, If they can get that through their head and know that, "Okay, I'm making 20% on this business. I'm going to have to spend half of that on the first year to actually transact this deal. Then from Year Two on I'm back to 20% or more, again." Hopefully there's synergies involved with this M&A deal - that is going to make their margins even higher. They're going to be making probably better through bonuses and contingency bonuses, and they're going to be making higher point-in-scale comp from their carriers. So it is expensive when you look at the pure numbers. When you look at, "Gee, I'm going to have to cut a check to Springtree Group for tens of thousands of dollars.".. we get it, it is expensive. But in the grand scheme of things, we're talking about a business-to-business environment. You have to separate - for a seller and a buyer - you have to separate a personal transaction from a business transaction. Business transactions are more critical, bigger and more expensive.
Peter 13:04
Yeah. Do you see carriers having an opinion about acquisitions? Are they supportive of it? or indifferent? What are the trends that you're seeing on the broader insurance agency world that maybe could impact acquisitions from the - I would say the "higher ups" - the carriers, the MGAs. Do people want agencies to come together? Or are they not supportive of this?
Sam 13:34
Our opinion is that carriers - the insurance markets themselves - are tuned in to finding high quality distribution arms (aka: agencies) to manage their business. Their preference is to have fewer and bigger agencies to actually do the marketing of their products. So we're seeing that insurance carriers are tuned in and like to see this happen. It impacts the agent from a number of positive perspectives, in that, if an agency has a bigger block of business, then typically they go to a higher point-in-scale with insurance company. The insurance company has to spend less resources keeping an active marketing channel open and available. So they like it. But all insurance companies will actively vet the agencies that they're bringing on. So if an agency currently has a contract with the market, so be it and that's great. They just move up in scale, their contingencies are better. Oftentimes they get a higher percentage on their commissions. But if they're not involved, then we have to go through the process of getting those agencies attached to those given insurance companies. And there's a process to that that they go through. But generally, an insurance company does not want to walk away from a book of business that's being purchased by another agent. So they are involved and interested in making sure that that new agent - if he or she is not involved with them - is taken care of and is in good sorts with them to move forward. So it's a positive thing for an insurance company, most of the time, to be able to pull in bigger agencies, and that is typically done when you bring books of business together.
Peter 15:38
Another advisor, other than us - on the financing side - and you - on the relationship side - that we've seen in transactions are the lawyers - the legal side - as well as the accounting side. Now, our experience has been, I'd say a third to 50% of the time you will have an accountant or outside lawyer involved. In your experience, is it better to involve an outsider - such as a lawyer - advising? Are the contracts pretty straightforward? Is it better to have your accountant review the financials, or - we've seen financials be pretty simple - and so it can be done by the purchaser? How do you see it work best? Or is there no true best and it's very dependent on the situation?
Sam 16:24
We always advise both buyers and sellers to have independent third party support for both the legal side as well as the accounting side. If a potential buyer and/or sellers give us the opinion that it's not necessary, we can provide the templates for contracts, non disclosures, bills of sales, and things like that. But we always advise buyers and sellers - we always advise in writing - that they should have that technical support on both sides of that equation; both the legal side as well as the accounting side. Most of the time, both the buyer and seller will bring to the table logical and consistent accounting practices with their current vendors. Most times, however, there is not a M&A type attorney involved; and this is specialized practice, on the legal side. So we have a list of folks that we will recommend. We don't get paid by them, we don't influence them or anything like that - because it is important to have independence in those opinions. But we will bring folks to the table for buyers and/or sellers to consider. So we think it's important that both of those practices be clearly articulated and have professionals working on them in a deal.
Peter 17:53
Interesting. We've seen cases where lawyers and accountants get involved, and sometimes to the detriment...they may not know the insurance agency world very well. And we've seen situations where we believe a lawyer or an accountant should be involved, because the issues may be complex, and the buyer or seller is refusing due to cost. So, we see a wide range. I do like your recommendation, which is: it's always best to get that third party looking at things because you just don't know your own blind spots.
Sam 18:28
Peter, granted there is a whole army of attorneys that will - and I'm not here to talk down towards any practice - but it is important that the attorney and the buyer and/or seller understand what the end result here is. We are trying to conclude a transaction. We're not trying to delay or postpone or drag on a project because of nuancing over a sentence syntax. And so there are times where we advise either the buyer or the seller that, either they need to take control of their legal support or they're going to lose the deal. And so we try to get that point across.
Peter 19:16
You bring up another good point and a question I've had, which is: Is there a better time to be doing an acquisition? Do you see more acquisitions that are at year-end? Or are there cycles to when acquisitions happen, or is there just a natural rhythm of the business that you see?
Sam 19:36
As you would guess it depends. If the seller happens to own a shop that has a large segment of health-related business, as an example, then Q4 and Q1 are not good. Their attention is being directed towards enrollments during the winter open enrollment seasons for most - 60% of health care products renew January 1 - so there's all that process that is distracting those folks. So with those types of businesses, we tend to concentrate on Q2 and Q3. However, with P&C shops, most of those buy and sell dates do not have the same type of seasonality that the healthcare folks do. So they're pretty wide open. Most financial years do end December 31, so there are a number of folks that try to - because of strategic plans or what have you - try to conclude their businesses, if they can, to transact on January 1 so they have a clean year. It's almost the antithesis of the health care agencies on the P&C side.
Peter 20:52
Sam, we're in a new world today, I would call it "The post-COVID World". Do you see anything that we've kind of talked about materially changing in the near term, and then in the long term, as we all navigate not just the economic impacts, but the social impacts of COVID-19, and how people are operating? I can say, what we've seen is most of our clients have done exceedingly well in the near term. The long term is to be determined. There's some caution that we've seen in the M&A market on our side, but you see it much more than we do. So I'm curious how you're seeing this whole new world look.
Sam 21:38
From our operational perspective, from a Springtree Group perspective, it surprisingly hasn't changed our world as much as one would assume. We've always run our operations on a distributed basis. From a pure operational basis, we have folks in Nashville, Columbus, Phoenix, Charleston, multiple locations in North Texas. As you know, we headquarter in Carrollton, Texas. So we've been able to operate somewhat normally.
From a client perspective, it seems both buyers and sellers - the leaders of these organizations - seem to have a little more time to think strategically about their businesses and work through that decision to sell or buy versus build. That's typically high on their conversation list. And granted, there's certain pieces of the business or certain sectors that are suffering - like those agency owners that cater to restaurants or the travel industry or airlines, as examples - but generally the need and demand for insurance product is sound. We view agencies as very stable and recession-resistant. But we just have to keep an eye on those sectors that we know are going to struggle. But as long as, Peter, we have folks like you that are able to help us figure out the financing side of this equation, we can typically bring buyers and sellers to the table.
The transactions themselves are now done electronically. You seldom have to go somewhere and shake hands or meet folks. We have that separation that this COVID impact appears to need, but at the same time we can get business done.
Now, in the long term, I don't see anything that's telling me that this stable, recession-resistant, highly profitable, distributed system that we have for insurance agencies is going to crater. There was talk years ago - and there still is periodically - about agency work going to technology platforms and people just accessing their products through the internet versus actually talking to an agent and such. And we're not seeing that. We heard that and we know companies like Allstate with the insurance etc. have - you know, they tried to make a foray into it - and it's just it doesn't appear... the independent agency world doesn't appear to be collapsing like some pundits had thrown out into the market that was going to happen. So it's...we're still seeing things pretty stable.
We're also seeing that turning trends, as an example: private equity guys will continue to see the value in owning these agencies because of what we just said. They're recession-resistant, stable, and they have high profit. The private equity world, you know, they're smart guys...but they tend to focus on larger deals. Mostly above what we, here at Springtree Group, consider our target market.
Concerning pricing of the agencies, everyone wants to know, "Gee, are the multiples trending up or down?" And you know, the industry has been pushing up multiples for many years. But our sense is that, for the last two years, we are pushing the upper limits. Once the price gets too high - especially in the market that we're talking about... we're talking about businesses...our average is $1.2 million, as I, as I mentioned - so, once the price gets too high to have an agency cash flow, it's difficult to sell it. There has to be enough margin, or net profit, to cover the debt and make some money for the new owners. So, you know, we believe that there's going to be at least a half a dozen more years that will continue on this trend.
And we do see some change - Peter, this isn't your question - but concerning structure: we're seeing fewer and fewer earn out type deals than we saw in the 90s, and more all cash or cash and seller note type deals. And this is primarily a point of the knowledge of their lender, like AgileCap. It understands the space and is willing to lend into it utilizing reoccurring cash flow, common in insurance agencies. Fundamentally, as anyone that's been around the space knows, there's very little hard collateral to actually leverage for a loan in financing. So the use of reoccurring cash flows collateral has changed how we underwrite. And sellers know this. So they're coming to the market with "Gee, I'd like to have a big chunk of cash and then maybe a seller note". But generally a multiple year (4 or 5 or 10 year) earn out, according to results process, the way we had in the 80s and the 90s...we don't see that much anymore.
Doug 26:43
Wow, Sam, thank you. That was really, really insightful and really helpful. I really enjoyed getting to know you on this podcast.
Peter 26:50
Sam, thanks for joining us. It's really great to get your insight into what's going on in the marketplace for insurance agencies. Our next topic is going to be a look at the Lending Landscape, which means: how can you borrow money, whether that's your uncle or your family member or AgileCap or SBA banks. And kind of what the landscape is for borrowing money right now. We'd appreciate it if you could follow us on Twitter @AgileCapFunds, or on Facebook @AgileCap and finally, online at www.AgileCap.com, where you can sign up for our newsletters and other information. Sam, where can people find you?
Sam 27:29
Thanks, Peter. Thanks, both you and Doug for allowing me to join you guys today. Again, my name is Sam Patterson. And please feel free to email me Sam@Springtreegroup.com. We're on Facebook, we're on LinkedIn. Please visit our website at www.springtreegroup.com. Communicate to us via email, voicemails, call us, whatever you would like to do. But we'd love to engage with you and see what we can do to help you.
Peter 28:03
Great. Sam, thank you so much. I appreciate everyone taking the time to speak with us and stay safe and stay sane out there everyone