The Lending Landscape, part 1, with guest, Kelly Drouillard, SVP at Live Oak Bank

Peter and Kelly discuss SBA lending, the importance of finding the right borrower-lender fit, and the future of M&A and lending as the insurance industry enters an initial recovery phase from the COVID pandemic.

Transcript

Doug  0:14  
Welcome to insurance agency insights, we're committed to helping small and medium sized 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  0:28  
Peter Friedman, CEO and president of AgileCap, a specially lender focused exclusively on the insurance agency industry. At AgileCap we believe agency owners can take control of their businesses when they have a thorough understanding of the financial aspects of their agency. Over the last 20 years, through the ups and downs of the US economy, AgileCap has advised agencies on borrowing money, acquiring new businesses, and investing in their future. Every other week, we'll bring insights on how financing and  capital can and will impact your agency's future.

Doug  1:00  
Peter throughout an agency's lifespan, there are several ways that an owner might want to build, grow or evolve their agency. These can include the startup costs; working capital for marketing and equipment and other things; hiring employees and top producers; refinancing for improved cash flow; acquiring another book of business or another agency; partner buyouts; building a property to expand into; the payment of tax liabilities; or even agency perpetuation issues. And unless you're sitting on a big pile of cash that you can use to fund your plans, or you have friends and family or access to private equity that will provide you the money you need, you're typically going to have to borrow. Peter, how should an agency owner think about borrowing money to grow or start up their agency?

Peter  1:50  
There are lots of lenders out there, everything from large national banks to local community banks, SBA lenders, and specialty lenders. Each one has its strengths and weaknesses. When it comes to the strategic fit for your borrowing goals, it's important for you to understand all the options out there. You make an informed decision about that best fit...it's like matchmaking. We thought it'd be worthwhile to introduce our audience here today to some of the lenders who we know and respect and trust; and sometimes we refer business back and forth. They can talk about where they fall in what we would call the "Lending Landscape". Today we have Kelly Drouillard from Live Oak Bank joining us. Live Oak is one of the premier SBA lenders in the country, and they have a very strong team focused on insurance lending. Welcome, Kelly, if you could just introduce yourself and tell us a little bit about Live Oak Bank. 

Kelly  2:42  
Thank you, Peter. I'm Kelly Drouillard. I've been with Live Oak Bank a little over five years. I'm a career insurance person. I have been in the industry for over 30 years. I've been involved with everything from retail agencies to reinsurance. For the past 15 years, I've focused exclusively on lending to insurance distribution; primarily to retail agencies. At Live Oak Bank, we are the number one SBA lender in the country. And we're also the number one Insurance Agency lender. We have a team of five on our insurance lending vertical team and we work on insurance deals all day every day. Across the bank, we lend to 30 different industries. Last year we did about $2 billion in loan originations. For insurance agency deals, our minimum loan size is $200,000. And we go up to about $10 millionn. We can go higher with syndicated capacity. Most of our clients are first time buyers, most of our clients are first time doing a commercial loan. We really take time with our clients to understand exactly their business plans and needs, and also explain everything about the loan process, every step of the way.

Peter  4:08  
It's so interesting, recently, with everything that's been going on with COVID, the SBA has taken a predominant role in lending. It was always there. It's always been a reliable, excellent source of capital for all sorts of industries, especially in insurance. But right now you have the SBA program, the EIDL, which is the Economic Injury Disaster Loans, and finally, the PPP, which is the Payroll Protection Program, that's been rolled out. And so the SBA has taken a huge role in kind of access to capital in small to midsize businesses. And I know Live Oak is one of the leading SBA lenders. What's going on? What is the future of  all these programs and how are they going to play out over the next six months?

Kelly  4:52  
Well, you know, there is so much going on. So let's talk about the two headline SBA Programs first. The Payroll Protection Plan loan; that was obviously unprecedented. Although the SBA has been an economic force during recessions for many, many years, the PPP program was the first of its kind. So the PPP had two rounds. If an agency has not yet received a PPP loan, there is a last call, you can still apply. And there's probably I believe, $40 million left to be dispersed, last I heard. The interesting thing about PPP is the forgiveness process is still muddled. The forgiveness rules have changed; the PPP rules have changed. So PPP lenders are not in a position to process PPP forgiveness yet. Congress is back in session, they are due to recess by August 7. We hope the PPP forgiveness rules will be final as well as the tasks that PPP lenders like Live Oak Bank are required to do to process the forgiveness. Interesting, is there is a movement to have all PPP loans under $150,000 automatically forgiven. This is not final, it is absolutely not certain. That would simplify the forgiveness process immensely for most PPP recipients, but we just don't know yet. So for now, PPP recipients should just sit tight, and we expect more clarity on the forgiveness process and rules in the coming weeks. The other SBA loan program, the short word is EIDL, the economic injury disaster loan. Idle loans are directly from the SBA And that was an immediate source of coronavirus economic relief. Once the pandemic was underway, the EIDL program kind of had a rough start, but then it gained momentum and the processing became pretty simple. It's been very successful. That's a 30 year loan with a 3.75% interest rate. Now the EIDL program is currently out of money. You can still apply directly with the SBA, and it's uncertain if Congress will appropriate more funds to the EIDL program. But it's very popular, gained a lot of momentum, and currently it is out of funding. But that's another possibility for Congress, that it will be refunded in this session. So one program with the Cares Act that has been overshadowed by PPP and EIDL is a provision within the Cares Act provides for six months of your loan payments to be made by the SBA. So if you had an existing SBA loan, or you have a new SBA loan that closes by September 25, the SBA will make six months of your loan payments. This is an incredible opportunity for agency owners to rebuild working capital to maximize cash flow. And we're extremely busy with SBA loans to close by September 25. I would urge you that, if you are interested in this, you need to act quickly, as most lenders -- including Live Oak Bank -- we have a huge pipeline of deals that will close by September 25th.

Peter  9:01  
As Kelly and I -- I think we cooperate and we compete at the same time -- and we see this program of six months of forgiven payments...it's surprising to see it in the marketplace. And to be honest, it's hard for us not to advise our clients to pursue an SBA loan. The feedback we've heard is the pipeline is pretty jammed up. If someone were applying now, is it impossible or just really difficult to get it done by that deadline?

Kelly  9:30  
Well, certainly with Live Oak Bank, it's possible to get it done. We internally have established an August 1 cut off of applications. So you know, we're a week away or more from shutting down new business applications. But at this point, we can absolutely get it done by September 25.

Peter  9:52  
And you don't have any insight on whether that's on the table to be extended in the latest rounds of negotiations? I know Live Oak, being just such a great SBA lender, probably has better insight than we do at AgileCap.

Kelly  10:05  
There are so many changes to SBA programs being considered that it's too soon to tell or too soon to make predictions. We have not heard that that deadline will be extended. So I would not wait.

Doug  10:21  
Kelly, what are some of the pros and cons of taking an SBA loan?

Kelly  10:25  
Well, from my perspective, there's a lot of pros. I've worked with a lot of different money over my career. Different types of money from specialty lenders like AgileCap, to conventional bank loans. The SBA loan is a 10 year loan that is fully amortizing with no prepayment penalty, and generally the interest rate is very, very favorable. So I think it's the friendliest money you can borrow. On the con side, there is a level of regulation that must be followed for an SBA loan, as sometimes transactions are just not eligible. There are different reasons for that; there's some quirks in the SBA program. Sometimes they're showstoppers, and it just won't work. I think that the myth of it taking too long and requiring too much paperwork... that has dissipated a lot as Live Oak Bank and other lenders, we've really done an extremely good job of streamlining the SBA loan process. So I wouldn't say that it's timing or paperwork. It's more eligibility and use of proceeds that can limit if the SBA is a good solution for the client.

Peter  11:49  
We find that we were comfortable referring our clients to an SBA, and then there are times that they'll come back, though. A quirk of the SBA -- Kelly, you'll have to correct me if I'm off here -- is they'll support buyouts of partners, but not partial buyouts. And that's just a quirk of the regulations.

Kelly  12:09  
You're correct, Peter. A partial buyout is a quirk of the SBA and SBA proceeds cannot be used for a partial buyout. You have to buy 100% of the business, or 100% of the exiting shareholder.

Peter  12:26  
Interesting. Kelly, we all live in the COVID times, as you do. And you've experienced -- I think you're working from home -- we're all working from home. And we've seen some pretty direct impacts on our clients. Some immediate, and then some, kind of, people are trying to understand. So, with some things that we've seen -- and I'm not sure if you've seen it as well -- is there seems to be lenders want to see that their borrowers understand that COVID is there and they're not ignorant to it. You know, sometimes the client will say. "That's a non-issue." And we see internally -- our underwriting team very much wants a month-by-month over the last, roughly six months, to understand what's been happening to the business. We also are seeing potentially a disconnect between buyers and sellers on pricing. Sellers want to believe their businesses are strong, and want the same pricing they had pre-COVID; and buyers are uncertain. I'm kind of curious...some of the things that you see COVID impact... what it's done and, kind of, what you expect it to do in the future.

Kelly  13:30  
Oh, you're exactly right. Depending on the type of insurance agency and the book of business, the impact can be negligible or it can be pretty dramatic. So with our commercial lines agency borrowers, we're definitely in close contact and we're monitoring the activity in their hospitality, their fitness, retail, those types of businesses that are having a big vulnerability to the COVID-19 impact. We're analyzing the trends; were extrapolating to predict -- based on what we know now -- where their revenues are headed. But it's definitely a lag until their workers comp, premium audits, and the commercial lines adjustments come through. Right now it's still a little bit of a guess and we're watching it very carefully. On the valuation in the M&A market, it's interesting because the M&A market for what we do -- typically transactions under $10 million -- it is absolutely booming. And I think there's two reasons for that. Obviously, the SBA incentive for six months of payments made on your behalf is a huge incentive and has definitely accelerated some deals. Even moreso, we have seen sellers that have been standing on the sidelines debating about selling. Now they are very motivated to sell. So it's really kind of broke that log jam up. It's just taken too much energy for some agency owners to put the right technology in place to work from home. For many agency owners, it's their fourth recession, they just simply don't want to deal with it anymore. And there's also a big concern about what tax rates are going to do and the November election. So we're definitely seeing 21 and 2022 deals, accelerate and actually becoming live today to close by September 25. On the valuation and price side...the valuation...there hasn't been a change in the multiples or the methodology, but there is a lot more scrutiny in the commercial lines books, to understand the COVID-19 impact; really drilling down to the line of business level, and even the account and client level to see what that exposure is. And we're starting to see, you know, policy cancellations, endorsements to reduce headcount, endorsements to reduce the exposure base...take commercial autos off of the auto policy...that kind of stuff. So, a lot more due diligence. One thing we are seeing in terms is a stronger emphasis on a partial seller note with a clawback. For example, if the purchase price was 80%, cash at closed and 20% of a seller note, we are seeing more clawbacks in their seller notes that are subject to revenue adjustments. If revenue comes in less than expected over a two to three year period, there will be a decrease in the seller note that would result in an overall lower purchase price. So this gives the ability for the transaction to go ahead and close. The seller gets a fair purchase price, the buyer gets a fair deal, and there's a protection in there, that if revenue falls off more than anticipated that that seller note would be adjusted, and ultimately there would be a lower purchase price.

Doug  17:20  
Kelly, you bring up a great point about the election. No one can actually predict what's going to happen on November 6, but if the Democratic candidate gets elected, it's likely -- they've already proposed -- that the capital gains rate would go up. It's not certain what date that would be set at but typically it's on the new calendar year -- sometimes it's when the law actually passes -- and it also depends on who controls the House and the Senate, post-election on November 6. So, between November 6 and 12-31-2020, there could be a lot of activity trying to close in the M&A market, depending upon the outcome of the election. 

Kelly  18:12  
It's certainly possible.

Doug  18:14  
If you want to try to do a transaction in that narrow time window, you better get ready now. 

Kelly  18:14  
Absolutely, you need to be working now. Typically, in the end of the year, we have a lot of transaction effective dates go to January 1 because the agency owner has almost an entire year of ordinary income from the operations of their agency, and they want that long term capital gain to be in the next tax year. And then they have a lot longer timeline before they have to physically pay those taxes. Yet, if the capital gains tax rate changes, it is likely that those transactions would go ahead and close by 12-31.

Peter  19:00  
So it's a "who knows" sort of scenario. A lot could happen in that two month window.

Kelly  19:05  
No one knows.

Doug  19:07  
I think the takeaway is: get your house in order and be prepared for the possibility. Because if you have to jump through the hoops between November 6 and 12-31, there's going to be a lot of people trying to jump through the same hoop.

Kelly  19:22  
Yeah, it really it's if you don't start until November 6, it would be very difficult for that to be completed. 

Peter  19:30  
For you, Kelly, timeline ideal is... how many days or months is optimal for the buyer and seller to have come together and said, "Here are the general terms"... now me, as a buyer, need to go get financing. What is kind of optimal for you?

Kelly  19:47  
Well, we love 60 days; we'd love 90 days; we can adapt and do 45, if needed. With the current workload and the deal flow that we have right now, very different to do anything faster than 45 days. I think what's important is that everyone involved in the transaction has the same sense of urgency and ability to be responsive. So if it's the attorneys, if it's the CPAs, the buyer, the seller...everyone has to make sure that their resources are accessible and have the ability to respond quickly, so we don't get bogged down waiting for documents or information, you know, two or three weeks.

Peter  20:39  
As we look at the broader Lending Landscape, say everywhere from traditional banks, to credit cards, every kind of slice in the capital-availability structure has a role to play. We've had clients come to us and say, "Hey, can I get $10,000?" and we say, "You know, that's where your credit card comes in". Or "I'd like to borrow off my house or a commercial property" and I've said "That's where a real estate loan comes in". So, in our view, across the Lending Landscape, there's -- depending on the phase that an agency or an owner is in -- whether that's a start up, to when they want to do a roll up strategy, or whatever the case may be, there is a match of borrower with lender. They kind of have a fit, and they may fit for this year with AgileCap, and then they really fit with Live Oak for next year; or it just kind of depends what their business strategies are. What are some of the things that you see make a really good match, and then where are most of your customers?

Kelly  21:40  
Well, you're exactly right, Peter. It's important to have the right fit with your lender, and I think all of us are really "Coopetition". I freely refer people, if we're not the best solution, because really, at the end of the day, we all want the best solution for the client. And trying to force a deal is just never going to work. So when you look at the borrower fit, I think the client -- the agency owner -- should evaluate the expertise and the team of the lender. Make sure that the lender has the expertise to understand your business, not just the person you're working with, but that there's additional people there as well. So at Live Oak Bank, there's five of us; all of us have insurance industry lending, four of us have been with the bank more than five years. So we have a really deep bench and can help each other out. None of us are on commission, so that plays well with assistance...if someone's out of the office, we have another teammate that can step in. Make sure that your lender has capacity, not just for your immediate transaction, but also your growth needs. Having a one and done banking relationship can be frustrating when you're ready to do your next acquisition. And also evaluate the track record and the value add. It's important to understand how long the lenders been active in insurance agency deals and how well they've served their clients. We talk about value add -- it's an overused term -- but it's still very relevant. Are those people at your lender -- like Live Oak Bank -- are they able to provide M&A introductions; make introductions to markets, carriers, agency management help. So the other thing is accessibility. Can you pick up the phone and call your banker and just talk -- run something by him? We talk with our clients all the time as an "informal CFO", and just a sounding board. So it's important to really take your time and feel comfortable with your bank.

Peter  23:56  
That's great advice, because we say that we, as a lender, are really your partner. Once everyone signs the documents, we're in business with you. We're looking out for our own interest, but in parallel, they're also your interests. And that's critically important. It sounds like it's the same at Live Oak, which is great. Are you seeing some things that clients have as concerns? You kind of mentioned how there's the fear of paperwork with the SBA loan, and approval and timeline, and I think you've been amazingly transparent. What are other things that you see concerns that borrowers have? At AgileCap, we see this as a big financial step; many of them taking -- sometimes first time borrowers -- off their business. What are some of the things that you see that a potential borrower, who could be listening to this podcast, should be thinking about as they go for -- whether it's a loan with you, or us, or whoever they're borrowing money from?

Kelly  24:51  
Well, these are cashflow businesses and they're controlled by the owner. So, obviously the owner's going to provide a financial guarantee, and that's something that the owner needs to be aware of -- that their personal credit situation is relevant to this commercial loan. They need to be mindful that their personal credit is in good standing. Because when you look at the insurance agency business, the agency owner's personal financial situation is as much a component of the overall cash flow picture as just the agency operation itself. So, get your financial house in order. Be mindful of your personal credit -- that's something that typically the first-time borrower may not have spent a lot of time thinking about. With the SBA product, there is the requirement for a second mortgage on personal real estate. It is not for the purposes of paying off the loan or getting in the way of your homeownership -- or if you own rental property or any other type of commercial real estate. So don't let that take you by surprise. It is a second mortgage when there is more than 25%, what they call "available equity", meaning that the mortgage is less than 75% of the market value on the home. So that's something that comes up from time to time. It's usually never a showstopper because most insurance agency owners are pretty confident in their cash flow of their business; they understand the risks that they're taking, and they feel really comfortable. So it's typically not a showstopper, but we just don't ever want that to be a surprise.

Doug  26:50  
Hey, Kelly, if I'm a Live Oak customer prospect, what's the best way to approach your bank and what should I be prepared to answer and have ready on that first conversation?

Kelly  27:04  
The first conversation, be prepared to talk about your agency revenues, and your agency cash flow. Know your numbers, and also know how much of your revenue was contingency-related for the last two or three years. So just spend some time and refresh. Look at your agency financial statements, be familiar. Know what your profit and loss statement looks like. That's the best for the first conversation. So you can get an idea of if that lender is going to be a good fit. Our minimum loan size is $200,000. And we fit best with agencies that have at least $250,000 of commission revenue.

Doug  27:54  
So Kelly, you have that discussion and it's not a fit...I know you refer a lot of business to Peter and vice versa. When do you usually refer the business to someone who's a specialty lender, like AgileCap?

Kelly  28:09  
It's generally in the first conversation. We are very respectful of time. And we don't want to waste anybody's time. And we're also very transparent. If it's not a fit, we want to try to help the owner find the appropriate solution. So we try to get enough information, have enough conversation, in that first phone call so that we can refer at that time. If not, it may be the next round of data when we're in the financial analysis that we determine it's not a fit. But generally that first conversation we have a pretty good idea.

Peter  28:47  
And we see the same thing, Doug, which is we'll have an initial conversation; it sounds like it's very similar to what Kelly and her team does. Back to something we said earlier, is borrower-lenders fit together. There's a match-making aspect. And you can pretty quickly tell...if this person has great credit, running their business with years and years of experience, the structure is pretty straightforward, the amount is north of $200,000, all the things that kind of fit an SBA loan...that's where the pass-off happens and we talk to Kelly and someone from her team, from our side of things. 

So Kelly, I'm gonna ask you to predict the future. What's in the next 12 to 24 months? I imagine COVID is in there somewhere, but what is going to change in kind of this insurance Lending Landscape, do you think? What are some factors that maybe our audience should be thinking about, if they're looking to do an acquisition or grow their agency during the next several years?

Kelly  29:47  
Well, it's difficult for anyone to predict the future at this point in time. One thing the insurance industry has going for it is, it's a necessary product, so the ability to withstand the pandemic...we're in great shape, as an industry. The insurance industry will make it through this time, I think, in pretty good shape. We expect the deal flow to be pretty consistent. There are still a lot of agency owners that are retirement age. We expect interest rates to stay low. The next election could change that; it could be interesting in the next 12 to 24 months...what exactly happens? So, our outlook is very confident. It's very promising. We're bullish on the insurance industry. Overall, the independent agent is still extremely critical to insurance distribution. Despite the online platforms that keep coming every day or every week -- we'd see a new insurance online platform -- the somewhat traditional insurance agent that is modern and a go-getter... those are still wonderful businesses to own. So we feel pretty bullish about the industry sector.

Peter  31:12  
As do we. We think it's an essential service. It has a long future. And for the right type of owner, there's significant upside. 

First, I want to thank you, Kelly. Great insight. It's wonderful to hear from the "Queen of Insurance Lending" and everything that you do. You're such a great promoter for the industry, but also so knowledgeable with so much experience. We really, we thank you so much for coming on our podcast here. Once again, if you could just give our audience your contact information.

Kelly  31:44  
Sure. Thank you for having me, Peter. It's been my pleasure. My contact information is 913-980-7773. That's the best way to reach me. Shoot me a text and I'll reply with my email address and we'll schedule a time to talk.

Peter  32:05  
Thank you so much. Thank you everyone for listening to our podcast today. Feel free to follow AgileCap on Twitter @agilecapfunds or on Facebook @agilecap and finally, online at www.agilecap.com, where you can sign up for our newsletters. Look forward to speaking to you again soon and stay safe during these difficult times. Thanks so much. Bye bye

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