P&C Brokerage Industry – Let’s talk Management Buy-ins

Let me start by saying that some of the best managed and most profitable brokerages in Canada are employee-owned. We believe that every succession planning process should, at the very least, consider this option.

When talking about management buy-ins, a good place to start is to understand the reasons why we don’t see more of them. Keep in mind, some of these reasons are sometimes more perception than reality. Here are a few examples:

• Lack of Bench Strength – your organization does not have the talented young people who have the drive and ability to run your business
• Finances – employees don’t have the financial strength to commit capital to do the deal
• Financing – the organization does not generate enough cash flow to support the debt servicing costs given current valuations
• Too Complicated – it is easier to continue to operate and then monetize through a full divestiture
• Control – while you own the business, you want full control

Of course, all these issues are real and, in many cases, good reasons for not under-taking a management buy-in. Having said that, I think management buy-ins make sense in certain situations and they are often overlooked because the brokerage owner either doesn’t know this might be a viable option or, they don’t know how to proceed.

Let’s look at some fundamentals of a good plan. First, there must be a process from which to evaluate what is best for you, your family, the organization and then the potential investors. While each situation is different, we typically suggest the following:

• With the help of family, and or a trusted advisor, come up with some specific financial outcome goals. It might be as simple as I think my brokerage is worth $5 million. I would like to monetize $2 million now with the balance greater than $5 million in seven years;
• Complete a deep dive of the business. The resulting document describes the composition of the business from an underlying book and financial perspective, lays out the possible market valuation, cash flow available for debt service and areas of possible value enhancement. This will be needed for both investors and potential financing sources.
• The deep dive help focus on the type of investor that is best suited for you and your brokerage. It might be current employees, outside producers, an insurance company or even an executive that is currently working at an insurance company.
• Prepare a detailed step-by-step plan of all the structural issues that must be addressed, including income tax, legal structure, governance and potential financial structure.
• Execute the plan.

Proper planning and preparation are the key to success. There is little point in inviting employees or outside investors in the process unless they are going to add value. It is a far better approach to advertise for exactly who you’re looking for. There will be a lot of interest if they see a possible return.

The same goes for governance. You need to protect your investment and exercise ultimate control. At the same time, the investment must be meaningful to your new partners. A strong governance model supported by a well-crafted shareholder agreement is critical. The agreement needs to address those issues that require unanimous shareholder consent, under what conditions shareholders can obtain more or divest in shares and how they will be valued. There are a number of great lawyers who both understand the P&C sector and know how do craft effective agreements.

There are two issues that generally take some finesse. In the case of employee investors, it is getting them to commit some personal capital. For younger people, they generally don’t have any capital. But if they do, then it is paramount that they have at least something at risk. While you can work around this, I struggle to justify why a Brokerage Owner should commit to a plan to transfer ownership without some immediate commitment by the investor.

The second issue is financing the transaction. The financing approach depends on the circumstances. Banks, insurance companies and private investors each have unique advantages and potential challenges. Your chosen plan will play an important role in what type of financing you look for.

Management buy-ins should be part of an overall plan that leads to the eventual transition of ownership. Yes, there are complicated financial and emotional considerations. But, with a well-designed tax and financial strategy you can protect your family’s financial future, reduce the organizations dependence on you and ultimately increase the overall valuation of the business.

If you have any questions or comments, please send them to Mike Berris at mberris@smythecpa.com.