Insurance Agency Valuations Are Crashing? The Truth About AI, Private Equity & Selling at the Right Time

Speaker A: Foreign.

Speaker B: Welcome to the podcast Insurance Banter. In each one of our episodes, you'll experience insightful discussions that you can turn around and implement in your business to make you a more effective insurance professional. Chris and I are excited to be joined by Kevin Donahue today from Mystic Capital Advisors. Well, Kevin, as we get started on this conversation, why don't you tell everybody a little bit about yourself, about your firm and what you do.

Speaker A: Well, my name is Kevin Donahue. I run Mystic M Capital Advisors Group. We're a New York based M and A advisory firm serving the insurance industry in both the US and in London. We focus entirely on insurance, uh, whether it be retail brokers, wholesalers, MGAs, insurance companies, claims administrators, captive managers in any sort of loss control type service entities. We have offices in Charlotte, New York, Miami, Denver and London. We are happy to be celebrating our 25th anniversary this year. Seems like just yesterday we started the company.

Speaker B: Well, with all that going on, time can fly, that's for sure.

Speaker C: That's a, uh, pretty broad breadth of, uh, insurance entities that your firm services in the M and A space. Um, I'm not sure of too many other firms that specialize insurance that can handle that breadth. Kevin, how does that come about? That man? You've got some insights as to where the market is active and where it's going?

Speaker A: Well, insurance at its base, uh, element is transactional, but there's so many components that serve it. From you know, your retail broker to your wholesalers, MGA's to your insurance companies. There could be Lloyd's brokers involved, there could be reinsurance companies involved, there could be captive managers involved. So a lot of different risks require a lot of different skill sets. And with that comes different entities and different service sectors inside the insurance industry.

Speaker C: It's unreal to me that there's all these specialties and they all have a legitimate role. Recently there's an article in, um, I think it was carrier management or maybe business insurance that broker values, publicly traded broker values had decreased, uh, in some cases pretty substantially. Where do you kind of see the M and A market for retail brokerages and wholesale brokerages in particular going?

Speaker A: So the multiples of the publics have come down quite a bit. Between January 25th, in the end of April 26th, the mean for publicly traded brokers has gone from 20.2 times EBITDA to 12.8 times EBITDA. Ah, wow. It's quite the contraction. And then the median on that is 17.7 to 12.6. There's been quite a compression.

Speaker C: Does that mean that there's going to be a slowdown or is it just simply a correction and we'll keep going at the, these lower numbers.

Speaker A: The top driver of that compression is AI concern and how it might affect personal lines and small commercial, you know, nobody knows how that will affect, you know, Acrisure just announced at 11% employee reduction and it was all AI driven in their announcement. So some of that has to do with that. There's also been quite a bit of poaching going on amongst, uh, the larger brokers. Howden in the UK lost out on Risk strategies a year ago and Brown and Brown got that. And so Howden is entering the US by hiring broker teams from various firms. So there's some of that going on as well.

Speaker C: Yeah, they've made quite a splash.

Speaker B: Not a lot of friends.

Speaker C: Not a lot of friends. If you have a broker that's wanting to go, uh, sell their agency now, do you advise that they wait a little bit? Publicly traded and maybe that's a reflection of the private equity as well. Multiples are going to go back up or do you suggest. No, they're still a good time to sell.

Speaker A: Well, it is a very good time to sell still because there's a number of smaller private equity backed firms, a number of new ones as well out there and they've got ample amounts of cash so they have to deploy that in the acquisition world is where they're doing it. So there's still fairly frothy multiples. Now some of the larger publicly traded, uh, firms may decide not to participate in that auction process, so to say. But those private equity firms have to. So, uh, we were talking with a client earlier today and they asked what is the population of these firms that are eligible to buy? Is it six? Is it a dozen? And there's over three dozen firms out there, private equity backed. A lot of them people haven't even heard of. So when we introduce them to them, they're so surprised. And generally we tell groups that are selling, let the process run the course for the value, but focus on the fit. You know, maybe you want to be folded in, maybe you want to be a platform, maybe you want to be part of something, uh, AI driven, tech enabled. So we introduce various groups to various parties and we see how the personalities interact and play out.

Speaker C: So this really brings me to a key reason why I wanted you on the podcast. And that is there's no way that an individual agent thinking of selling can find 36 buyers.

Speaker A: Yeah, they're just used to who's calling them. Who's been calling them lately? I got a call from XYZ or, or Brown and Brown or Gallagher and they just assume those are the, those are the buyers. So I might as well just talk to them. And we uh, we ran a panel at Target Markets a few years ago and we had a number of these private equity backed M and A executives on the panel. And one of those panelists, a guy by the name of Tom Riley who was top executive at Brown and Brown years back and then became a founder of Assured Partners, he says if there's a broker involved you generally will get 2 times more EBITDA in the process than if they were one on one. In that clip we have it recorded and it was, I just said afterwards I go that's going to make a lot of money.

Speaker C: That's a lot of extra money. Two times ebitda, uh, on top of it pays for your fees.

Speaker A: Oh yeah, more than pays for it. Yeah.

Speaker C: So your advice to somebody that's looking to sell is to use a broker. I not uh, just sell it self serving but it's in their best interest otherwise they're not going to have access to all these different markets.

Speaker A: Yeah, use a broker and use one that specializes in the insurance industry. There's a lot of quality brokers out there and they know the space. It's generally try to find a broker that's a good fit for you to try to find a broker that may not have certain conflicts of interest. It's been an exciting time and some of the advisors have taken equity stakes in certain private equity backed firms. That's a conflict of interest. Hopefully they disclose, disclose it. Um, or else they're going to try to steer you in a certain direction. But ultimately it's about value and fit and you want to make sure you understand if there's a conflict, what it could be.

Speaker B: I think that is a good thing to understand. I know in a lot of the industries with the consolidations and the deals that get made, it's interesting to watch those conflicts develop. And the disclosures may be on page 68. It's something to be careful of and having somebody that knows that space I think is hugely important.

Speaker A: I agree.

Speaker C: And I'm not sure all those conflicts are disclosed. I've seen a few lately where when I brought up the conflict the people were pretty surprised. So is there a way for people to know who have these conflicts in the event that it's not disclosed?

Speaker A: Well, they should ask the question straight up to them. Do you have any Conflicts and see how they react. Body language says a lot from a

Speaker C: perspective, uh, of what's the sales process, how long does it take once somebody makes the decision to sell and they hire you?

Speaker A: We tell people to plan on six months and that generally builds two months of issues that might come up. You know, due diligence might drag out legal, might drag out the actual process. To go from launching a sales process to, to really choosing a suitor is generally about three months.

Speaker C: So somebody's wanting to sell in 27, they need to get started now.

Speaker A: They should get started, uh, definitely get the agency uh, in the market by the end of August.

Speaker C: Are you seeing um, all these new players come in? They have the teams that, they have the labor, call it labor bandwidth to get on top of it and do their own due diligence pretty quickly.

Speaker A: Yeah, they're pretty good. A lot of these groups are, ah, some of them may be young but they're, they're ramping up fairly quickly and fairly professionally.

Speaker C: That's good to hear. We don't want people coming in and doing a marginal job and messing everything up. From the perspective of the sellers universe. I saw a number the other day suggested the number of independent agencies are staying pretty daddy.

Speaker A: As you've seen Chris, teams that got, whose agency got sold that may have been younger, they, they get out and they start their own agency. So there's an ample group of fresh entrepreneurs out there in this industry and there's a lot of money that will support the growth of new agencies.

Speaker C: That's pretty fascinating if someone's buying an agency and the young people are quitting and starting their own agencies, or someone like a hound is coming in and taking teams, how do they protect uh, their investment and are they in your opinion, adequately protecting their investment for the money that they're paying for these revenue streams?

Speaker A: Well, um, an executive once said that the value in an insurance agency leaves the building at 5pm and you hope they come back the next day. So that's the key is the uh, employee agreement. And oftentimes the standard agreement is if you sell your agency that you're required to have a non compete, non solicit for the greater of five years post transaction or two years post termination. So that's the standard. And then when you have, let's say Chris, you have an agency that has two owners but four critical producers. If there's someone that's very critical to that, you want to make sure they're tied up and you want to make sure that they somehow participate in the deal, something that could be a hook to keep them there. Because the last thing you want to do is lose a top producer because you had a two year non compete but you just paid a fortune to the owners.

Speaker C: Yeah, definitely. I've seen that happen more than once where that hook didn't exist and revenue walked out the door pretty quickly.

Speaker A: Yeah, greed has a way of trickling into any deal and oftentimes they overlook the those key individuals that should be participating because there's an earnout in all these deals and that earn out is significant.

Speaker C: Are uh, you seeing changes in uh, the nature of the structure of the deals, the earnouts, the portion that's cash versus buyer stock, things like that?

Speaker A: On some firms, yes. So the traditional is 80% cash, 20% equity and we're seeing some shift with that to more 70% cash, 30% equity. When you have a shift from 20 to 30 you have to really understand what type of equity you're getting. Is it the same as all the other shareholders? Is it different? Are there aspects of that that aren't protected? So you want to make sure you get your lawyer to review those agreements to see if there's weaknesses in that because that's a material piece of the puzzle. The pitch is if you take that equity there's going to be a multiple on that that you'll get that traditional other bite of the apple. But you want to make sure that that's achievable. Now if you go back over the last 30 years there's only been two firms who have huh, failed in a private equity backed. And failure is defined by me as where that equity goes to zero. And there was a firm back 15, 20 years ago called Kinloch, it was the east coast space firm. The executive that was putting it together used to work at HRH and Kinloch rated the HRH office of Boston and took 60 people. The HRH sued them because the, the non solicit that that executive had in place and HRH won. They won a, I think it was $12 million settlement. And that to a new private equity backed firm was a uh, was a death kill. And then the other firm is a firm down in Florida called Seaman Holtz. They got uh, raided by the FBI for selling illegal products. So that was more of a Ponzi scheme type uh, environment.

Speaker C: I remember reading about that one. Is it heating uh up for the other types of insurance entities for M and A, like um, all the new MGA's that have been created out of nowhere and program managers?

Speaker A: Yes so they are also flush with cat, uh, private equity. So if you look at retail and you look at the size of potential suitors, it's dozens and dozens. If you look at the wholesale, probably another two dozen plus. And that's very different than it was 20 years ago. There may have been three or four players.

Speaker B: You talked about the change in the multiples in the public markets. I'm m reading a lot about the stresses in private credit. Are you seeing anything there in the insurance space? I've never seen the insurance space referenced in any of those articles.

Speaker A: Yeah, credit is always the key point here, because some firms will leverage the transactions higher than others. So if you think of, uh, a multiple of ebitda, a very secure, safe spot to leverage is three or four times ebitda. But if a firm is levered, you know, north of six times, that's, uh, that could be a challenge. They have to have an experienced team that manages that debt load. If they pull it off, it's exciting for all shareholders. That comes with a risk element that some sellers may not want to be a part of.

Speaker C: That's a lot of leverage.

Speaker A: When interest rates are at zero. There were some groups really pumping it up. You know, we saw some north of eight. It's scary, but they pulled it off.

Speaker C: Eight, that's, that's up there.

Speaker A: So you can see how it can get very dicey.

Speaker C: Yeah, we were talking today, it looks like the odds of interest rates going up or higher than their odds of interest rates going down. Yeah, we probably won't get back to that eight and that six might be stressed.

Speaker A: Yeah, the six is six. Anything above a six is, uh, should be raising flags across the board. You got to be careful there.

Speaker C: How does a seller discover what the leverage rate is for private equity? I mean, I've seen them where they're like, nope, our financials are a matter of trust. Trust us. We will not disclose anything, as Reagan

Speaker A: said, about the Soviet Union trust, but verify. Oftentimes, sellers, when due diligence comes up, Chris, they think it's about them. They have to prove their numbers. There is a flip side. You want to have the buyer prove what they said as well. Providing a balance sheet is critical.

Speaker C: I can't agree with you more. But when I advise clients that are selling, the buyer says, no, you can't see our financials. My advice every time is that's a red flag.

Speaker A: Massive red flag. Let's say for some reason they don't walk away right there. They better have representations in the agreement, like leverage ratio Buyer represents that their leverage ratio is below X. Yeah. They should be certain representations that the buyer has to make that get the seller comfortable.

Speaker C: And I think that brings us back to why it's so important to have a high quality broker represent you in a sale. Because most of my clients, at least most of my experience, is that their accountants and attorneys are not specialists in this space. They are not specialists in this space. They need someone that can give them the confidence to ask for that balance sheet and then give them the idea of what, of what those reps and warranty should need to be. And that's what you do, right?

Speaker A: That's what we do, yeah. I mean, we've been involved in well over a thousand completed transactions in 25 years. We've seen great deals and we've seen deals that didn't happen. We've seen things fall apart. We've seen due diligences blow up. So you have to have that track record and that experience.

Speaker B: No, I think this has been a great conversation. And this last little bit reminds me of that Donald Rumsfeld's little matrix where you have the known knowns and the unkn unknowns and the known unknowns. And that's where it pays, I think, to get that broker that there's a lot of things that are unknown to you and even to some of the friends that you have that are advisors. But being able to engage with someone that knows those things that are unknown to you could be massive.

Speaker A: Donald Rumsfeld, that's a good one, Paul, because he had some great ones.

Speaker C: He had a bunch of great ones. He really did. Well, I, I really appreciate it and I'm, I'm going to put my two bits in here. Um, I've had several clients work with Kevin on, uh, the sale of their agencies. It's turned out just wonderful. Um, in every one of those cases. And one of the other reasons I advocate working with, uh, a broker that doesn't have conflicts of interest like that is that you're selling your agency once the buyers are buying agencies dozens and dozens of times, who has the advantage and the experience and the knowledge? And if you don't have somebody on your side that's at that same level, you're at a massive disadvantage advantage when you go to sell your agency. Kevin's firm. Kevin and his firm's done great for a number of my clients. And, um, Kevin, I just really appreciate the value that you brought to them and I appreciate you being here today.

Speaker A: I appreciate being on Chris. It's been, uh, it's been a pleasure working with you over the years.

Speaker B: And, Kevin, if people want to get a hold of you, how can they get in touch with you?

Speaker A: They can, uh, email me. My email is KPD, as in Kevin Patrick Donahue, kpdysticcapital.com or they can call my cell phone direct 617-901-8747.

Speaker B: We appreciate everybody listening, and we'll talk to you next time.