What a buyers’ market means for brokerage M&A

How can consolidators afford to buy brokerages when interest rates on bank loans to finance deals have steeply increased? Firms that are actively engaged in brokerage buying and selling told CU they have become more selective.

“We are getting a bit more particular around, ‘Is this the right partner?’” said Shawn DeSantis, president and CEO of Navacord. “Is this a geographic area where we could see significant growth, because [the selling brokerage’s] value proposition is something we can build off and scale?

“We always asked those questions. But now we’re challenging ourselves to make sure [the deal] has a higher probability of success because the cost of capital is challenging us to do that.”

And so, in a higher interest rate environment, consolidators are taking a closer look at green lights (indicating a good deal) and red flags (which could lead buyers to walk away from a deal).

Many say the signs are the same regardless of the interest rate environment, but when the cost of capital rises, the green lights may look a little greener and the red flags may give greater pause.

Green lights

Brokerage buyers are looking for three predictors of deal success:

Sellers have a good workplace culture;
Alignment between a buyer’s and seller’s lines of businesses and geographic territories; and
Sellers show steady, predictable and profitable growth.

Part of any deal involves the buyer taking on the seller’s employees. So, a key green light is high-performing producers with low staff turnover, and an active, engaged leadership.

“The Number 1 most important thing in our businesses is relationships with our people; talent is a green light for us, for sure,” said Michael Stack, vice president of acquisitions at BrokerLink. “It’s really important in the deals we do that our values match with those of the brokerage we’re buying. You want to make sure their business culture can continue.”

Westland CEO Jamie Lyons noted the appeal of alignment between buyers’ and sellers’ lines of business and territories, given the higher interest rate environment.

“In terms of size and scale for us, I would say [we’re interested in] a space in the market where we’ve got very well-entrenched capabilities. It might be a nice, smaller opportunity in a region where we’ve got some established leadership presence,” he told CU.

“For us, those are pretty straightforward deals to underwrite and [show] little variability in terms of the outcome. There’s not much risk in those fields, just because those are spaces with which we’re very comfortable.”

Sustainable growth is key

Alex Wong, partner and M&A and valuations practice group leader at Smythe LLP, typically represents brokerage sellers in a deal. He sees buyers emphasizing sustained, profitable growth.

“Sustainability, that stability, is key,” said Wong. “That’s why I think prices [for brokerages] are so high. That’s why so much private equity money is attracted to the broker space in the first place. When the rest of the economy has so much uncertainty, the broker space has always been an industry that’s been sustainable, stable, and it’s been growing.”

Provided a seller’s profitable growth is steady and reliable, buyers may be willing to take on a deal even if it varies from the brokerage’s more familiar lines of business or territories.

“In terms of opportunities, [we’re looking for] a fit within what we’re currently doing, but at the same time, we may look at adjacent verticals, or we may look at different types of opportunities that round out our service offering, which means maybe going into scenarios that would expand our capabilities,” said Lyons.

“That’s still very much on the table. But I think you do need to be a little more careful. I think there’s a point at which you could be straying a little too far.”

This story is excerpted from one that appeared in the October print edition of Canadian Underwriter. Feature image by iStock.com/Gwengoat