What has, and hasn’t, impacted brokerage M&A trends

Consolidation rates for property and casualty (P&C) insurance brokerages, which slowed slightly starting in 2022 following repeated Bank of Canada interest rate hikes, are again on the upswing.

Since the Bank of Canada began trimming rates on June 5, brokerage buyouts are “seeing a significant pickup,” says Andrew Mathias, senior vice president, investment banking, at KPMG Corporate Finance.

“June was the busiest month in probably 15-to-16 months.”

And while some sales may have been intended to pre-empt an increase in the federal capital gains tax rate, which took effect June 25, the pace of future transactions is still expected to rise.

“We’re two months past [the capital gains tax rate change] and they’re still very robust,” says Mathias, who stresses his expertise is in investment banking, so his examples should not be considered tax advice. Those pursuing deals should obtain both proper tax and legal advice, he adds.

“We’re still 15 times EBITDA [Earnings Before Interest, Taxes, Depreciation and Amortization] as expected, and that didn’t really change. The reality is, unless the seller has a proper succession plan in place [to pass a brokerage to family or management], they’re going to do a transaction [with an outside buyer]. The only thing you can do is properly tax plan around it,” he tells CU.

Size of the sale

In cases where sellers are producers who own their books of business, they’re likely to be selling in the low seven-figures, Mathias says.

And, regardless of the capital gains changes, buyers will value the business in the same way. It’s the sellers, he says, who risk taking it on the chin and paying an almost extra 17% in gains tax.

But, while the tax rate on capital gains from such transactions rose from 50% to 67%, the new rules also raise the capital gains exemption for each shareholder from $900,000 to $1.2 million.

“We had a scenario where a brokerage shareholder [told me] ‘I don’t want to be paying 67%, I want to take 50%,’ and we sat down with them and worked through the math. The size of their book of business and the offer they had on the table [meant] the new, higher capital gains exemption was actually beneficial,” says Mathias.

“If they had closed the deal pre-tax change, because the book of business was relatively small, they would have been [significantly] over the [older] $900,000 [exemption].

“But they were less over the [new] $1.2 million [exemption] than they were over the older $900,000. They would realize capital gains…but they had enough people, [when you included all] the family members that were involved [in the business], to have sufficient capital gains exemption room [so that] they’re going to pay less tax.”

Buyout breakdown

Because the capital gains exemption applies to each shareholder, the tax impact can be reduced – and the burden decreases further if tax-planning measures are in place.

“You set up a trust that has five or six family members in it,” Mathias says. “You’re getting the capital gains exemption for those five or six people.”

For example, using easy math, if a brokerage seller will get $10 million and the capital gains burden is shared among six family members, the new higher capital gains rules leave nearly $7 million in exemption room.

“[So] You’re only paying tax on $3 million…at 67%. Previously [with the exemption room for] that same five or six people, you’re paying tax on $5 million at 50%,” he tells CU. “Depending on the delta of the purchase price, minus what the gain is, it can actually be more beneficial under the current rules.”

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Feature image by iStock/Zelfit