Long-term business success relies on three strategic pathways to equity growth: organic growth, operational efficiency and capital. This final topic in the Pathways to Increasing Equity Value series examines how capital structure can help unlock the value of insurance brokerage firms.
While organic growth drives expansion by leveraging internal resources, and efficient management and structures ensure operations can sustain growth – as businesses scale, their capital structure must also evolve to support stability and opportunity.
How Capital Fuels Business Growth
Access to appropriate capital is essential for funding growth initiatives and management decisions generated through strategic planning. A well-designed capital strategy enables businesses to invest in key areas, such as:
- Market expansion
- Technology
- Human capital (recruiting, producer hires)
- Mergers and acquisitions (M&A)
- Shareholder dividends
- Perpetuation planning
Identifying capital needs begins with setting strategic goals and determining where funding will have the most significant impact. As businesses grow, their capital needs evolve, often requiring external financing like equity or debt to sustain growth and meet objectives.
High leverage ratios in the insurance industry are possible given recurring revenue streams, low capital expenditure requirements, and strong growth potential. Higher debt, however, means more significant risk. Taking on debt requires careful evaluation of revenue stability, potential benefits, and risk tolerance. Engaging an advisor to align capital allocation with strategic plans ensures effective funding decisions for initiatives like recruiting talent, entering new markets or improving efficiency. Decisions about these initiatives should be informed and guided by expected returns.
What Is Capital Structure?
Capital structure is a business’s mix of equity and debt used to finance its operations and growth. A strategic mix of debt and equity can be a key factor in a firm’s ability to drive shareholder returns and growth. The relationship between return on equity (ROE) and capital structure is critical. ROE measures a company’s ability to generate positive returns from their investments, especially from equity invested. Management and investors expect greater returns for invested equity than they could achieve in alternative investments. Debt can be used to enhance equity returns by providing an alternate source of funding with a lower cost of capital Choosing the right balance of debt and equity is essential and requires a clear understanding of each financing type’s costs, risks, and benefits. Each serves a distinct purpose: Equity is often preferable for higher-risk initiatives with uncertain outcomes, while debt is typically suited for lower-risk activities with more predictable results.
Equity Financing
Equity financing involves giving up a share of ownership in the company in exchange for funds. Key types include:
- Common Equity: If the company is successful, common equity is the most expensive form of equity. Shareholders are last in line to claim assets during liquidation but benefit most from company growth.
- Preferred Equity: Preferred equity is a less expensive option than common equity if the company is successful, but a more expensive form if the company doesn’t meet the preferred equity’s dividend requirements. Preferred equity comes with conditions like fixed dividends and seniority in asset claims, which can reduce value for common equity holders.
Debt Financing
Debt financing involves borrowing funds to be repaid over time with interest. While the risk may be higher if things don’t go well, debt is materially less expensive than equity, as lenders do not acquire ownership or a share of revenue and value. Additionally, interest payments may be tax-deductible. Common debt capital options include:
- Senior Debt: Lower cost, higher covenant debt from traditional lenders, such as banks.
- Mezzanine Debt: Higher cost, potentially lower covenant debt from non-bank lenders, often including convertible debt or equity kickers. This is a flexible but complex option for filling capital gaps; it also allows higher leverage ratios.
Due to their impact on the overall value distribution among stakeholders, both preferred equity and mezzanine debt require expert guidance with careful evaluation and structuring.
Strategic Considerations for Capital Decisions
Business owners must carefully weigh the risks and rewards of leveraging debt or equity to finance growth. For businesses with $5 million or more in EBITDA (earnings before interest, taxes, depreciation and amortization), debt becomes a more practical option, as they are better positioned to manage risks while benefiting from the lower cost of capital. Having a detailed use case for the capital is extremely important in securing the best terms.
The Evolution of Capital Structure
As businesses expand, their capital structures evolve. Sole proprietorships depend on the owner’s capital, but scaling requires additional debt and equity sources. Typically, the progression for insurance brokers follows this path:
- Individual Ownership: The business relies solely on the owner’s funds.
- Partnership Model: Partners contribute capital and share in ownership.
- Debt and Equity Partners: Outside capital is introduced to fund growth.
- Public Offering: Going public is typically only an option for larger firms seeking access to permanent capital.
With each stage, the business faces new considerations, including the need for transparency, corporate governance, and a clear understanding of ownership terms. Equity partners, for example, hold legal rights to the business’s profits and value, which can impact decision-making and autonomy.
Alternatives to Equity Partnerships
Businesses seeking to incentivize key employees without granting equity can consider alternative long-term compensation options like synthetic or phantom equity, deferred compensation plans, and stock options. These tools tie value to company performance without transferring shareholder rights, offering equity-like benefits while maintaining control.
Deciding between full partnerships or alternative incentives requires careful consideration. Initial partners often hold larger ownership stakes, making subsequent equity decisions critical to alignment and fairness.
Optimizing Capital Structure for Long-Term Success
Capital structure is a critical factor in valuing an insurance brokerage firm. An optimized mix of debt and equity can enhance shareholder returns while enabling the company to expand, execute managerial initiatives, and pursue strategic objectives. By regularly assessing capital needs and evaluating financing options, business owners can ensure their capital structure evolves to drive growth and maximize long-term value.
Partnering with MarshBerry
Managing a growing business’s capital structure requires specialized expertise. MarshBerry supports business owners in assessing capital needs, crafting growth strategies, and implementing tailored solutions. Whether exploring debt, equity, or alternative financing, MarshBerry advisors provide guidance through every stage of ownership.
Additionally, a MarshBerry investment banker can provide objective guidance to help ensure a business’s capital strategy aligns with its growth objectives and risk tolerance. Tailored solutions include funding from private equity, family offices, pension funds, traditional banks and non-bank lenders.
Exploring the Pathways
The Pathways to Increasing Equity Value series has highlighted the vital connection between organic growth, operational efficiency and capital structure. Pursuing these pathways strategically—and often simultaneously—within a cohesive business plan can empower firms to unlock greater potential, scale confidently, and drive measurable increases in value.
To learn more, join MarshBerry’s upcoming FocalPoint Webinar, Pathways to Increasing Equity Value, Part III: Optimizing Capital Structure, which will be available soon. Director James Graham and Managing Director Eric Hallinan will discuss actionable strategies for evolving capital structure, supporting shareholder returns and positioning your business for sustainable growth and success.
