Today's Viewpoint: A MarshBerry Publication

SECURING GROWTH CAPITAL IN AN UNCERTAIN MARKETPLACE

As insurance agency and brokerage owners survey the current macroeconomic environment, what part can “growth capital” play in helping them reach their growth objectives, without losing control over their firm’s destiny?

Most insurance agency and brokerage owners looking to grow their business want to maintain majority ownership and operating flexibility without assuming exorbitant debt. Chances are, they have reinvested most of their profits (taking only limited cash distributions) and don’t want to sell yet because of their business’s strong long-term growth potential. With a recession looming and a potential political gridlock on governmental economic solutions, now more than ever, having access to capital to both protect vulnerabilities in a business, and capitalize on weaknesses of smaller competitors, could provide an owner with the funds needed to thrive during these changing economic times.

What exactly is growth capital?

Growth capital, also referred to as “expansion capital,” “non-control equity capital,” or “minority equity capital,” can infuse a business with added funds to help accomplish many long-term objectives for a firm: roll out a new product offering, hire more unvalidated producers, expand into attractive geographies, or complete an acquisition. A business can then work to achieve these objectives while also reducing shareholder risk, achieving partial liquidity, diversifying personal assets, preserving majority ownership, buying out retiring shareholders, retaining significant economics in the business, and maintaining operating control over the firm’s destiny. 

Benefits to raising growth capital 

Private capital providers, including private equity (PE) funds, family offices and public pension funds, invest in companies that are looking to expand or restructure their existing operations, enter new markets, finance an acquisition or grow their producer base without giving up control of the business. Maintaining control is the key benefit of growth capital and is what draws owners to this structure rather than to traditional buyout capital or debt financing.

But here are other benefits to consider:

  • Raising growth capital permits owners to leverage their historical investment (cash and “sweat equity”) and use other invested funds to increase cash flow to execute their growth strategy.
  • Raising growth capital can help owners achieve greater diversification of their assets. By selling only a minority portion of their equity stake, an owner can achieve diversification and partial liquidity.
  • Finally, all too often MarshBerry observes owners that have nearly all their net worth tied up in their business and become more risk-averse over time. By securing private growth capital, business owners can both sell a portion of their ownership and begin taking calculated business risks that helped grow the business in the first place.

This last point is especially important in an uncertain economy where insurance brokers could be adversely affected by certain customers suffering their own economic hardships. When a broker’s customers feel the effects of reduced revenues in an economic downturn, a negative consequence for an insurance firm many times manifests itself in customers buying less insurance, or in a worse scenario, losing the entire historical annuity stream because customers forego coverage or go bankrupt.

Is growth capital a match for your business?

How does an owner know if their firm might be a suitable candidate to raise growth capital? Here is a partial list of criteria that may suggest an organization is a viable candidate to seek expansion capital from professionally run pools of private capital: 

  • The business has at least $25 million in revenue and has been generating an operating profit (EBITDA, or earnings before interest, taxes, depreciation and amortization) for the past three or more years. 
  • There is a history of meeting or exceeding financial growth and profitability objectives. 
  • The business’s one-to-three-year financial forecast, while aggressive, is achievable based upon historical trends. 
  • The leadership team is strong, cohesive and committed to growth. 
  • The owner wishes to retain corporate governance control (i.e., greater than 50% equity ownership), but is willing to share major corporate decisions with the new financial investor. 
  • There are specific, identifiable needs for the growth capital. 
  • The company’s technology requires a major upgrade to remain competitive or developing new technology will leapfrog them to the next level of competitiveness. 
  • To adequately fund an acquisition, additional cash is needed beyond which a bank is willing to lend. 
  • Cash flow is proving to be inadequate to hire new seasoned or unvalidated producers. 

Choosing the right growth capital provider 

In today’s crowded marketplace, there are generalist PE funds, financial services-focused PE funds services, business services-focused PE funds, generalist family offices, and public pension funds seeking closely held, family-owned and operated enterprises.

Some capital providers are heavily involved in strategic planning and helping build their investee companies. Others are mostly passive. Generalist PE funds invest across all (or most) industries. They are shrewd investors and know how to build businesses, but they may not be experts in insurance distribution. PE funds with a business services focus may be less concerned with the insurance industry than with your customer base and how that PE fund can help generate business with, and for its other, non-insurance investments.  

Here are several questions that we believe an owner should ponder when considering from which capital provider they should seek growth capital: 

  • How much capital does the organization need to grow? Is that amount too large, or too small, to be of interest to an institutional investor? 
  • Is the owner prepared to sell a non-controlling minority position at a value that preserves the ability for them to retain a majority of the economics in their business, but which provides a financial investor attractive upside potential? 
  • Does the capital provider have an ability to invest additional funds into the firm as it grows? How many other investments in the capital provider’s portfolio will be competing for a limited amount of capital? 
  • If the capital provider is investing from a traditional PE fund, when does the fund need to begin liquidating its investments? Does this time horizon align with the company’s growth strategy and/or with the owner’s personal liquidity needs? 
  • How will the capital provider fit into the corporate culture of the firm? 
  • Can the capital provider introduce acquisition targets? 
  • What best practices (e.g., measuring optimal financial performance, protecting against cyber threats, incentivizing key shareholder and non-shareholder employees with profit share or phantom equity, etc.) can the capital provider introduce into the organization? 
  • If the capital provider needs to exit before the owner is prepared to sell the company, what mechanisms are available to smoothly orchestrate an exit for the capital provider? 
  • How involved will the capital provider be in helping orchestrate an attractive exit for all shareholders? 

Determining whether to raise growth capital is a very personal decision for owners. There are significant benefits for infusing capital into a business and helping it to grow. However, there are also sacrifices and changes that owners must fully understand and accept as part of this large step forward. Having the right expert in your corner to help navigate this process is important.

If you have questions about Today’s ViewPoint, or would like to learn more about how MarshBerry can help you determine if your firm is a viable candidate to seek expansion capital, please email or call Gerard Vecchio, Managing Director, at 860.916.4149. 

Investment banking services offered through MarshBerry Capital, LLC, Member FINRA Member SIPC and an affiliate of Marsh, Berry & Company, LLC. 28601 Chagrin Boulevard, Suite 400, Woodmere, Ohio 44122 (440.354.3230)

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