Financing the future

Whether a broker is looking to expand through acquisition or to fund a management buyout, raising finance is likely to be an issue as few businesses have sufficient resources of their own for such transactions.

Traditionally, insurers have offered financial support for brokers, however, this has become less common.

Oliver Laughton-Scott, managing principal of IMAS Corporate Advisers, says: "Insurers come in and out of the market, depending on how concerned they are about controlling distribution. Their broker lending can take the form of either a minority equity stake or cash as a straight loan or advance of commission."

"Insurers are less interested in putting money into brokers than they have been in the past. It is a function of the hard market, as they are making money out of underwriting. As the market softens they may look again at the issue."

Support for broker growth

Axa has a financial interest in broker Layton Blackham. Colin Calder, head of broker development at Axa, says it is not in the broker loans market but can support its brokers' plans for growth in a number of ways.

He says: "We effect introductions to sources of finance and support brokers in ways that will help them integrate acquisitions efficiently. Among the examples are business process re-engineering, IT consultancy and marketing/communication support."

Norwich Union has never had a policy of investing in brokers BY taking an equity share, although it did own Hill House Hammond outright before the brokerage was sold earlier this year. However, NU helps brokers with interest-rate repayments on bank loans on a case-by-case basis, according to intermediary business director Ken Wallace.

He says: "We may also consider an upfront loan against earnable commission in specific cases where a broker is acquiring another broker and business is being transferred to NU. We would consider releasing some annual commission upfront."

NU also has a business consultant in each of its regions whose job is to act as a strategic consultant to brokers and look at ways to take a broker forward, which may involve advice on acquisitions.

Accountant and business advisers Mazars advised on the sale of broker St Margaret's to Amlin earlier this year.

However, Debbie Clarke, director of corporate finance at Mazars, says: "Many insurers are waiting to see what will happen post 14 January 2005 when the FSA will be operational and brokers have their approvals.

"If the insurer is keen to maintain a book of business and, specifically, have access to the underwriting profits attached to that book, they will be interested in acquisitions. The target, however, will need to prove that their FSA procedures are robust."

Debt finance

Laughton-Scott says the starting point to raising funds is to have a clear plan showing the logistics of the transaction, the benefits and the money it will generate, and the timescale to repay the lender. It should also consider all the consequences of the deal and, if involving acquisition, all the steps necessary for successful integration.

He says: "High-street banks are usually cautious and often require security. Banks focus on free cash flow first, then profitability and asset backing. Having a good relationship with an existing lender is important, but competition always helps - especially when it comes to price - and maintaining relationships with two banks at the same time can be beneficial."

However, Laughton-Scott says that the amount banks will lend is limited and will be of most use for funding organic growth, modest acquisitions or buying out existing partners. He adds: "By itself, a bank is unlikely to be a good source of finance for a management buyout as brokers are people-based businesses without the solid asset base that banks typically like to see as security."

City banks have an established presence in the insurance industry and are familiar with the market's peculiarities, according to Clarke. However, the knowledge and experience of City banks is not necessarily reflected in regional branches. Clarke suggests that the advice from a City adviser can be helpful in directing the broker to a banker who is familiar with the insurance market.

Clarke says: "Banks remain cautious and any company must ensure it can sustain debt payments. Owner-managed brokers may have to negotiate personal guarantees as it is often difficult to place a financial value on assets such as computers and office furniture. If the broker owns property, personal guarantees are often not required."

Clarke says: "Banks are generally quick to decide whether or not they are interested, usually getting a faster response than the venture capital route. However, the company must still proceed through the lengthy due-diligence process. This time period is further increased if the company is making a significant acquisition and has multiple lenders."

Clarke adds: "As a rule, venture capitalists will lend more than banks, however, banks will consider lending more if there is a well-established relationship between themselves and the company.

Venture capital

Venture capitalists have become increasingly interested in pursuing opportunities within the complex and heavily regulated insurance market, according to Clarke.

She says: "Venture capitalists are looking for competitive, well-established brokers that have ambitious development plans and can deliver high returns.

Following the venture capital route can be an attractive proposition to brokers rather than bank debt alone. The use of venture capitalists often allows companies that are looking to grow through acquisitions to look at larger targets."

Clarke regularly introduces venture capitalists to brokers. She feels that companies become more attractive to venture capitalists if they have sought professional advice either from an accountant, a lawyer or a business adviser, as a venture capitalist will have a large number of proposals to review and will need to determine quickly which to read and which to ignore.

Venture capitalists have differing appetites and approaches. Many of the more publicly visible funds look for transactions that require in excess of £50m, while the more specialist managers consider investments of between £2m and £10m. Many high-street banks have venture capital arms and a successful introduction to one of these may provide access to the right mix of finance for transactions according to Laughton-Scott.

He continues: "Venture capitalists require high rates of return for their investments and will normally be looking to realise them in three to five years. Many venture capitalists now look to own the business and hire the management to run it for them in return for a significant minority stake and seats on the board. Using venture capitalists to buy out an existing majority shareholder will probably mean the owner selling for significantly less than full value, although it provides a clean exit."

Manchester consolidator Community Broking Group was formed in 2000 with the backing of venture capitalist Texas Holdings. The company has since listed on the Alternative Investment Market and recently made its eighth acquisition.

David Worsley, former group finance director of Texas Holdings, joined CBG as chairman in order to devote more time to the venture. Initially, CBG loaned money and before floating on AIM. Texas still has a 12% share in CBG.

Worsley says: "Texas was not going to carry on feeding money into the company for all the acquisitions we wanted to achieve. In three to five years, there was not an end envisaged for all the growth.

"Venture capital companies tend to charge higher rates than banks for loans. They tend to look for an exit within three years. They then drive for growth to get back money at a higher return." Texas, however, took a longer-term view than the normal venture capitalist.

Worsley adds: "Often venture capitalists will put someone on the board and take a lot of interest in the running of the business. Banks do not usually lend for major development of the company in relation to the size of the company such as start-ups and acquisitions or entering new markets."

"AIM has enabled CBG to fund its aggressive acquisition plans. The cheapest cash attainable is from shareholders. For insurance brokers it is much better to go to shareholders for cash than to borrow; because of the problems with regulation as there are certain solvency tests that must be met. Shareholders tend to be in for a longer term than a lender would be as debt is usually repaid over a fixed period."

However, Worsley warns that becoming listed is an expensive business.

It cost CBG around £200 000 on advisers alone before becoming listed and costs in excess of £50 000 a year to remain on AIM.

He says: "The cost of listing is high because every statement has to be verified and this is a time-consuming process. In addition, being listed requires directors to publish full-year and half-year results, to make announcements whenever a significant shareholder changes or every time a director and a member of the director's family trades shares and when there are any significant changes to the company such as acquisitions."

Good client base

Mazars is seeing more of its clients secure finance through AIM. "The key to a good listing is having a good client base; you have to ensure you capture the attention of the financial institutions and, more importantly, keep them interested," says Clarke.

She adds: "If a company has a good client base then it becomes a little easier to showcase a business and sell your story. However, this route takes time. Companies must spend up to six months planning ahead in order to ensure the company is in shape and the target price is achieved. Long-term plans must be made in order to determine the development and format of a company after acquisitions have been made."

Clarke says: "To achieve a listing on AIM this year, companies must have already completed the planning process and disclosed all essential information to the market concerning all aspects of the business. Indeed, next year might also be a difficult year as the UK will experience a general election, thus, investors will be more cautious as to the future state of the economy."

Whether they opt for a bank loan, venture-capital backing or a public listing to attract investment, brokers should first always ensure their own house is in order and that the transaction makes good sense both in the short and long term.