Focus - Broker funding: Finding your way through

Brokers, like so many other smaller businesses, are being squeezed by banks' continuing reluctance to lend. So, much so, that for a chosen few, Aviva has decided to take action.

David Skinn, Aviva's head of bids and propositions, explains: "We've set up an arrangement where brokers in our Club 110 can talk to Macquarie Bank and if all goes well, borrow funds at a preferential rate.

"Certainly from talking to brokers, finding access to funding is not easy - there seems to have been little activity. But, we also appreciate that some brokers do need to borrow if they want to grow. The arrangement with Macquarie does not guarantee they can borrow, but it means they can talk to a bank which understands brokers and is interested in their business model. Club 110 brokers are regional independents and there around 240 of them."

Mr Skinn adds: "We don't interfere at Aviva but, hopefully, there will be some useful talks between brokers and Macquarie and this will enable them to save time by talking to the right people: those able to lend."

While the financial crisis remains far from resolved, many brokers, however, have remained relatively resilient. They want to borrow money for the same reasons as before, such as to fund an acquisition or to allow a management buy-out. In the case of the latter, there are still plenty of broking firms out there run by a principal in their 60s, who is looking for a way out.

This individual may well prefer to sell to in-house younger managers rather than to a consolidator or a local rival. The problem is, while those individuals will almost certainly be required to put some of their own money into a purchase, they will also need access to capital. Other typical scenarios include brokers looking to set up a new venture, or having done this in recent years, looking for growth.

Frustration
It can be a frustrating experience, as James Sharp, director with Ten Insurance Broker Network explains - his company specialises in working with start-ups and young broking businesses. "Funding has all come to a crashing halt. It used to be that brokers were a favoured group when it came to talking to mainstream banks such as RBS or Lloyds - but they are now being far more cautious," he says.

He believes that despite its conservative image, broking was caught up in an unsustainable bubble and that some of the loans given out a few years ago by the big banks "may turn out to be toxic."

He says: "You had some businesses who were trying to go for three times brokerage - now prices are more likely to be times one or one and a half. There is no doubt that many start-ups are now having to use either all, or far more of, their own money. It is very hard - it used to be that insurers were far more willing to lend as well - but this activity has lessened and beyond this, results in some difficult conflicts of interest issues."

Sharp adds that even where relatively small amounts are being requested, brokers can face rejection: "Even overdraft facilities are being turned down - brokers are saying it is ridiculously tough. Some are finding banks are even turning down overdrafts of as little as £1,000 a month, whereas a while ago, being granted £10,000 was not a problem."

Macquarie is one of the few names that pop up when experts are asked for a solution and has replaced the traditional names as being ready and willing to talk to brokers.

Oliver Laughton Scott is managing principal at IMAS Corporate Advisors, which has acted in many acquisitions, and comments: "It is far harder but it is not hopeless if the business is right. Macquarie and Clydesdale Bank are both in the market to lend to brokers." Interestingly, both are Australian-owned. This means having less legacy issues than UK banks along with knowledge of broking markets that are not dissimilar.

Laughton Scott adds: "There was an unsustainable feeding frenzy a few years back. But, banks like Macquarie and Clydesdale, along with a small number of private equity providers, know that there is still money to be made." He says there could also be the odd insurer-funded loan - although these are being kept under wraps. "Insurers are only going to be looking at these if they can squeeze distribution deals, there are going to be a lot of strings," he comments.

Aden Nguyen, associate director with Macquarie Relationship Banking UK, says there are clear advantages to using a bank to other sources of capital. He comments: "Access to capital has been a major challenge for brokers over recent years as the mainstream banks have been reluctant to assist brokers with their funding requirements. This has led to brokers being less active in the M&A space and unable to complete internal buy-outs, which in turn has contributed to a decline in the value of brokers' businesses."

Break with tradition
He explains that while private equity firms continue to be active in assisting brokers, this has mainly at the more corporate end of the broker market. Nguyen comments: "Equity is typically a more expensive form of funding for brokers, and private equity firms stand to benefit greatly from equity returns on what is ordinarily a debt risk.

"Instead, brokers have turned to non-traditional sources of capital such as premium finance companies, their insurer partners or to specialist banks such as Macquarie. While insurers may have been happy to assist to safeguard their distribution channels, it may bring in to question issues such as how independent a broker really is and how that impacts on their ability to be impartial when recommending which insurer their clients should choose."

He agrees that since most brokers are cash flow positive they do not typically have significant working capital requirements and so are looking for funding to enable growth plans.

But, he emphasises Macquarie is in a position to help: "In the current environment, we see the ability to make acquisitions and successfully execute succession plans as effective strategies to not only protect the existing business, but also grow the business."

A broker may also want to expand its existing portfolio or perhaps poach a team of people. It was recently reported that Clydesdale Bank Corporate and Structured Finance has completed a senior debt re-financing for AIM-listed and Bristol-based insurance broker Brightside Group.

The deal saw Clydesdale take over as Brightside's principal relationship bank and senior debt provider for its premium finance subsidiary Panacea Finance.

At the time of the deal, Paul Chase-Gardener, chief executive officer of Brightside, said: "This is an important step forward for our company. Clydesdale are helping to provide extra capacity to our premium finance business at a time when premiums are rising in the market and payment plans are increasingly important as part of our offering."

John Holm, director with Clydesdale Bank Corporate and Structured Finance, was formerly with RBS and is now developing a name as one of the leading specialists in broker funding. Even so, Clydesdale is highly selective and has particular target markets. He comments: "We're talking to brokers who are stable, with a loyal client base and a sustainable cash flow. For those with the right model, we can help them grow.

"We are typically looking at the mid-corporate market with premium income of £20m to £100m. We're also interested in the refinancing of existing debt, preference shares and loan notes and we like to talk to brokers who have a strong track record as well as a clear plan for the future."

He agrees that there are a number of strong candidates who are interested in management buy-outs where the principal is looking to take on a non-executive role. But, he cautions: "Some want too high a price for their business and they do need to be realistic in the current market."

This is a view supported by John Needham, partner with accountants and business advisers Littlejohn. He says: "Brokers need to realise the price they could achieve for their business is nowhere near where it was. We are seeing deals happening, but not at rates that were being achieved, which were two and a half times income. As such, more deals are being filtered out."

Missed the boat
Certainly, it is an uncomfortable truth for a broker to realise they have missed the boat in terms of obtaining top dollar.

"We have to be quite brutal in what we tell brokers in some cases," says Needham. "Equally, those brokers looking to buy or enact an MBO need to have a credible plan, there is no room for any pie in the sky ideas in this market."

He says the fact Aviva has spoken to Macquarie about dealing with brokers directly is encouraging: "The more help and understanding brokers have the better. There are a lot of brokers who simply contact their local branch. They are unlikely to speak to anyone who knows about broking.

"This is why using a professional adviser can also help as it is about being introduced to the right people as well as preparation of a quality business plan."

Littlejohn recently undertook a broker roadshow speaking to them about their funding options, which he says has resulted in many more inquiries.

Meanwhile, brokers dealing with local bank branches may also be more likely to be asked to put up their home or other property as security, he adds, or need to come up with another guarantee. Needham says: "Understandably, many brokers do not want to do this."

However, Bill Cooper, managing director and sector head of insurance and financial services at Lloyds Banking Group, says confidently that markets have eased and that some brokers may be in for a pleasant surprise if they talk to Lloyds.

He says a correction was unavoidable following the heady days of 2008 when "there was a whole rash of selling at inflated prices" and that because of the financial crisis, capital dried up fast: "It was not a good environment for brokers, but we are now seeing more deals starting to happen and CCV is a good example."

He says vendors, however, need to be realistic and it is their reluctance to drop prices that is holding the market back to some extent. Cooper's team would typically look at deals of in excess of £10m, but he says they will advise local branches on the broking market, which should mean a more knowledgeable service.

Cooper advises brokers to bring on board professional advisers at an early stage if they want to secure funding, saying it makes a huge difference. He adds: "You need to have a sensible proposition, banks are not going to be interested in one man bands, they want to see a business that is growing and in good shape and in particular, with a strong management team."

He says this is one of the weaknesses affecting a number of brokers - namely that they are good at broking and little else: "For those who do have the ability to manage and can get a convincing business plan together then I'd say now is a good time. Just make sure that if it's an acquisition you don't over pay and if it is an MBO that you have the right people on board."

Going private
Needham adds that private equity is another option. He says: "Some providers are interested in brokers and could well be worth speaking to. It is obvious that there are still some good opportunities around - there are quite a few brokers producing a 15% or 20% return and that is undoubtedly going to be of interest to investors."

He points out that seasoned broker Chris Blackham, formerly of Layton Blackham and Bluefin, is now involved with the boutique Endorphin Investments and knows a lot about starting businesses and acquisitions.

Another specialist, he says, is Alpine Risk Services led by Francis De Zulueta who has worked with Nelson Hurst and Marsh, Willis, Aon and Marsh McLennan. He was also a founding partner of international niche Lloyd's broker Special Risk Services from its start to its successful trade sale to Minet, as well as the business development director for AIM-listed venture capital company BP Marsh & Partners until 2008.

Alpine also benefits from the support of a senior advisory panel of insurance industry professionals, in addition to institutional investors, including Alcuin Capital Partners. The company will partner with businesses by investing in either a minority or majority position for extended periods of time and providing additional financing as needed during the partnering period.

Inflexion Private Equity is another broking specialist and recently announced its involvement with Fish Insurance; a niche broking business focused on the disability sector. Inflexion will work with the management team to capitalise on current market growth, develop new products streams within the disabled sector and investigate potential bolt-on acquisitions.

In addition, it has introduced Tim Ablett, an experienced executive chairman from the insurance sector, who led his own buyout of First Assist in 2003 and is currently chairman of Age Concern and non-executive director of Hastings Insurance. Inflexion's Catherine Richards and Tim Smallbone will join the board as non executive directors.

But, as Needham says, even if funding is secured, this is not going to be an option for the faint hearted. He comments: "There is going to be a pain period. It may well be that brokers who undertake an MBO are going to have to take a pay cut to make sure they can pay cash back, say within the four or five years agreed. They are going to have to put their own money into the business and many will find it highly challenging."

Meanwhile, Stuart Markley, partner with accountants and business advisers Moore Stephens, says the market for funding is not as black as painted and that "there are a few deals bubbling around. But, it is a mixed picture, and brokers should expect to go through a stringent due diligence process before any undertaking is given to provide funding."

Even so, he says that for the chosen few, some good deals are being agreed. "I'm aware of interest rates being set at around four per cent, which is pretty competitive and should make expansion affordable for those brokers." He says Macquarie and Clydesdale are developing names as being particularly broker-friendly, and has also picked up that RBS may have set some funds aside. However, no one from RBS returned calls to confirm if this was the case.

There is no doubt that banking decision makers will want to grill brokers who want funding and Markley says the business plan is crucial: "It needs to be extremely well produced and focused. A bank does not want to wade through 50 pages, around five to 10 should be adequate and there needs to be a strong executive summary. The bank will want to tell at a glance what the proposal is and there needs to be a lot of emphasis on the management team."

Macquarie's Nguyen explains further the type of information a business plan should contain, saying a bank will typically focus on the following points:
• the experience and capabilities of the management team
• a well thought out and cohesive strategy, with realistic projections to support it
• profitability / cash flow
• evidence of regulatory compliance
• debt/equity mix
• key risks and mitigating factors.

Time factor
So, if all goes well, how long should it take for a successful broker to secure their funding deal? Nguyen says that timescales for transactions vary greatly in length.

"In our experience, we have seen transactions completed in weeks and others that span beyond 12 months. Once the negotiations have been completed and terms for all parties have been agreed, we typically find that the funding for most transactions can be completed in around three months," he says.

He points out that this can vary due to complexity and the organisation and commitment of both parties. He notes that interest rates vary from transaction to transaction, depending on the complexity and risk profile of the transaction.

He also agrees that seeking advice from professional advisers is vital: "M&As and MBOs tend to be complex transactions which may give rise to significant regulatory, tax and legal implications. It is therefore critical that a buyer - and seller - seek professional advice to ensure they are adequately informed and protected. The cost varies between providers, however when a broker is considering it, they should also balance this with the potential cost of not seeking advice.

"We would always recommend that where possible, engage industry specialists who have the experience and knowledge required to provide the right advice in the most efficient and therefore cost effective way possible."

Clearly, an outright funding deal is going to be most brokers preference, but there are alternatives. Michael Rea, chief executive of Cullum Capital Ventures, says his company has ready access to funds and can offer brokers what he terms as "mini MBO" deals.

This is where a number of key managers would be incentivised with share holdings in the acquired business.

Rea says: "For example, CCV might buy 80% of a business and the remaining 20% could be given to the management team - it means a lot to have a share in the business going forward."

CCV has been one of the most active players in a lacklustre acquisition sector and could make around 14 purchases by the end of the year. Rea argues: "Even though market conditions have changed so much, the underlying factors remain that there are still a lot of older brokers looking to retire and some 3,000 businesses out there."

The government has been putting banks under increasing pressure to start lending again - but, even if the situation does pick up, the heady days are long gone. That said, those brokers who are the outstanding players in their field and can put across a convincing case, will find a few doors are open and that elusive cash is waiting for them.