Equity Investors Must Recapture Wasted Capital (How to Choose Your Insurance Broker Series)

As an equity investor and partner to successful organizations, you know that the due diligence completed before your offer is critical to your success. This analysis includes a number of important factors that all contribute to your final offer or transaction costs. You now have many more tools at your disposal by way of analytics and cloud computing data.

Historically, insurance brokerage firms have provided you due diligence regarding the potential costs of risk financing placements or unfunded claim reserves. That is now “old school” as those services have been around for decades. While they are important, frankly many brokers can provide you those same services. Truthfully, some of these costs are the smallest part of your opportunity for ROI.

You should work with a brokerage firm that can help you identify and quantify the current Financial Leakage that is inside each transaction. It will create millions of dollars of increased equity or reduced purchase costs. In the past, this tremendous amount of capital has gone unnoticed by most brokers and their investment banking clients.

Financial Leakage is the quantifiable amount of money that is currently being wasted inside of the acquired firm’s cost structure. This money is not the insurance or risk financing spending. It consists of the frictional costs around indirect loss costs and ineffective risk control. In the past, this leakage has been hidden from view for the buyers.

In many cases, it is an additional 40% to 60%* on top of the insurance cost. It is not a line item, as it’s spread throughout the operational costs of the organization. This amount is controllable and creates substantial wasted capital.

Historically, this amount has been unknown. However, with the recent advances in cloud computing data, a sophisticated brokerage firm can now pinpoint this amount and translate it into EBITDA, margins and multiples of shareholder value. If you are not currently getting this information from your broker, you are probably being underserved.

The bottom line is this: If you know how much controllable certified Financial Leakage is currently being wasted by the targeted acquisition, you can do one of two things:

  1. You can negotiate the purchase price by removing this quantifiable expense, thereby reducing the price by a multiple of the Financial Leakage.
  2. You can proceed at the agreed upon terms and then work to attack and reduce these costs after the purchase. This will allow your equity partners to receive an accelerated ROI from the improved profits.

Let’s use a simplistic example. Inside a transaction with $1 million of Property/Casualty premiums, you can expect to find between $400,000 and $600,000 of Financial Leakage. So, for our example we will use $500,000 as the amount of certified Financial Leakage.

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Now, we realize that your formulas for acquisition are much more complicated than the abbreviated example provided above. But, for illustration purposes, you get the picture. Are you and your investors really willing to leave that kind of money on the table? On every transaction?

Of course not.

So, in selecting a professional brokerage firm that delivers the best advantage for your partners, here is what you should look for:

  • They must be able to provide you a projection of the Certified Financial Leakage that currently exists inside of the potential acquisition. This will provide you with a financial perspective on their current wasted capital.
  • This projection must be data-based and lead to either a purchase price reduction or an accelerated profit once the transaction is completed.
  • They need to have the data and analytics required to help you focus on the implementation plan to recapture that wasted capital. The plan should include the quantifiable goals inside your margins and shareholder valuations.
  • They must be prepared to help you measure that leakage throughout your ownership stake to keep it from eroding your potential future sale.

We have said it before, and any sophisticated broker knows it: the smallest impact they can make is in the risk financing choices. The lion’s share of your opportunity is the Financial Leakage that is already baked into the target’s overhead. Your ability to unlock this existing windfall lies with the brokerage firm who can help you quantitatively identify it, use it in your negotiations, and return it to your investors.

Here are a few of our prior installments of the “How to Choose your Insurance Broker” series…

  1. The Worst Choices a Buyer Can Make – How to Choose your Insurance Broker
  2. Where’s The Beef? – How to Choose your Insurance Broker
  3. How to Tell if You Have Outgrown Your Insurance Broker
  4. The Only Fair Way to Pay Your Broker – How to Choose your Insurance Broker