Used productively, debt can help an agency grow
Q&A: InsurBanc’s David Tralka talks about the smart ways agencies can use credit.
NU PC360 recently talked to David Tralka, president and CEO of InsurBanc, about productive ways agencies can use debt. An expert on agency perpetuation and financing, Tralka often speaks and writes about how agencies can increase the value of their firm. InsurBanc is a division of Connecticut Community Bank, N.A., and provides financial products and services tailored to the independent agency community.
NU PC360: Are there times when it makes sense for an agency to borrow money?
David Tralka: Every agency is unique, but yes, for agencies that want to grow, either organically or inorganically, using debt can make a lot of sense. Rather than drain their own working capital, agency owners may wish to borrow using a line of credit or a loan so they can reinvest in their agency or expand into a new market.
NU PC360: What are some of the top reasons why an agency might want to borrow?
DT: I would put hiring new producers, and investing in technology and office systems at the top of the list. From time to time, agencies may also want to buy a book of business or acquire a smaller agency. In addition, many business succession plans call for a buy-out when a partner retires. Financing the purchase of those shares to perpetuate the business can be an attractive option.
NU PC360: You mentioned organic and inorganic growth. Is one strategy better suited to borrowing?
DT: Actually, debt can be a good tool for either organic or inorganic growth, depending on your objectives. With organic growth, you’re investing in your agency, but you may want to borrow so you aren’t tying up all of your cash. A short-term loan that gets an agency through the validation period for a new producer may be a very smart investment. The same goes for a new agency management system that leads to a more efficient operation and better customer service.
With inorganic growth, borrowing can be a good strategy for acquiring an agency that fits into your business plans. While organic growth strategies generally result in better returns over time, using credit to facilitate any growth strategy can be an effective approach to increase value in your firm. By the same token, using leverage to purchase another agency is a time-tested approach for growth. It is important to remember that too much debt can strangle any growth strategy, so being prudent with leverage is critical. In any case, the goal of borrowing is always the same: to create improved cash flow and grow over time.
NU PC360: Agencies that are well-capitalized and perhaps aren’t thinking of borrowing, should they consider taking on debt?
DT: It depends on the agency, but, yes, debt can support entry into new markets or acquiring a book of business. A well-capitalized and profitable agency is more likely able to access financing at very attractive terms. Debt can be a very powerful tool for growth if used properly. It gives you more options, and options are always good for a business.
All agencies should think about how they might access needed capital. Where can they get credit, and what are the terms? The preparation that goes into securing a loan results in better financial management. It gives you discipline and focuses on the basics of running your business. I liken it to a homeowner who qualifies for a home equity line of credit. He may not use it right away, but he’s taken the steps to get his financial house in order. And that puts him in a better position if he ever needs credit.
NU PC360: Are there times when you would say not to borrow? How do you know when you’re over-leveraged?
DT: Always keep in mind that your goal is to increase value, and the way you do that is by creating recurring, predictable cash flow into the future. You never want to be so leveraged that your ability to generate cash flow is in jeopardy. Every agency is unique, with different geographic markets, lines of insurance and types of clients, so it boils down to how each agency drives its business. How much debt can you take on and still generate enough cash flow to pay your debt service?
A good lender will go over your financials and help you determine a realistic growth rate, one that can generate the capital you’ll need to repay your debt. Remember that you are looking for measured growth when you use debt. You always need to be able to sustain your cash flow to meet the needs of your long-term strategy.
NU PC360: How do you see borrowing fitting into a succession or perpetuation strategy?
DT: One trend I’m seeing today is owners wanting to keep a part of their agency rather than sell it outright. By using debt, they can recapitalize their agency to get some of the equity into the hands of the next owner. At the same time, they can hold on to a percentage of the equity to take advantage of future growth. For example, an owner may sell a 30% share in the agency to someone he is grooming for ownership such as a family member or producer. The owner would continue to receive a 70% share of the agency’s cash flow and enjoy the fruits of its enhanced value when he sells the remaining shares.
Borrowing is an affordable way for the future owner to buy into the business. The current owner receives a down payment on his retirement but still has a stake in the agency. This pruning of equity can really strengthen the long-term viability of the agency.
NU PC360: There are different sources of capital — for example, seller financing or a bank. What are some considerations?
DT: Seller financing has always been a popular strategy to finance perpetuation or acquisitions. For some, however, the notion that the seller is now your banker may not be attractive. Some buyers prefer a clean break in the transaction, which brings us to bank financing. If you are considering a bank loan, you always want to go with an institution that knows your business. Make sure your banker understands the needs of independent insurance agents and understands what your long-term plan is. Is there another transaction down the road? Know that there are many options in the banking market and taking the time to evaluate all of them should result in the best outcome for your agency.
NU PC360: In a nutshell, it sounds like you are saying that borrowing, if done smartly, can increase the value of an agency.
DT: Most definitely. Anything that helps an agency increase its value, and by that I mean improve the sustainability of its cash flow over time, is going to inevitably lead to growth in agency value. Taking on a reasonable level of debt to facilitate your growth strategy can really pay off in the end.
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