Episode Summary

During this episode of “The Practice Manual,” host Rob Chaplin is joined by colleagues George Gray, Anika Goodfellow and Usman Sawar to examine the ins and outs of brokerage M&A. The team covers a range of topics, including how acquirors of brokerage businesses must tailor their transaction documentation to protect value, why a standardized approach to deal documents can be a costly mistake and how the interplay between earn-outs, management reinvestment, leaver provisions and restrictive covenants is critical to aligning interests post-acquisition. The panel also explores the FCA change-in-control process and multijurisdictional regulatory approvals, among other key topics.

Key Points

Why brokerages are different: The primary assets in a brokerage are client relationships, key producers and regulatory permissions rather than tangible property or proprietary technology. Revenue is relationship-dependent and largely intangible, which means the legal documentation must work hard to protect what the buyer has actually paid for. Sponsors and acquirors need to resist the instinct to use standardized documents and instead tailor the transaction carefully to preserve value.

Earn-outs and consideration structuring: Earn-outs are a common feature of brokerage M&A, particularly on bolt-on acquisitions and platform establishment transactions, where they serve to defer consideration until revenue sustainability can be verified and to keep sellers economically incentivized post-acquisition. On larger, more institutionalized transactions, earn-outs are less common, as sellers — and any external private capital in the structure — tend to push for greater upfront certainty of value.

Reinvestment and management incentivization: The obligation for sellers to reinvest in the go-forward business is becoming increasingly central to brokerage transactions. Reinvestment ensures alignment between seller and buyer interests post-closing, with key personnel sharing both upside and downside.

Gap controls and interim period management: Gap controls in brokerage M&A require a careful balance between protecting the buyer’s position and allowing the target to continue operating — and, critically, continuing its own acquisitive business model. Restrictions around changes to key personnel, remuneration structures, insurer relationships and key contracts should be calibrated to ensure the business delivered at completion has moved forward during the gap period.

Execution risk and shareholder dynamics: Founder-owned brokerages often have large, fragmented shareholder bases with differing tax positions, views on value and levels of transaction experience. Without early planning — including establishing a shareholder representative structure, mapping drag-along and tag-along mechanics and implementing a disciplined power-of-attorney process — deal friction can cause economic terms to reopen and bidder tension to collapse.

Regulatory approvals and FCA change-in-control: The FCA’s change-in-control process is typically the dominant timetable driver on U.K. brokerage transactions, with a statutory assessment period of 60 working days that can be extended through clock-stopping and further information requests. Where deals require filings across multiple jurisdictions, each regulator will have different requirements, tests and documentation expectations, and long-stop dates must be calibrated accordingly.

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“The Practice Manual" is a podcast by Skadden, Arps, Slate, Meagher & Flom LLP, and Affiliates. This podcast is provided for educational and informational purposes only and is not intended and should not be construed as legal advice. This podcast is considered advertising under applicable state laws.

Rob Chaplin (RC): Welcome to The Practice Manual, the podcast where we break down some of the mysteries of the insurance and reinsurance sector and the latest trends. Today, we're going to be talking about brokerage M&A. I'm Rob Chaplin, head of our Financial Institutions Group here in London. And with me today are George Gray, Anika Goodfellow, Usman Sawar, who all work closely with me in this area.

Usman, what is it about insurance brokerages that make them interesting from a transactional legal perspective?

Usman Sawar (US): Thanks, Rob. So at a headline level, brokerage businesses look simple. They earn commission income, they don't carry balance sheet risk, and they're lightly regulated relative to insurance carriers. Unless, of course, you've got an insurance carrier in the group, which then can extend the regulation over the whole group. But that surface simplicity can be a little bit misleading. The core legal complexity on brokerage M&A comes from two primary areas. And the first really is that revenue in these businesses is very relationship-dependent. And the value in a brokerage is largely intangible and sits with key producers and their clients. And that can create real tension around how you structure consideration, how you retain the key people and what your warranties and indemnities are actually protecting.

And we'll unpack that a little bit later as well. And the second is the regulatory permissions. FCA authorisation, the appointed representative network and any delegated authority agreements — these are all critical to business operations, and when you've got a regulated business, any change in control will give rise to an approval process from the applicable regulator.

George Gray (GG): And so from a sponsor's perspective, or anyone else that's buying this type of business, what does that mean in practice? So, the legal structuring on these transactions tends to do a lot of the heavy lifting that you wouldn't necessarily have if you were buying a straightforward manufacturing or technology business. Really, the way you need to think about brokerages is you are buying a business whose primary asset is a set of client relationships and regulatory permissions, rather than a business with tangible property or proprietary technology or anything of that nature. And therefore, the documentation really has to work hard to protect what you've actually paid for. Another factor here is that these businesses are often founder-owned and those client relationships are normally managed by an internal team of people who are very, very important for those relationships. It is wrong to assume that you just buy the relationships and that people management isn't important. And we'll come on shortly to talking a little bit about incentivization and how that plays in.

But generally, that fact pattern means that sponsors, acquirors of these businesses tend to do things a little bit differently. The commercial instinct can be to try and move forward with a very standardised set of documents, particularly if you're under pressure to acquire the business quickly. But, given all the points that I've mentioned, including the fact that you have a lot of founder relevance and internal emotional dynamics on these transactions, you need to take care to make sure that you are tailoring the documents very carefully to make sure that they are appropriate for the transaction, but they are also preserving that value for you.

RC: That's so true, George. Yet another case of more haste, less speed, and probably the case that you can entrench a lot of value for the future in terms of how you actually structure and implement the transaction when you're buying the business.

And I'm guessing transactions look very different depending on whether you're acquiring a brokerage platform as a stand-alone business, which you're either going to develop organically, you're going to do team hires, or you're going to do further acquisitions to integrate into that platform. Or you're acting for a stand-alone platform already, which is doing bolt-on acquisitions, George.

GG: That's quite right, Rob. So, the overall structure of the transactions tends to be largely similar, but there are some nuances, particularly as you're thinking about how do we incentivize individuals as part of the transaction we're doing now, but then on an ongoing basis. And I'll talk a little bit about that now. We do have another episode or two coming down the line on management incentivization where we'll explore this in a bit more detail. But earn-outs are quite common on brokerage M&A, but more so I would say on bolt-on transactions, or if someone's looking to establish a platform with maybe a smaller initial platform acquisition.

Where an existing brokerage is acquiring a number of other brokerages as part of a roll-up strategy, earn-outs can be quite helpful as a tool to make sure you're appropriately incentivising people at the time of the transaction, then on an ongoing basis. The transactions, as I said, tend to be founder-led businesses when you are acquiring those smaller bolt-on divisions. As a result of that, there can be a little bit of uncertainty around sustainability of revenue, particularly given the importance of those client relationships as I said, one thing that you need to be thinking about is: Who are the senior team? What stage in their career are they at? Is there an appropriate succession plan in place? This can all feed into how much are we paying for the deal now? How do we need to be thinking about earn-outs and other types of protections you might look for on an ongoing basis?

In that context, earn-outs can provide two benefits. One of them is it defers consideration until the point where you can actually verify that revenue that you've used as the basis for your acquisition price. It also keeps the sellers economically incentivised to continue to grow the business, at least in that period immediately post-acquisition while the earn-out is in place. Where a sponsor is acquiring a more institutionalised business, a more well-established business, in those situations, we don't tend to see earn-outs as often. We sometimes do, particularly if the general market is choppier or if there are certain aspects of the business or its revenue streams which are more appropriate for an earn-out. The sellers in those larger transactions or more established transactions tend to resist earn-outs and other forms of deferred consideration. That's for a few reasons. Even if you are buying a founder business, the founders are normally running a larger business. They are more confident in the revenue that they're generating. More often than not, once a business has scaled to that level, you often have external private capital in the structure, and there the conversation becomes even more difficult around having earn-out protection because financial sponsors, private capital will want more certainty of that sale value up front. So, we don't tend to see them as often on those deals. Those transactions tend to focus much more on how do you incentivise management on an ongoing basis.

Now, again, as I said earlier, we'll come back to this in some separate episodes of the podcast, but the way you would typically do that is by a mixture of rollover of existing security value into new strip or hard equity, but what is the management incentivisation plan that you're going to put in place? And as with all things, there's a million and one ways of doing this. Brokerage M&A is one area where you have to be quite finessed about how you're thinking about that. Is it appropriate for this business? Is it appropriate for this founder, this management group? And how are we appropriately calibrating this to make sure that it works not only on this transaction, but in three, four, five years if we're looking to sell, will that distribute value in an appropriate way that also makes that value creation event desirable for the management team, but then also attractive for the incoming buyer so that they don't think people are walking off the pitch with too much value at that point.

So, a further point on earn-outs is that tax structuring is very important. The treatment of earn-out receipts, whether they're taxed as capital, income, employment income, that depends heavily on how it's structured and documented. For sellers expecting a capital event, getting that wrong can be an unpleasant experience. It's therefore critical to ensure that tax advice is embedded up front. The other two points I'd add is, number one, it's very important to focus on the mechanics that drive value as part of that earn-out, particularly where they're structured as securities-based earn-out arrangements. How is EBITDA defined, etc. That can be the source of a lot of dispute later on. It may feel tactically better to introduce a bit of flex there and up front, certainly as a buyer, that might make you feel as though you can game the process later. What we tend to see in practice is without clear parameters, what you actually do is end up in a potentially nasty dispute scenario, which can end up being more costly and not get you to the right outcome.

The final point I'd make on earn-outs is from a seller perspective, always important to make sure that there are appropriate protections in place so that a buyer cannot game the earn-out process.

US: Another really important aspect of brokerage deals is the gap controls, and gap controls are important on all M&A deals, but they're particularly important on brokerage deals. And in particular, on the deals we've done, we've seen that a lot of the brokerages that are subject to the M&A transaction, they're themselves acquisitive. So, their business model relies on going and consolidating other brokers and buying businesses in the gap period. So, if you're on the buyer side there, you don't want to stop them doing that because most of these transactions are lockbox deals. You're accruing value in that gap period. So, it's in your best interest to really allow them some flexibility to continue their business model, continue acquiring businesses and building that platform. But I think you need to balance that with giving yourself adequate protections and effectively ensuring the business that you want to be there at completion is there at completion. So one thing that really is subject to negotiation is the gap controls around M&A and acquisitions, and I think you can't be too heavy-handed there with the lawyering, and I think you need to really embed some commercial flexibility.

And then more generally, I think you need to look at the business and make sure that the revenue stability is there. So, changes to key personnel, remuneration structures, insurer relationships, key contracts, you want some restrictions around those, but really you want to work together with the management team to, collaboratively insofar as you can in the gap period, ensure that really you're getting delivered a business at completion that has moved forward in that gap period.

RC: Anika.

Anika Goodfellow (AG): We're now also seeing that the obligations for sellers to reinvest in the go-forward business is becoming more and more central. This is often picked up in the equity work stream of transactions as opposed to the acquisition items that George and Usman just touched on.

The reasoning for this reinvestment obligation is pretty simple. Brokerages are at their core a people business, and the employees and management are central to the ongoing profitability of these businesses, meaning you want them to stay put. The reinvestment obligation is the structural mechanism that ensures sellers' interests remain aligned with the interests of the buyers on a go-forward basis. It means the people most important to this business and its revenue generation are invested, sitting alongside the buyer and sharing the same upside and also the same downside.

The legal work in this area focuses on the terms of that reinvestment. For example, how much and on what basis, and where the reinvested equity sits within the acquisition structure. You're also negotiating the leaver provisions very carefully because the consequences of management departure whether they're a good leaver, bad leaver, or somewhere in between, need to be proportionate to the reinvestment commitment you're asking management to make. A management team that has reinvested a significant portion of their proceeds needs to feel that they are being treated fairly. Otherwise, the reinvestment obligation becomes a source of resentment rather than alignment.

We actually saw this recently when advising the shareholders of a leading credit and political risk brokerage on their investment from a financial sponsor. The sellers in that case retained a majority stake post-closing and committed to reinvesting a portion of their proceeds.

The terms of that reinvestment and the negotiation of the leaver mechanics were particularly detailed.

GG: I would just add one point there, Anika, because all of those points are really crucial for when you're buying a business in this sector, absolutely. There's a very complex interplay between what are those securities that people have invested in that gives them that skin in the game, how do those leaver provisions operate, and then also particularly where you have a large number of managers that have those securities, are you giving opportunities for liquidity, or if they're leaving the business, how does that all interact alongside the restrictive covenants just to make sure that there's a very clear framework in place for how maybe middle managers or slightly more senior producers, what happens to them if they leave the business to go to a competitor and how does that interact with that value that they've got in place? That can be a really key hook to make sure that you retain that value creation and make sure that you're protecting those client relationships from a brokerage perspective.

RC: And I think it's fair to say, George, it's another one of those sectors which is a chatty sector, so people talk to each other, for better or worse. And therefore, you should always try and make sure as a buyer that whatever you're doing for your management team that you wish to retain and you wish them to grow the business in the future is at least in line with market.

GG: 100%.

RC: So earn-outs, reinvestment, super important. Usman, what are the other things that get heavily negotiated in these deals?

US: Look, warranties and indemnities are always a significant workstream like with other M&A transactions. But look in particular on brokerage transactions, you've got the overlay of your client book composition, producer arrangements, historic complaints handling, commission structures, conduct risk. So all of these matters really give rise to the fact that a purchaser is not going to just want a standard warranty package that you see on lots of M&A deals. The warranties are going to be specific and bespoke, and you need to think about them and make sure that you're really covering the key areas, especially with the kind of additional regulatory scrutiny in this area over the past few years.

Look, aside from warranties and indemnities, as George touched upon, nonsolicits and noncompetes are critical in this sector just because of the nature of the business and the dependency on key individuals. If those individuals walk and take their books with them, then effectively you paid for a business that has lost real value. So I think you really need to think and calibrate that package appropriately. It needs to be wide enough to protect your concerns, but it then also needs to be defensible under English law. And English law is becoming increasingly more demanding on enforceability of restrictive covenants. So I think you really need to have a think about the scope, the duration and the consideration being given in relation to these covenants.

And look, it's such an important area that we've got another podcast just on this topic. So, our listeners should definitely listen to that one and we'll unpack in more detail.

GG: I think your point there on warranty packages was a really good one, Usman, and one specific example that springs to mind is just because you have been used to doing cap-light brokerage-type M&A, you may have in your mind what is a standard warranty package that you think is going to be suitable for the next deal. If you have a small carrier component of the group, which you mentioned earlier, it can be very easy to forget that you actually need a highly customised set of warranties which reflect that, and getting that wrong can make the difference between a poorly executed DD exercise, which doesn't have the benefit of the disclosure that you're going to get around certain key issues, and then also potential value leakage later if you don't have the protection of the warranties that you need.

In terms of our next topic, I think we should talk a bit about execution risk. Now, we've talked a little bit already about the founder-owned nature of these businesses. Quite often, you might have a lot of people in the capital structure. Given the shareholder dynamics of these founder-owned businesses, when you have a large cap table, which they often do, that can be a real source of deal friction and it is an issue that financial sponsors or other acquirors of these businesses need to get ahead of early. Unfortunately, we don't always see that. When we're buy-side on transactions, this can be a topic that the sell side hasn't thought about in enough detail or early enough. But, where you have that fragmented shareholder base, there are a lot of different tax positions to think about, different views on value, different levels of transaction experience. All of these things come together to mean that you need a really trusted representative on the sell side who is going to have proper authority to negotiate and bind these people into a transaction. And, without that, you end up in a process where the economic terms keep reopening as other shareholders come into the picture and start engaging at different stages.

The other big risk that you have if you're trying to move extremely quickly to execute a transaction, if the sell side hasn't got their ducks in a row on this, or if you're a sell-side group that's trying to work towards moving a transaction forwards quickly and developing a lot of bidder tension around that speed. If you haven't got this lined up well in advance in a meaningful and well-constructed legal manner, you are going to be in a situation where that bidder tension falls down, or as a buy-side party that is looking to, for example, preempt on a transaction, you are going to get stuck. Now, what does that mean in practice?

On a sell-side basis, on many of the transactions that we work on, we get ahead of this very early, often at the outset of the transaction by helping to establish the structure, make sure that we're clear on who is going to lead on the sell side, what mandate to that they have, how does that interact with the drag along provisions, what are the tag mechanics that are existing in the shareholder documentation that's in place at the time. Essentially, what does the existing shareholders' framework say around how the transaction is going to be executed, and what levers do key people in the structure have to pull to ensure that they can bring everyone along for the ride. For example, on one recent transaction that we worked on, we had well over 100, maybe towards 200 shareholders. The shareholder rep structure wasn't just helpful there, it was one of the main reasons that the deal got done on the terms that it got done. What does this mean in practice in terms of trying to get everyone signed up to a deal? We are very forensic around how we go about the POA process. So, first of all, we identify which groups definitely need to sign documentation and how they are going to be individually managed. We work very, very closely with the management teams on these transactions to make sure that we have a legal process, yes, but also a commercial and practical process for making sure that we can get all the right people signed up. That might be a town hall, it might be different Zoom calls. We may be involved, it may be management-led, but we have an absolutely tight, locked-down process, which makes sure that when we need to get the deal signed, we can get it signed without having this as a problem.

RC: Anika.

AG: So one of the other areas that's a source of friction in negotiation is, unsurprisingly, valuation. And in brokerage, it has a specific technical dimension. The cyclicality of commission income makes normalized EBITDA genuinely difficult to agree, and buyers and sellers often have very different views on what's a legitimate add-back, how you treat one-off items, and whether certain adjustments are defensible.

That flows directly into price and then into the price mechanism used. The choice between a lockbox and completion accounts and how each interacts with any earn-out structure requires very careful thought.

RC: That's so true, Anika. And I think the other thing we should touch on is what happens between contract and completion and regulatory consents.

Generally, people, Usman, want to get deals done as quickly as possible. And you mentioned earlier the Financial Conduct Authority, the FCA, consents required for U.K. brokerage deals. Tell us some more about that.

US: Thanks, Rob. So in the UK, the FCA change-in-control process is typically the dominant timetable driver.

The statutory assessment period is 60 working days, but in practice, you'll find that it's an iterative process. The FCA can stop the clock. They can ask for more documents, and it can cause delays. So really, upfront, you want a fully formed application with all of your key documents in place. Ideally, you'd try and do as much of this before signing as possible so that you can submit as soon as possible after signing.

And then you also have to factor in that on some recent deals we've done, we've had to file in the U.K., but also in Europe, America and Asia, with various different regulators. And where people sometimes come unstuck is that they don't appreciate that the different regulators have slightly different requirements.

The test itself for change in control is different. The documentation is also different, and their expectations of how you present it is also different. So, you can't just assume that you've got your FCA application and you can roll that out for others. You need to bespoke them. And, so, I think the key practical advice is map out that regulator early. Get local counsel involved. Make sure you know all of the requirements. And look, understand the timelines. Some regulators are a lot slower than others, so you really need to calibrate your long-stop date with that in mind. And if you do as much work on all of them before signing as possible, then you should be able to get the deals done as quickly as possible.

GG: And from an exit perspective as well, regulatory robustness is really linked to optionality. And so what do I mean by that? A platform that has a clean regulatory history across all jurisdictions in a well-documented way with the compliance infrastructure being robust and there not being skeletons lurking in the closet from that perspective, that is a materially easier story and regulatory risk profile to sell to a buyer. And that doesn't matter whether it's a strategic buyer or a sponsor or you're looking to do something in the public market. It is important in all cases. Regulatory risk that has been allowed to accumulate is something that we see as a real deal killer in certain situations. Now, there are ways of mitigating it sometimes if it's not got to an extreme level. That's why a robust vendor due diligence process is always important. But, where risks have been allowed to accumulate, we see that as something that can be a real prized chip for future buyers, and we do see it used as such.

So, the time to address regulatory gaps is always now, not when you're trying to run an exit process. Of course, if you're doing the VDD exercise and something crops up, we do enough of these transactions to be able to address that and deal with the issue as it is presented, but then also ensure that we are appropriately explaining that to buyers, bringing them along on the journey, and ensuring that how that's going to be remediated is not as materially impactful on price as it could be. But trying to make sure that you get ahead of these situations early, you have a good compliance and governance framework in place to avoid them happening in the first place is crucial.

RC: Anika.

AG: One, an example of regulatory risk is complaints handling. That's an area where we've been seeing an increased focus partially as well because the FCA has been focused on the area recently. If there are systemic issues in a target's history regarding how it handles complaints, buyers want to understand the exposure and deal with it appropriately, whether that's via purchase price adjustments, specific indemnities or ensuring that there's enough W&I coverage. The key is, as George has said, identifying those issues early enough that they can be addressed in the deal structure rather than punting it to a post-closing dispute.

RC: That's great, Anika. Before we close, I think it would be great to have one practical takeaway from each of you for these transactions. George.

GG: So, I'd say mine's probably on deal structure. So, use earn-outs where appropriate and reinvestment mechanics to do the real work, not just to bridge a cash flow gap. The best brokerage transactions we've worked on are those where the incentive design really does align interests over the medium term, where management has real skin in the game. But you're creating a structure at the outset of that transaction, which is going to drive value for you on an ongoing basis.

RC: Anika.

AG: Mine's on execution readiness. I would say one of the most important things you can do as a seller or as a management team before you run a process is to get your house in order legally. That means knowing exactly what your shareholders' agreement says before the buyer even asks, and having clean corporate records and also understanding where your key arrangements sit and how they interact with each other. Buyers who find structural surprises mid-process often reprice or even walk away entirely.

RC: Usman.

US: Mine is never losing sight of the fact that brokerages are fundamentally a people business. So, really, it's a battle of the hearts and minds. And on the deals that we do for financial sponsors, those that come in with that mindset and they really take the people along on the journey, we find they're the most successful. Because we've talked a lot about the legal structures, but, ultimately, it's winning those people over and incentivizing them to continue growing the business post-completion.

RC: Usman, that is such a strong point. Yes, these transactions are to a certain extent about financial engineering, having the right amount of leverage in the transaction, etc. But we know as we've acted for countless founders over the decades, we've acted on the other side of founders buying founder-owned businesses.

The really absolutely key point is that no two founders, no two management teams are the same. It's just like everything else in the world. Everybody is different, and it's really important as the advisor or for that matter as the buyer to really understand who you're dealing with, to get under their skin, and that's ultimately what, A, delivers a successful transaction in terms of getting the deal done, but B, and most importantly after that, delivering a successful investment and ultimately a successful exit. So thanks, team. That was absolutely amazing. A great account of brokerage transactions.

So, that's it for now for this episode. Do please join us next time.

Outro: "The Practice Manual" is a podcast by Skadden, Arps, Slate, Meagher & Flom LLP and affiliates. Skadden is recognized for its deep experience in representing insurance and reinsurance companies and their advisors on a wide variety of transactional and regulatory matters. This podcast is provided for educational and informational purposes only, and is not intended to be and should not be construed as legal advice.

This podcast is considered advertising under applicable state laws.