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InsurTech: Don’t go public until you have to

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If you had one dollar to invest in insurance at the start of the 2010s, the best part of the industry to put it to work in was probably privately owned retail brokers – the Hubs, the USIs, the NFPs of the world.

These firms have in some cases been able to achieve long-term internal rates of return in the 20s and 30s, and the strategy has been pretty much as safe as houses – with even the weaker management teams pursuing this model delivering strong returns.

The retail broking investment strategy could no doubt have been outperformed by an adept investor stock-picking within InsurTech since 2015, even if they just set their dollar to one side for the first half of the decade, but the errant InsurTech investor could equally be nursing their losses. Good and bad InsurTech investors could both be having problems with their blood pressure this year.

My point is that the private brokers are exemplars that InsurTechs would do well to look towards for lessons, and in particular in terms of one of the defining decisions for management – how to finance your business.

During the early 2010s as these private equity-backed broking platforms grew rapidly through acquisition, the received wisdom was that the entry of Hub and its smaller competitors to the public markets was only a matter of time.

The rationale was that private equity is exit-driven and that as the brokers grew in scale there would be no way for them to refinance privately.

Through a combination of effective leveraging of co-investors like Canadian pension funds, the scale-up of private equity houses and the increasing prevalence of GP-led secondary offerings, the exit-driven IPO just wasn’t needed.

And speaking to management at the broking firms throughout this period, it was clear that they were not going to go public unless they had to.

So, a whole cohort of big PE-backed brokers that have might have been expected to go public through the 2010s remained entirely – and very successfully - in private hands.

Some of this was cultural. The executives that lead these businesses were true business builders – and had little interest in performing the role of the CEO for the public markets.

But alongside this, there were at least five substantive reasons for remaining private:

1. Avoid investor scrutiny/short termism – The management teams did not want to run their businesses to deliver quarter-to-quarter wins that matched the rhythms of the public markets; and nor did they want to have to engage with multiple analysts and investors that understood their businesses only as outsiders

2. Maximize personal wealth – Successive private refinancing allowed management teams to re-cut the equity repeatedly in ways that allowed them to accumulate wealth that would be impossible in the public markets with a one-and-done IPO

3. Minimize regulatory interest – Management teams didn't want the increased prominence that came with being a public company because it inevitably brought heightened regulatory attention, which is at best a drain on time and at worst a real risk to the business

4. Optimize valuation timing – Being valued once every three, five or seven years allows you (if you're good) to push valuation higher by timing the deal

5. Maintain freedom around leverage – Management teams wanted the freedom to run these businesses with debt leverage of 8-12x Ebitda, which would not have been supported in the public markets

By choosing to remain private, these management teams have had increased room to operate freely and have been able to retain a greater share of the wealth they have created.

It is still possible that Ryan Specialty Group's recent IPO will change the calculus somewhat for the coming years by re-setting the outer edge of an achievable valuation in the public markets. But you are likely to need a clear valuation delta between private and public markets to bribe most of the private brokers into filing S-1s.

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InsurTechs – going public when you can

If there is an independent broker culture that is averse to the public markets, then in the technology world the opposite bias seems to exist.

Within this worldview, a business has not truly Made It until the founder is ringing the bell to mark their stock market debut, with the imprimatur of the public markets placed on their multi-billion-dollar valuation.

For the most part, technology firms don’t go public when they have to – they go public when they can.

There are some indisputable benefits to this path. Being public gives you access to permanent capital. And – setting to one side the CEO's ego – there are real brand benefits.

Being publicly traded credentializes a business – and this can support both new customer relationships and closer trading relationships with partners, buttressing growth at a crucial time.

Those benefits are not trivial under certain circumstances.

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But at this stage, I think InsurTech businesses going public are typically giving up far more than they are getting.

There is certainly no sense given all of the major InsurTechs are worth <$10bn (substantially less than Hub) that these businesses are too big to finance privately. And although it may have been the case for a time, the sharp fall in public InsurTech valuations this year (which has not been matched privately) means that there is not a strong case to go public even if the target is simply to maximize Day 1 value.

Most of that five-point private broker list of reasons to stay private applies well to InsurTechs (excepting leverage), but points one and four are particularly compelling.

By going public, these firms subject themselves to all the rigors and distractions of listed life, disrupting the ability of these relatively young businesses to develop and mature.

At a time when their founders should be focused on building a strong platform for future success, and setting their firms on a path to sustainability, their focus is diluted. Instead of thinking about the future of the franchise, they are fighting to craft a narrative of success for a broader constituency of investors, sinking time into managing the Street and exerting themselves to project confidence.

If private brokers optimize their valuations by timing the market, public InsurTechs have two struggles around timing.

The first relates specifically to InsurTechs going public via SPAC deals. In these cases, a valuation is agreed between the SPAC (sponsors) and the InsurTech when the de-SPAC merger is signed. This valuation then has to stand up and remain attractive to the original SPAC investors three-to-six months down the line when the redemption vote is held.

If the initial valuation is set too high or the market moves against you, you can get huge capital flight – which can be enough to kill the deal (as we saw with Qomplx-Tailwind).

The second challenge relates to the fact that the public InsurTechs are constantly – and publicly – marked-to-market. By listing in a major bull market for technology stocks and IPOs, the public cohort of InsurTechs typically debuted at rich valuations.

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The next generation of InsurTechs weighing up the public markets would do well to heed the lessons of the independent brokers and go public only when they have to.

They did this while they were immature and heavily cash-destructive, with their models largely unproven and in some cases badly misfiring.

This has created a race against time for these companies to improve and get their share prices back above water before they need to raise additional equity to finance their businesses. If they are unable to do so, then there is scope for their challenges to become terminal.

Had they remained private, there would have been no mark-to-market of their valuations and they would be able to operate with less intense pressure around their future capital needs. The danger here is that the North Star of these businesses becomes getting the share price higher when they should be thinking about how to solve customer problems.

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