The Deal That Blew Up the Day Before Closing, and the Deal That Came Out of It

I started Oak Stream Partners in 2013. I came out of mortgages, so one of my first theses was simple: look at the financial sectors next door. Insurance was the obvious one. As I dug in, I found a niche called nonstandard auto insurance, the coverage for drivers the mainstream carriers don't want.

When I saw how much money that niche made as a percentage of premium written, my jaw dropped. It reminded me of the scene in The Wolf of Wall Street where Leonardo DiCaprio's character learns how much commission brokers make on penny stocks. I had the same look on my face, minus the yacht.

Nonstandard auto is a strange, fee-rich, expense-heavy corner of insurance. It's concentrated in a few big states. In 2013, California, Texas and Florida together wrote about 59% of the country's nonstandard auto premium, and California alone wrote more than 22%. If you know how to underwrite it, it pays. If you don't, it can bury you.

The chase

I found a company for sale, a managing general agency, and the broker representing it didn't strike me as sophisticated. I made an offer, but it didn't come together. The company was growing so fast that my own investors couldn't fund it alone.

So I kept at it and brought in a private equity sponsor. We put together a side car investment for my search fund investors. I also negotiated a finder's fee in case I didn't become CEO, because the PE firm already owned a company in the space and wanted to combine the two. Had that happened, I would have been the first search fund to return a positive ROI while still in the search phase. We got the company under a letter of intent.

The blow-up

The PE firm turned out to be so abrasive that the owners couldn't stand them. They kept trading terms with the seller and piling on conditions no one in the industry would consider normal. Everyone had poured in countless hours, their own money and plenty of sweat. Then, one day before closing, the PE firm blew up the deal.

I was crushed. If you've ever had a deal die at the altar, you know the feeling. The worst part is the silence afterward.

The phone call

Not too long after, the owners called me. They'd been impressed with me during diligence. They liked the relationship we'd built, and they'd noticed every improvement opportunity I'd dug up. They wanted me to run the company. I wanted to buy it. But hey, this way I would get a free look while the seller acted as my "investor" and provided my promote while we had first right of refusal to purchase it. Not a bad deal.

There was a catch. They gave me two jobs at once:

1. Turn the company around from the ground up.
2. Do it with no new investment. Instead of selling, the owners would pay themselves extra distributions until they'd taken out about what the purchase price would have been.

"Fly on the wall"

Before I'd finished negotiating my employment contract, I was invited to a meeting so I could watch the outgoing CEO at work. It was with a large Ohio-based nonstandard auto carrier that Allstate would later buy, and one of the largest claims administrators in the country was also in attendance. I was supposed to be a fly on the wall.

I walked in. The carrier's CEO was there, a sharp-elbowed executive who was a Progressive and Allstate veteran, along with his whole management team. So were the claims administrator's CEO, some of his team, and our company's CEO and full leadership team. She opened the meeting by announcing that I was the new incoming CEO.

I had no preparation and no signed contract. Needless to say, it helped my contract negotiations.

The town car

I flew home and pulled up in a town car. My ex-wife, pregnant at the time and juggling our other child, gave me a look that said, Must be nice. She was frazzled and figured I'd been living the high life. I stepped out and told her to start packing. We were moving.

How not to hand off a company

At my first company meeting, the outgoing CEO explained who would report to me and who would report to her. The CFO would report to her, because she was moving to the board and the board wanted tight control of the finances. In laying all that out, she skipped over the president, who had expected to be next in line for CEO. The president learned in that meeting, in front of everyone, that she'd been passed over.

If you ever want a textbook example of how not to run a leadership transition, that was it.

Sharp elbows and a lightning storm

That carrier's CEO from the first meeting where I was unexpectedly announced as CEO had such sharp elbows that his own attorney would often apologize for his behavior. That's never a good sign. He gave us a tour of their offices, some of the nicest I've ever seen, and bragged about how much of the leadership team he'd fired when he came in. He seemed unaware that those were the people who had built the ostentatious office he now sat in.

There was more history there than he let on. After my deal blew up and before I joined, the owners of the MGA had tried to sell to that carrier. It couldn't afford us. It was in the middle of its own turnaround, and at the time we were actually more profitable than his much larger company.

So when we met, he wanted to lower our commission rates and break our contract. We faced off in his hugely oversized office. As the meeting got tense, a lightning storm broke out over the city, perfectly timed and on full display in the giant windows behind his back. He couldn't see it. I could. It's hard to feel outgunned when the sky is doing your talking for you.

Rebuilding everything

The company was near Silicon Valley while tech was booming, so office space was scarce and rents were through the roof. We rebuilt the company from the frame up:

• Analyzed more than $400 million in premium data and built an underwriting strategy that brought the loss ratio down significantly.
• Brought in a new policy management system. The old one ran on an IBM AS/400 midrange computer, programmed in RPG, a language few people still wrote. Everyone worked on green screens with no graphical interface, and the daily reports came off a dot-matrix printer on green-bar paper, the kind with the perforated, hole-punched strips down the sides that you tore off by hand. Near the middle of Silicon Valley.
• Wrote a new employee handbook and documented every internal process.
• Incorporated new technologies at the forefront of innovation. We were one of the first to use AI, in the form of IBM's Watson, and we worked with the founder of EagleView to use satellite tracking and video pixel analysis to both prevent and adjudicate claims.
• Took the margin seriously. Over about 18 months, EBITDA margin went from 24% to 39% on more than $150 million in premium, written through more than 2,100 brokers.
• Secured new fronting carriers and the quota-share reinsurance behind all 13 of our programs.

On at least three occasions I went 72 hours without sleep. We turned the company around, grew it, prepared it for sale and moved a 20-plus-year-old institution, all while rewriting every policy and procedure. It was a huge job, and one of the most exhilarating stretches of my life.

The ending

The owners took out close to what they would have gotten in the sale. But the company had one big risk: heavy concentration with a carrier that was heading toward insolvency. My investors and I had a right of first refusal to buy the company, and we passed. Instead we found a buyer who would come in after that big program had finished running off. The company is still operating today, under new leadership with a new strategy.

Both jobs got done. The company went to a third party, the owners got their liquidity, the carriers were taken care of, and the employees and the company's legacy carried on. And some of the relationships I formed with that team are still great friendships today.

The lesson from the trenches

A dead deal isn't always the end of the relationship. Owners remember who did the homework, who listened and who treated them with respect, and they remember who didn't. Being the one they trust can lead to more than a closing.