Agencies Face Crossroads On PerpetuationPlanning

Fewer automatically opt for internal ownership transfersgiven market realities

Say you have an agency started by your dad back in 1930. Youcame on board in 1960 and bought your father out in 1974. Your sonand another young person someone you had coached in Little League,perhaps came into the agency in the early 1990s. From that pointon, your mindset was always on internal perpetuation keeping thebusiness in the family, literally or figuratively.

This is a desirable scenario for many agency owners, but for thefollowing reasons, it is one that fewer owners choose to pursue orare able to achieve.

A third-party sale typically results in at least a 25-to-30percent higher selling price than an internal sale, and thatdifference is hard for many sellers to leave on the table.

Well-capitalized banks and regional/national brokers the mostactive acquirers are willing to pay the higher price because,long-term, the economics work. They know they can bring resourcesto the table that will enable the acquired agency to increaseearnings, thereby justifying the higher price.

Internal buyers, on the other hand, are constricted by therealities of the agency's cash flow. It must be able to service thedebt of buying out the seller. For the economics to workinternally, the seller usually has to be willing to take a lowerprice.

The current merger-and-acquisition market, where demand forwell-run agencies exceeds supply, has caused many agency owners toput their commitment to internal perpetuation on hold.

Owners feel they must consider the opportunities presented inthis type of environment. Doing so, however, can irrevocably damageperpetuation plans by creating uncertainty for the key employeeswho are anticipated as future agency buyers.

Without a clear message as to what the perpetuation plan is andthe sure promise of ownership ahead, certain key employees mightlose their commitment to maintaining the health and viability ofthe agency or may decide to leave. Internal perpetuation thenbecomes very difficult to achieve.

Too many agency owners fail to start their perpetuation planningin time to execute it properly and are forced to take a differentcourse of action.

The key to success is starting early enough to make sure thatthe right people are in place and equipped to assume the ownershipand control of the agency, and that the funding will be availableand sufficient when the time comes to make the transfer.

Five-to-seven years is a bare-minimum time frame for developingleadership and management skills, building the agency's assets, andemploying various methods for transferring ownership. For example,deferred compensation to make a transaction more affordable to theemployee-buyers and “gifting” to put stock into the hands of familymembers are very useful tools, but both require significant time tobe used effectively.

Unfortunately, many owners wait until they are nearingretirement to begin the process. By then it is usually toolate.

Staying Internal

In spite of today's opportunities and barriers, many agencyowners are committed to, and do achieve, internal perpetuation. Forthose who want to pursue this option, a well-thought-out plan isessential. It will go far beyond a buy-sell agreement. It will mapout the long-term process for meeting the needs of both the sellersand the buyers, for the actual transfer of ownership, and for thesuccession of the agency's management.

A few years ago, the principals of Reagan Consulting worked withthe Independent Insurance Agents and Brokers of America to developand publish the “Best Practices Perpetuation Study.”

Although changes in the tax laws have affected some aspects ofownership transfers (for example, a lower capital gains tax rate),the information and worksheets contained in the study are extremelyuseful resources. Because the planning process described in thestudy and the critical issues it addresses are so relevant, theyare worth summarizing again.

These are just a sample of the questions you need to answer.

o As the current owner, determine what your objectives are.

You have determined that you want to sell to family members orcurrent employees, but what are your personal financial needs?

Do you want/need to maximize the purchase price received ormaximize the income that you will continue to receive for someperiod of time?

Over what period of time will payments be made? Are you willingto take less to maintain the vitality of the agency?

Are you able and willing to finance the purchase of yourinterest?

When do you want to transition the ownership? Do you want thetransfer to begin before you actually retire?

Consider the options available to you for transferring ownershipand leadership.

A variety of ways can be used to actually transfer ownershippurchase of stock or selected assets, payments for covenants not tocompete, deferred compensation, consulting arrangements, brokerageagreements, etc. all of which will have different tax, funding,legal and risk implications. You will need to weigh each based onyour objectives.

The financing to be used must also be considered. Has the agencyretained earnings over time to use to repurchase stock?Realistically, what financial resources does the next generation ofowners have? Preparing cash-flow projections can help validatewhether the agency's future cash flows will be sufficient torepurchase your stock.

For the succession of management and leadership, consider thecapabilities and desires of employees and/or family members to whomyou hope to sell. Since it may be necessary for you to receivepayments over time for your ownership interest, are you confidentyou have a group of successors who are capable of keeping theagency viable after your departure? If not, can you recruit talent?If the talent is there, how much development will need tooccur?

Based on your objectives, weigh your options.

Will the options you have identified work in your agency? Ifnot, what needs to change to make them work? If the options areimplemented, will they still meet your objectives? You may findthat you will need to revise your objectives and go through theprocess again.

Once you have weighed your options, determine the mostappropriate plan and commit it to writing.

Putting your plan in writing will help you to communicateclearly to the involved parties your intentions for perpetuation.Since it will incorporate legal documents such as a buy-sellagreement and will, as well as your strategic business plans, awritten plan provides a basis for making decisions when internal orexternal factors impact your objectives.

With your long-term plan in place, take the steps required toprepare for perpetuation and management succession.

Implementing your plan might involve such big-picture items asidentifying and training future leaders and building the agency'svalue, but can also involve actions steps such as securing lifeinsurance, getting appropriate contracts in place and changing theorganizational structure.

Periodically review your plan and adjust as needed.

Although you have defined a preferred course of action,recognize that change may be necessary. Leave the door open forvarious contingency options by making sure the agency is managed tocontinuously enhance its value.

By taking these steps, you have a much higher likelihood of asmooth transition and success in meeting your objectives and thoseof your buyers. And remember thisit is never too early tobegin planning for an agency's perpetuation and managementsuccession.

Bobby Reagan ([email protected])is the chairman and CEO of Reagan Consulting, an Atlanta-basedfinancial and management consulting firm serving the leadinginsurance agents, brokers and financial institutions. For moreinformation, go to www.reaganconsulting.com.

Reproduced from National Underwriter Edition, May 28, 2004.Copyright 2004 by The National Underwriter Company in the serialpublication. All rights reserved.Copyright in this article as anindependent work may be held by the author.