Someone recently asked me what causes agencies to go out of business. While I can't provide statistical proof, in my experience there are three factors that kill agencies far more frequently than anything else: partnership disputes, non-producing producers and bad balance sheets. Like many fatal diseases, they can cause pervasive damage before you even realize there's a problem, so let's examine each one and try to detect some warning signs.
Partnership disputes
I've seen partnership disputes destroy many agencies. The good news is that when a partnership falls apart, the agency can still survive if the shareholder and buy/sell agreements are properly written (see last month's column). The bad news is that few of these agreements are, and the time to negotiate a new one is not when the two parties are mad at each other. As a result, partnership disputes often take the agency down with them, and it has to be sold.
With good contracts, the agency has a better chance of surviving even irreconcilable disputes. The key is having a good buy-sell agreement within a good shareholder agreement: one that properly defines agency value, has reasonable buyout terms, addresses partnership disputes, and includes all the applicable buyout triggers (not just death and disability).
Agencies need more than their attorney's help in formulating these agreements, because few attorneys know enough about insurance agencies to capture all the important clauses in the contract. I've seen attorneys commit huge gaffes writing these documents, resulting in agencies being valued from 10 times their book of business down to 0.05 times the book. (A valuation based on a multiple of commissions is wrongheaded in the first place, since it entirely skips the critical importance of the balance sheet.)
Another key component of a shareholder agreement is a compensation clause, so partners earn what they deserve rather than a straight share of profits. Partnerships fall apart when one partner's income is disproportionate to his or her contribution. That's why a good agreement will clearly delineate performance standards.
Non-producing producers
Non-producing producers kill an agency in slow and quiet ways. When an agency hires a producer who doesn't produce, losing "only" $100,000 to $200,000 without incurring collateral damage is the best that can be hoped for. Most often, however, collateral damage can't be avoided. It takes such forms as low morale or increased E&O risk. The staff gets tired of working with a producer who doesn't produce. It creates needless stress and hampers their ability to help producers who are producing. Sometimes there's damage to carrier-agency relations, and there's often bad business to clean up.
Hiring one poor producer usually won't kill an agency, although it may cripple it. The fatal blow comes from making a habit of it. The dollars spent drain the agency; carriers, employees and clients lose confidence. Continually hiring producers who fail to produce weakens the balance sheet to a point where the agency can no longer invest in the future (see below).
Death isn't so slow and quiet when the non-producing producer is a partner. When a partner doesn't produce, everyone in the agency knows it. This is where one bad apple can truly spoil the barrel. Odds are the compensation and buy-sell agreements do not adequately address poorly performing partners, so the agency is beset with the worst possible situation: The partner is handsomely rewarded despite failure, he or she has zero incentive to improve, and the other partners are powerless to do anything about it.
Bad balance sheets
By my estimate, approximately 40% of agencies and brokerages are out of trust. They're robbing Peter to pay Paul. Being in trust means the agency's cash plus receivables is greater than its payables. It does not mean, or even have anything to do with, paying your companies on time. Rarely can an agency invest adequately in the future if it's spending clients' money, which is what happens when an agency is out of trust. The result will be a slow demise brought about by inadequate investment to increase sales--if not a sudden death caused by the loss of company contracts or prosecution by the insurance department.
Bad balance sheets result from many totally preventable causes. The two most common:
1) The accountant does not understand insurance agency accounting protocol and recommends the agency drain its cash at year-end to minimize taxes or, in some cases, help the principals pay their taxes. An agency should never drain cash below a trust ratio of 1.0. This is an absolute. If it means paying more taxes, then pay them. Funds needed for the trust account are not your money to spend.
2) The owners pay themselves $X, regardless of whether they've earned it or the agency can afford it. Rather, owners should be paid last, and their payments should not cause the trust ratio to drop below 1.0.
Interestingly, E&O claims don't usually cause an agency to fold, although that occasionally happens. I believe the reason is that agencies take E&O much more seriously than these other causes, because the penalties are so severe and immediate. By contrast, the agency-killers described here cause a subtle deterioration, similar to smoking cigarettes. The deadly effects of cigarettes are not immediately obvious, so people keep smoking. And then one day ...
To maintain a long and healthy life, agency owners need to give the same attention to partner agreements, hiring producers and bad balance sheets that they do to E&O matters. Fatal diseases do not always conveniently announce themselves. As the owner, it's up to you to see that the agency gets its routine checkups and focuses on prevention, rather than treatment.
Chris Burand is president of Burand & Associates LLC, an agency consulting firm. Readers may contact Chris at (719) 485-3868 or by e-mail at Chris@burand-associates.com
Partnership disputes
I've seen partnership disputes destroy many agencies. The good news is that when a partnership falls apart, the agency can still survive if the shareholder and buy/sell agreements are properly written (see last month's column). The bad news is that few of these agreements are, and the time to negotiate a new one is not when the two parties are mad at each other. As a result, partnership disputes often take the agency down with them, and it has to be sold.
With good contracts, the agency has a better chance of surviving even irreconcilable disputes. The key is having a good buy-sell agreement within a good shareholder agreement: one that properly defines agency value, has reasonable buyout terms, addresses partnership disputes, and includes all the applicable buyout triggers (not just death and disability).
Agencies need more than their attorney's help in formulating these agreements, because few attorneys know enough about insurance agencies to capture all the important clauses in the contract. I've seen attorneys commit huge gaffes writing these documents, resulting in agencies being valued from 10 times their book of business down to 0.05 times the book. (A valuation based on a multiple of commissions is wrongheaded in the first place, since it entirely skips the critical importance of the balance sheet.)
Another key component of a shareholder agreement is a compensation clause, so partners earn what they deserve rather than a straight share of profits. Partnerships fall apart when one partner's income is disproportionate to his or her contribution. That's why a good agreement will clearly delineate performance standards.
Non-producing producers
Non-producing producers kill an agency in slow and quiet ways. When an agency hires a producer who doesn't produce, losing "only" $100,000 to $200,000 without incurring collateral damage is the best that can be hoped for. Most often, however, collateral damage can't be avoided. It takes such forms as low morale or increased E&O risk. The staff gets tired of working with a producer who doesn't produce. It creates needless stress and hampers their ability to help producers who are producing. Sometimes there's damage to carrier-agency relations, and there's often bad business to clean up.
Hiring one poor producer usually won't kill an agency, although it may cripple it. The fatal blow comes from making a habit of it. The dollars spent drain the agency; carriers, employees and clients lose confidence. Continually hiring producers who fail to produce weakens the balance sheet to a point where the agency can no longer invest in the future (see below).
Death isn't so slow and quiet when the non-producing producer is a partner. When a partner doesn't produce, everyone in the agency knows it. This is where one bad apple can truly spoil the barrel. Odds are the compensation and buy-sell agreements do not adequately address poorly performing partners, so the agency is beset with the worst possible situation: The partner is handsomely rewarded despite failure, he or she has zero incentive to improve, and the other partners are powerless to do anything about it.
Bad balance sheets
By my estimate, approximately 40% of agencies and brokerages are out of trust. They're robbing Peter to pay Paul. Being in trust means the agency's cash plus receivables is greater than its payables. It does not mean, or even have anything to do with, paying your companies on time. Rarely can an agency invest adequately in the future if it's spending clients' money, which is what happens when an agency is out of trust. The result will be a slow demise brought about by inadequate investment to increase sales--if not a sudden death caused by the loss of company contracts or prosecution by the insurance department.
Bad balance sheets result from many totally preventable causes. The two most common:
1) The accountant does not understand insurance agency accounting protocol and recommends the agency drain its cash at year-end to minimize taxes or, in some cases, help the principals pay their taxes. An agency should never drain cash below a trust ratio of 1.0. This is an absolute. If it means paying more taxes, then pay them. Funds needed for the trust account are not your money to spend.
2) The owners pay themselves $X, regardless of whether they've earned it or the agency can afford it. Rather, owners should be paid last, and their payments should not cause the trust ratio to drop below 1.0.
Interestingly, E&O claims don't usually cause an agency to fold, although that occasionally happens. I believe the reason is that agencies take E&O much more seriously than these other causes, because the penalties are so severe and immediate. By contrast, the agency-killers described here cause a subtle deterioration, similar to smoking cigarettes. The deadly effects of cigarettes are not immediately obvious, so people keep smoking. And then one day ...
To maintain a long and healthy life, agency owners need to give the same attention to partner agreements, hiring producers and bad balance sheets that they do to E&O matters. Fatal diseases do not always conveniently announce themselves. As the owner, it's up to you to see that the agency gets its routine checkups and focuses on prevention, rather than treatment.
Chris Burand is president of Burand & Associates LLC, an agency consulting firm. Readers may contact Chris at (719) 485-3868 or by e-mail at Chris@burand-associates.com
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