Have You Checked Your Agency's Cholesterol Lately?

A lot of agency principals speak with passion about transitioning the ownership of their agency to their employees, instead of eventually selling to or merging with another firm, but my guess is that only a fraction of those who say their goal is internal perpetuation will ultimately pull it off. Why? Because for many a lack of preparation will simply make it impossible–they will be like out-of-shape athletes attempting to run a marathon.

If pressed to explain how they'll perpetuate, many freely admit they aren't sure whether they are on the right track. Preparing for perpetuation is complicated, and many don't even know where to begin.

There seems to be a real hunger among agency principals for diagnostic tools to help them assess their firm's level of “perpetuation fitness” and for prescriptions to help remedy those areas where their perpetuation plan is ailing. What if there was a “Perpetuation Fitness Exam” that an agency could undergo?

What would such an exam consist of? Of course, there would be a battery of tests, but the first thing the doctor would check is an agency's Weighted Average Shareholder Age, or WASA. Like a cholesterol reading, if an agency's WASA is too high, it is likely heading toward trouble. The lower an agency's WASA, the better.

For most agencies the WASA can be easily calculated–simply multiply each principal's ownership percentage times his or her age, and add up the results. The total is the agency's WASA. An example of a WASA calculation appears on this page.

Long-Tooth Associates has a WASA of 55.3. What do you think–is that healthy or not? In our experience, if that were a patient's cholesterol reading, he'd immediately be put on Lipitor!

The second accompanying table provides some guidelines for evaluating your agency's WASA. We developed this chart after reviewing the WASA readings for numerous clients–many of which still remain independent, and some of which have sold to a third party.

To give the benchmarks some perspective, we've compared them to the more widely-known cholesterol ranges. Simply stated, the higher the WASA, the less the likelihood that a firm will be able to internally perpetuate.

So, if the Long-Tooth principals in the accompanying example are truly committed to internal perpetuation, they'd better get moving! The good news in their case is that they have a couple of 5 percent shareholders in their 30s who are champing at the bit to get more shares.

In other words, if Bill wants to get the firm's WASA below 50 (a desirable target), he can do so by selling an additional 15 percent piece to both Mike and Steve. The third accompanying table shows the impact of the sale on Long-Tooth's WASA.

In our example, Long-Tooth's problem has temporarily been alleviated by Bill's sale of a portion of his holdings, but if additional transfers aren't made, the problem will rear its ugly head again in just a few years.

So, what should a firm do if it wants to perpetuate internally but has a WASA over 53? Here are some strategies:

o Get stock in the hands of key employees in their 30s and early 40s, even if you must be generous in offering financing terms on the sale. And keep in mind that direct sales of stock between older and younger employees are most efficient in pushing down the WASA (as shown in the Long-Tooth agency example).

o If you don't have any key employees in their 30s and 40s, start looking!

o Consider offering stock options to high-performing younger employees as a way to spread future growth in the value of the company.

o If you are a shareholder nearing retirement, recognize that the longer you wait, the more flexible you'll need to be in pricing your shares and in the terms of financing.

Like any other statistic, the WASA is far from infallible as a predictor of a firm's ability to internally perpetuate. Nevertheless, if you are looking for a tool to stimulate some hard thinking about your perpetuation plan, the WASA is a pretty good place to start.

If you've reached the point where you feel like giving up on internal perpetuation, keep in mind that even if you plan on selling the firm to a third party, the most powerful way to maximize the value of your agency is to position it to perpetuate internally.

Agency buyers know that the toughest possible competitor in the M&A marketplace is not another third-party buyer, but rather a talented and motivated group of key employees.