How many times have we considered what we'd do differently if we had it all to do over again? I was meeting recently with an agency owner in the midst of trying to undo some very ugly shareholder issues when he commented: "We could have used this advice when we were starting the business. Unfortunately, that's the time we could least afford to pay a consultant."
What are the basic principles that every insurance agency, new or old, should focus on to build a strong, viable and profitable enterprise? Recognizing that our industry is once again enjoying a great deal of start-up activity, it's worthwhile to consider some of the foundational organizational principles exhibited by many Best Practices agencies.
Avoid the trap of paying partners the same amount, regardless of contribution. What sounds equitable on the front-end of a business formation often proves highly problematic years later. The truth is that different roles have different values that should be compensated differently.
To avoid problems years down the road, pay for performance. Pay your owner-producers as you would pay any other producer in the agency. Pay your owner-managers what you would pay an employee to do the same job.
In addition, be sure to avoid the mistake of paying your owners nominal compensation packages, only to "make up the difference" at year-end when profits are distributed. This approach to compensation has the potential to disproportionately reward owner-employees on the basis of ownership rather than individual contributions–a common source of shareholder frustration.
One final compensation tip–do not compete for production talent by paying the highest commission rates in town. Don't forget the "Greater Fool Theory"–there will always be a greater fool out there willing to pay more to an available producer. Make sure you're not the greater fool!
Commission splits are only the tip of the iceberg when it comes to attracting sales talent. Pay local market wages and then focus your efforts on creating an organization that offers greater upside potential than your competition. (See infographic for suggestions.)
If the business coded to your producers is not protected via enforceable restrictive agreements, guess what? Practically speaking, the producers own the business, not the agency!
Needless to say, this has highly negative implications for an agency's value. I continue to be amazed at how many agencies still fail to require producers to sign restrictive agreements.
A properly drafted buy-sell agreement will go a long way to insuring that ownership transfers will take place in an orderly fashion, with a minimum amount of disruption to the business. In addition, it helps to ensure that both minority and majority shareholders (and their estates) will be treated fairly and reasonably when ownership changes hands.
Buy-sell agreements are broadly divided into two categories–repurchase agreements (requiring a repurchase of ownership interests by the corporation itself) and cross-purchase agreements (requiring a repurchase of ownership interests by other individuals, rather than the corporation). Some buy-sell agreements address both of these possibilities.
In short, the buy-sell answers the following questions regarding ownership transfers–how, when, why and at what price? Surprisingly, many agencies do not have buy-sell agreements in place. Many others have agreements that do not address the key provisions of a buy-sell agreement, which include:
o A list of triggering events.
Events that trigger ownership transfers typically include death, disability, retirement (or reaching a certain age), as well as voluntary and involuntary termination. In addition, a good buy-sell agreement will also address ownership transitions in the event of divorce and personal bankruptcy.
o Requirements or restrictions on sales.
A buy-sell agreement should establish a shareholder's requirements to sell in the event of a triggering event. It also establishes a requirement to buy on the part of the business itself or other individuals in the event of a triggering event.
The buy-sell agreement should also outline restrictions on the ability of shareholders to sell personal stock as well as restrictions on their ability to offer stock as collateral or have it encumbered in other ways.
o A valuation mechanism.
Without addressing this issue in the buy-sell agreement, you may find yourself in the unenviable position of having to negotiate price at the point each ownership transfer occurs. This is particularly unfortunate when an owner's estate is involved.
Not surprisingly, buyers and sellers often have very different views on value! The two most common valuation mechanisms are an independent appraisal of value, or the use of a valuation formula (such as a multiple of revenue).
Be very careful about relying on valuation formulas, as they can significantly over- or undervalue the business given their reliance on historical, rather than future, performance factors. Multiples are an excellent way to express value, but a flawed way to arrive at it.
o Terms and funding provisions.
A buy-sell agreement should also specify the financial terms under which ownership transfers will take place (seller financing, outside financing, down-payments, interest rates, number of years to be financed, etc.).
o Restrictive covenants.
Also known as noncompete or nonpiracy agreements, restrictive covenants are typically included in buy-sell agreements to ensure that departing shareholders are prevented from competing with the business for some reasonable time period after the transition of their ownership.
Strongly consider choosing (or changing to) any number of ownership structures other than the "C Corporation" structure.
In recent years, the tax advantages associated with the S Corporation, the Limited Liability Partnership (LLP), the Limited Partnership (LP) and the Limited Liability Company (LLC) have grown to the point that a C Corporation rarely, if ever, makes sense anymore for a privately-held retail insurance agency.
Avoid the temptation to distribute the profits of the firm at the expense of investing in the long-term organization's health.
Consider adopting a minimum threshold of 10-to-20 percent of the firm's profits to be reinvested annually on the people, systems and products that a growing business will depend on for its long-term health. Make this a systematic investment approach, just as you do with your retirement savings, rather than reacting to needs as they arise.
Find a trusted adviser to give you the critical feedback you'll need to grow your business and make it prosper. Whether it's an accountant, an attorney or a consultant, find a knowledgeable professional that you can trust to help to address the inevitable blind spots that will develop while building and running your agency.
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