Many agency owners aspire to keep their firms privately held. They believe that employee ownership gives them certain marketplace advantages, and to protect these advantages they are willing to work hard to ensure their firm can perpetuate internally.
Today these aspirations are colliding with a grim reality–at the very point that the baby boomer generation is beginning to retire, remaining privately held is getting considerably tougher. Why?
Several factors have converged to make perpetuation difficult. The economy has been weak for nearly three years and remains frustratingly uncertain. The soft commercial insurance pricing environment is nearing the completion of its seventh year, and few are predicting a hard market anytime soon. Finally, President Barack Obama's health care reform law is causing angst for those brokering health insurance.
As a result, agency performance has suffered in recent years, and the prospects of turnaround in the near-term seem dim. As the accompanying bar graph indicates, agency growth is at a stand-still, and profitability is down significantly.
The negative trends in agency performance and the uncertainty concerning the future are creating stress for agency perpetuation plans. Are soon-to-retire shareholders still prepared to accept a discount for their shares relative to what they could get from a third-party buyer when many of their other retirement assets have lost value? Does the next generation really want to buy stock in an agency that may see its revenue and/or profits decline after they buy in?
In reality, perpetuation planning is a complex process requiring the orchestration of four key issues. We call these the "Four Pillars of Perpetuation." Without having each of these pillars in place, an agency cannot perpetuate internally. Below is a brief description of each of the four pillars:
o Healthy Operation. Ideally, an agency will have a diversified and growing stream of profits and a strong balance of retained earnings to enable ownership transfers. Today's stagnant revenue growth and declining profit margins are driving valuations lower and making it difficult for both buyers and sellers to make internal transfers of stock work.
For many who stepped up and bought agency shares during the past three years, the financial forecasts they relied upon have had to be revised downward.
o Reasonable Sellers. First and foremost, "reasonable" sellers have to accept the fact that selling to insiders normally results in a lesser payout for their shares than if the entire firm were sold to a third-party buyer. In addition, they might need to be willing to sell at least some of their shares earlier than they would prefer.
A critical element in enabling a firm to remain private is to avoid a situation where an enormous percentage of the firm must be acquired all at once. Smaller chunks of ownership, transitioned in increments, can smooth out ownership transitions and make them more palatable for buyers.
o Able Buyers. One of the greatest differentiators among agencies is the degree to which they've effectively recruited and developed the next generation of sales, support and leadership talent. For those that have, internal perpetuation is a realistic possibility. On the other hand, for those that haven't, the prospects for internal perpetuation get bleaker by the day.
o Effective Transfer Mechanism. Even if the other three pillars are in place, an agency must have an effective mechanism for transferring shares from one generation to the next. A wide variety of techniques are used to transfer shares, and each has its unique strengths and weaknesses.
For example, direct purchases of stock work in some agencies but don't work in others. An employee stock ownership plan can be a useful tool in certain circumstances but not others. The key is that the transfer mechanism must be properly matched to the attributes of a particular agency.
Given the environment, it is clear that many agency perpetuation plans are under serious stress. In light of this, in 2010 Reagan Consulting has launched an initiative that will soon be released, called the "Private Ownership Study."
In this study, which involved hundreds of agencies nationwide, we have dug deeply into how successful agencies are accomplishing their perpetuation objectives. It has been fascinating to learn how they are dealing with each of the four pillars. (The results of the study will soon be available and are free to the industry).
Internal perpetuation isn't for everyone. It requires a significant investment in time and resources and carries with it no guarantee of success.
In addition, a well-selected strategic acquirer can often bring more than just a big payout to the table–it can also offer growth capital and resources that enable a selling agency to improve its game.
At the same time, simply planning for internal perpetuation can be rewarding. Why? Because many of the keys to internal perpetuation–such as building a healthy, high-performing operation and developing the next generation of talent–create superior shareholder returns regardless of the perpetuation alternative that is ultimately selected.
Kevin Stipe is a Senior Vice President and Principal at Reagan Consulting Inc., an Atlanta-based management consulting firm that developed and produces the "Independent Insurance Agents and Brokers of America Best Practices Study." He may be reached at (404) 233-5545 or by e-mail at Kevin@reaganconsulting.com.
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