Agency Owners: Are You Reasonable?

There are in excess of 35,000 independent insurance agents and brokers in the United States, and the vast majority of them are privately held.

Our experience would suggest that they are privately held for a number of reasons including the autonomy they desire, the quality of life they enjoy, the economic opportunities presented and the competitive advantages that can come from private ownership.

In spite of the many potential advantages that can be gained by private ownership, many agents come to the point of selling their organization to third parties. For some, it allows them to best accomplish their personal and corporate objectives. There are others, though, that still desire to remain privately held, but they have gotten themselves into a position where they cannot continue to do so. In many instances, this happens because they simply do not understand what it will take to remain privately held.

The reality is that it is difficult and complicated to remain privately held, and agency owners are getting a lot of confusing messages. It is for these reasons that Reagan Consulting initiated The Private Ownership Study and solicited the support of Amerisure Insurance, Cincinnati Insurance Companies, Hanover Insurance Group and Liberty Mutual Agency Markets to do this significant research and produce this study.

The purpose of this study is to demystify a very complicated process and to provide the information, insights and resources to help agency owners remain privately held, if it is their desire to do so.

The study establishes that there are four critical requirements for ownership to be perpetuated internally. These “pillars” on which private ownership rests include:

• Healthy operations
• Reasonable sellers
• Able buyers
• Effective ownership transfer mechanisms

Although each of these elements is required, clearly the starting point is the willing and reasonable seller.

Such sellers are the folks that currently own and lead insurance agencies across the United States. These are the people that we work with most closely in our consulting practice.

They are also my peers age-wise, and they are people with whom I have a lot in common. I started in the insurance business 35 years ago, I have been consulting for 25 years, and I founded Reagan Consulting 15 years ago. I am the chief executive officer of a privately held consulting firm that has every intention of remaining privately held indefinitely.

The basic question for my friends and peers that are principals of privately held insurance agencies, and for me, is: “Are we truly willing and reasonable sellers, not simply in words, but also in our actions?”

To answer that question, let's draw from the findings of the study and consider the key elements that will determine whether or not we are willing and reasonable.

The reasonable requirement has three components, the first of which is the value that will be established for the equity that will change hands. Internal perpetuation will work if the value is established based on the earnings and growth potential of the agency as it exists, not based on what a third-party buyer would be willing to pay for the agency. Reasonable sellers must accept an internal, going-concern valuation and cannot expect that the next generation of internal owners will be able to pay what the highest bidders will pay.

For Reagan Consulting, this was an easy point to come to based on the significant advantages we gain by being privately held, and the reality that the value that we establish must be supported by the earnings that we generate.

The second element of reasonableness is the current owners' willingness to provide or arrange financing for the buyers. This component results from the fact that the next generation of key employees coming along does not have the personal resources to simply write a check, and they need the majority of their current earnings to support their families and lifestyle.

It is also necessary to provide a source of funding, which in most instances is in the form of profit distributions. It was interesting for us to see in the study that the typical insurance agency provides financing terms which allow future profit distributions to cover most, if not all, of the future principal and interest payments required to purchase equity.

For Reagan Consulting, this was also a logical and necessary point to come to. The valuation that we use and the financing terms that we make available need to be largely covered by the distributions of profits that the new owners will be entitled to receive.

The third key component of reasonableness is the willingness of the current owners to sell and distribute ownership on a timely basis. If an agency principal hangs on to all of his or her ownership until he or she is ready to walk out the door, internal perpetuation is not likely to work. The best scenarios are where agency principals use stock as a means to attract, motivate and reward key employees and they begin transitioning a portion of their ownership well in advance of the termination of their employment.

At Reagan Consulting, I am still seven to 10 years away from my intended retirement, but it became apparent to me shortly after Reagan Consulting was formed in 1995 that it would be to my advantage and the firm's advantage to begin sharing ownership with key employees. The ownership that I sold to my six partners reduces the amount of ownership that I hold, but it makes for a much healthier organization with a meaningful percentage of ownership being held by key players in their 30s and 40s. From my perspective, I own less of the company, but the percentage that I own is more valuable due to the talented young people that we have been able to bring into our organization.

Well, if you pass the test for being reasonable, the final and ultimate question is are you willing to perpetuate internally.

Some agency principals are motivated to remain private based on their desire to maintain autonomy and a quality of life that they feel can only be preserved in a privately held firm. Others desire to remain private based on a clear sense that over time, they will get the best economic return. If you look at our industry and measure compensation levels, profit distributions and equity appreciation, insurance agencies have provided some of the best economic returns available in the marketplace.

In addition to all of this, many agency principals desire to remain privately held because they have found that they have a competitive advantage in recruiting talent as a privately held firm.

For Reagan Consulting, the commitment to remain privately held is not only influenced by each of the factors mentioned above, but also by the reality that we will be best positioned to consult and provide advice and direction to our clients when we are independent of the direction and influence of a third-party owner. As a consulting firm, being private is a critical part of our culture.

Our hope is that The Private Ownership Study will motivate agency principals to assess their commitment to private ownership and to determine if they are, in fact, “reasonable” and positioning their firms to remain private and enjoy the benefits of doing so.

We do recognize that the objectives of some agents and brokers can be best achieved by selling to a third party. For Reagan Consulting, we have determined that it is in our best interest and the best interest of our clients to remain privately held. As a result, we are not only willing to perpetuate internally, but we are prepared and positioned to do so effectively.

I am pleased to report that we have taken the same medicine that we have regularly prescribed and we will benefit from it. It is my hope that many of my agency owner friends and peers will do so as well.

Bobby Reagan is CEO of Reagan Consulting Inc., an Atlanta-based management consulting firm focusing on the insurance distribution system. He may be reached at 404-233-5545, or by e-mail at bobby@reaganconsulting.com.