We have seen first-hand a number of situations in which agency equity is owned by individuals not active in the agency. Those situations have evolved for a number of reasons. For example, an agency principal may have experienced a need for working capital and then turned to a friend or business acquaintance for funding. The cost of that capital may have been an equity position in the agency. In some cases, a major client might insist on equity as a condition for bringing the account to the agency. In other cases, a shareholder becomes relatively inactive but has not formally retired.
All of these situations share one issue in common. The active shareholders ultimately are put in the untenable position of continuing to build the agency while some of that growth in value accrues to individuals who have little or no ability to contribute to that success.
It is to everyone's benefit ultimately to put that equity into the hands of the "rainmakers" of the agency over some reasonable period of time. This accomplishes several goals. Key personnel usually are motivated to seek an equity position in the agency. Their motivation is twofold: to have their contribution in the agency rewarded by an ownership position; and to have the psychological comfort that they have a future as an agency principal.
Since the financial health of an agency is directly related to the effectiveness of its key personnel, the motivation factor in producing results should not be understated. Following are examples, based on Harbor Capital's experiences, of how specific situations were dealt with in the real world.
One example revolved around two agency shareholders who initially acquired equity in return for broker of record letters on several commercial businesses, which they owned, but were unrelated to the agency.
This situation was solved with the issuance of preferred stock with a modest interest rate. The face amount of the preferred stock was reduced from actual ownership value since they were now guaranteed both an annual financial return as well as an exit strategy, since the preferred issue was callable in several years.
A second situation involved an agency where one of the original founding shareholders, although still in his prime, had, with the agreement of his partner, decided to slow his involvement. The agency was trying to attract a new very aggressive producer. The logical solution was for the slowing partner to sell a portion of his equity to the new producer. This was a classic win-win situation where the slowing partner would ultimately benefit financially by having the new producer as part of the agency. The partner was able to cash in a portion of his equity as the balance of equity grew in value over time. The new producer likewise was able to become a shareholder and benefit from his contribution to the agency with his newly purchased equity stake.
A third situation involved an agency that had experienced some financial problems several years ago. At that time an investor was found that acquired a 50% equity stake. Although the cash infusion was necessary at the time, it became obvious after a number of years that answering to a passive shareholder, who was not in the business, would become a limiting factor in the agency's ability to grow. Fortunately, the shareholders' agreement contained a buy/sell provision, which enabled the passive shareholder to be bought out, although at a premium. The active shareholder found the premium well worth paying in order to ensure future growth and profitability by being able to carry out an unimpeded game plan.
In summary, while these examples of passive shareholder experiences may not be a common occurrence, they do, in fact, occur for the various reasons stated in these examples. Agency principals should be prepared to deal with these situations if they occur and position themselves to extricate the agency from the situations if they become burdensome. While it is not always possible initially to structure the most preferred agreement, it should be recognized that a rationale dialog with passive shareholders can, in many instances, have a positive outcome.
The professionals at Harbor Capital take a pragmatic approach with agency internal issues and seek creative and innovative ways of addressing shareholder issues. We feel that a proactive approach to agency problem solving is usually the best course of action when weighed against the alternative of keeping the status quo which results in a stalemate.
The authors
Paul J. Di Stefano, CPA, CPCU, is managing director and G. Edward Kalbaugh, MBA, is director of management advisory services for Harbor Capital Advisors, Inc. Harbor Capital is a New York-based national financial and management consulting firm which offers services to the insurance industry. Services include agency appraisals, merger & acquisition representation, strategic and management consulting. Harbor Capital Advisors, Inc., can be reached in New York at (800) 858-2732.
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