Top agency consultants tell it like it is to
newcomers and veterans alike
By Elisabeth Boone, CPCU
"As many as 90% of independent agencies and brokerages have no strategy to transfer ownership when the owner retires."
-- Catherine Oak, consultant<Oak & Associates, Glen Ellen, California
You're 37 years old and you and two partners have just acquired a thriving agency from its long-time owner, who has happily traded her business suits and briefcase for a sailboat and snorkeling gear. You wake up every morning brimming with ideas for building your business, and nothing could be further from your mind than retirement. Even if the thought does cross your mind, you aren't concerned. After all, you have years ... decades! ... before you have to worry about perpetuation, right?
Wrong!
The time to begin planning for perpetuation isn't in the dim distant future, or a few years before you want to retire. On the contrary, say two respected agency management consultants, perpetuation planning should begin as soon as you open
for business.
"The time to start planning for perpetuation is the day you assume ownership of the agency," says Sharon Cunningham, president of Business Management Group (BMG) in Hartford, Connecticut. "A lot of work has to be done to pull this off, so you need to begin early."
Adds Bob Hilzenrath, a BMG vice president and merger/acquisition specialist: "As you're preparing the initial documents to form or acquire an agency, it's a good time to consider how perpetuation might work. We often see buy/sell agreements that cover every aspect of what happens if one owner dies or becomes disabled, with life insurance proceeds payable to the surviving owner, but that doesn't reflect the kind of 'people planning' that's needed to ensure a successful transition."
"If you intend to sell to current employees rather than a third party, you have to identify the people who will become your successors," Cunningham says. "They may or may not be in the agency at the time you begin planning, because as an agency grows, it may require several people to take ownership and run the business--not just one or two people as in the past. So you need to take care of all the people issues: hiring and training them, and evaluating them to see if they're partnership material, as opposed to being good producers or coverage experts."
Waiting too long to start perpetuation planning isn't good, says Catherine Oak, founder of the Oak & Associates consulting firm of Glen Ellen, California--but even worse is not planning at all. "Agency owners spend their entire career building a successful business, and they're justified in looking back on their accomplishment with pride," she says. "After working so hard for so many years, why would an owner fail to plan for perpetuation? It's like an artist who creates a masterpiece and then destroys it at the end of his career." Alarmingly, Oak observes, as many as 90% of independent agencies and brokerages have no strategy to transfer ownership when the owner retires.
Perpetuation choices
It's important to note that perpetuation takes two forms: internal and external. Under an internal arrangement, the agency is sold to key employees, who may include family members. In external perpetuation, an outside entity--agency, brokerage, bank, or other financial services provider--purchases the agency. "Ideally, a perpetuation plan contemplates both of these alternatives," Oak comments. "One choice should be primary and the other secondary."
"Usually when agency owners talk about perpetuation, they mean internal: selling the agency to people who already work there and will keep the business going as it's currently operating," Cunningham says. "If you're going to do that, you have to invest your profit back into the business and the people you want to take over the agency someday. You might have to begin selling these people stock earlier than you intended, and that's hard for some owners to do; they don't like giving up the control." Not only are some agency owners reluctant to let go of financial control, Cunningham points out, they also may be less than eager to spend time training younger associates who someday will be running the agency. "For some entrepreneurs, that's not how they enjoy spending their time," she says. "They're not naturally inclined to be thinking about everything they know and what they need to teach younger people. But preparing your successors is essential if you want your perpetuation plan to work."
To prevent misunderstandings from wreaking havoc, a vital first step in internal perpetuation planning is communication and sharing of expectations. "We bring together the senior people and the junior people and try to identify what everybody wants, both financially and in terms of how the agency will operate," Cunningham says. "When do the senior people want to retire, and what kind of buyout will they accept? For the junior people, what roles do they see themselves playing in the future? Our objective is to get things out in the open--things that people may not be openly discussing." Another goal of such a session, Cunningham says, is to secure a commitment from the senior people to a specific time frame for the transition. "This is one of the hardest things for owners to agree to," she observes. "They may be willing to talk about a retirement date, but getting it down on paper can be difficult."
Dollars and sense
Another vital consideration for owners who choose the internal approach, Cunningham says, is planning for the financial aspects of perpetuation. "You have to maintain a financially strong company so you can generate the level of profit you'll need to make the plan work," she comments. "You're probably going to take a note from your successors, and they'll be repaying you over a long period of time. You don't want to be two years from retirement and all of a sudden everyone's saying, 'Where are we going to get the money to pull off this transaction?'"
That scenario, Cunningham observes, underlines the importance of choosing successors who are the appropriate ages. "I know of cases where the senior person is in his early 60s and the partners who are going to buy him out are in their mid-50s," she says. "First they'll have the burden of buying out the senior person, and as soon as they get through that, they'll be ready to retire themselves. Who's going to buy them out? The younger successors aren't there to keep the momentum going."
When structuring a buy/sell agreement for internal perpetuation, agency owners often use a valuation formula so that when the buyout occurs, everyone understands how the agency will be valued. That's an excellent idea, Cunningham says, but sometimes the formula may not be realistic. "The formula might be appropriate if the owner is going to sell to a third party, like a larger brokerage or a bank," Hilzenrath comments, "but for an internal sale, the question is, can that purchase price be funded from the internally generated cash flows?" Adds Cunningham: "Understandably, the senior partners want to get a good price for their years of work, but there could be a conflict between that amount and what the younger people can afford. There has to be some compromise."
Oak concurs. "In an internal sale, the owners may not get top dollar. In this case they may need to accept a lower price, as well as devoting some time to grooming the potential purchasers."
Kid stuff
In many agencies, the owners' children are intended to take over when their parents retire. In a perfect world, these younger people not only want to run the agency someday but also are prepared and motivated to do so. That's not always the case, Oak remarks. In fact, she says, family members may actually complicate the situation. "Just because they're your relatives doesn't mean they can manage the business profitably," she says. "They're even less likely to succeed if they have no insurance background or if they're simply not motivated."
In any internal perpetuation plan, Oak says, children and other family members should have to meet the same criteria as non-relatives:
1. Be able to oversee management of the agency's key operating areas so the profits will be sufficient to purchase the retiring owner's interest. These major functions are sales, marketing, service, claims, accounting, and administration.
2. Be able to produce enough new business that the agency can meet existing obligations while at the same time buying out the retiring owners.
External perpetuation
When internal perpetuation is either impractical or undesirable, agency owners can choose external perpetuation: merging with or being acquired by another agency. The key here, Oak says, is to effect the transaction while the agency is in good shape and the owner is still active in the business. The latter consideration is important, she explains, because the buyer often wants the seller to remain active for a period of years before retiring. For external perpetuation, Oak recommends a planning horizon of three to seven years.
A merger or acquisition also can be a good way to find prospective buyers for a future internal sale, Oak remarks. "Suppose an agency has three owners, all of whom plan to retire at about the same time," she says. "For whatever reason, there's no one within the agency who can buy it. These owners can acquire or merge with another agency whose principals are younger, and who can purchase the firm when the older owners retire." Such a strategy, Oak adds, offers the added benefit of promoting a smooth transition to new ownership.
Banks and brokers
Veterans of the agency business will remember when the most offensive profanity one could utter was "banks in insurance." That was then, but since the 1999 passage of the Financial Services Modernization Act, the barriers have come tumbling down. As a result, some agency owners are accepting purchase offers from banks--a key motivation being that banks usually are willing to pay top dollar.
Selling to a bank can be lucrative, Oak acknowledges, but it may not be the ideal choice for an agency owner who wants to remain active in the business. "I've heard of cases where the bank's management promised the agency principals a fair amount of independence, but that was forgotten once the deal was signed," she comments.
"I see very strong interest in agencies on the part of banks right now," Hilzenrath says. "If you're willing to sell to a bank, you can become its platform agency, and in that scenario you may be able to retain a good deal of independence in the management of your agency. It's a good way to build your agency further with some strong bank dollars behind it. Over the past year, banks have been paying superior multiples for agencies." On the downside, he points out: "You're going to become part of a much larger entity, and banks do business differently from insurance agencies, so you'll lose some of the flexibility you enjoyed as an entrepreneur. There will be more reporting requirements and bottom-line responsibilities."
Not only banks but large insurance brokerages are on the lookout for good agencies--and these organizations too are willing to pay handsomely for the firms they want. "National brokers and large regional brokers are aggressively making acquisitions, and they're particularly interested in agencies with $2 million to $5 million in revenue," Cunningham observes.
"With the hard market, revenues are up, but who knows how long that's going to last?" she continues. "Some agency owners are asking, 'Should I sell now and get my money, even though I won't have as much independence as part of a larger organization?'"
That question, like most of the big ones in life, has no easy answers. These days, independent agency owners face more choices than they might ever have imagined, and the fact that many of those choices are attractive doesn't make it any easier to decide. As both consultants agree, however, about one thing there should be no choice: If you haven't already done do, start today to prepare for your agency's perpetuation. *