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Agency Financial Management

Agency ownership transition

Case study #3—Weighing the desire for internal perpetuation vs. hard economic and operational issues

By Tom Sukay and Paul Vredenburg

In the January and March issues, this column featured the perpetuation plans of two agencies, Duncan and Associates and TOBI Insurance Agency. The firms' names and locations were fictitious, but the circumstances of each were based on actual situations we have encountered in consulting with agencies. We'll take the same approach this month with an agency we'll call Lakeside Insurance Services.

Duncan and Associates' plan (January issue) was to perpetuate externally, and TOBI (March) was planning to perpetuate to a legacy. We concluded that Duncan had no option but external perpetuation, whereas TOBI could have chosen any path.

The planning process for Lakeside Insurance will need to be lengthy and comprehensive. The owners have a clear goal in mind that they have discussed internally for quite some time.

As with Duncan and TOBI, it is important for Lakeside's owners to conduct comprehensive discussions of strategies and options with all of the affected parties to aid them in achieving their perpetuation goals.

Critical issues

Perpetuation planning is a difficult process for the owners of Lakeside because they must face their mortality and evaluate many facets of their lives. They need to ask questions such as:

• How long do they intend to be involved in the business? For many owners, the agency is an extension of their lives, and the business defines them.

• Is there an internal team that is capable of managing the day-to-day business and making the decisions to reinvest in technology and staff?

Do the prospective new owners have the ability to grow the business and to adjust strategies to adapt to the changing markets?

All of these factors are critical for the current owners to ultimately achieve/realize the value of their business. These factors are also critical in order to maintain the status of the agency in the community and to retain the existing client base. The business becomes like a child whom the owners have raised and nurtured.

As we did in the two earlier articles, we will analyze Lakeside's goals and strategies from three different perspectives. The first perspective is from the owners of the agency. The second perspective is ours as an advisor. The third perspective is from an independent third party: Paul Vredenburg, senior vice president of AssuredPartners, Inc.

Background of Lakeside Insurance Services

Lakeside is a full-service agency that offers personal and commercial insurance and also has an impressive book of benefits business. It has achieved growth organically as well as by completing several acquisitions within its marketplace.

The agency is well established with revenue of approximately $12 million. It is located in a part of the Southeast that draws from several major metropolitan areas. Lakeside competes throughout its regional network and has a reputation as the premier agency in its market. As a result, the agency is on everyone's radar screen as a desirable target for acquisition, and the owners are frequently approached by prospective buyers.

The agency is owned by six individuals. Two of them own approximately 75% of the stock, and the remaining 25% is divided evenly among the other four owners. The two controlling shareholders also have management control and make all the significant day-to-day decisions. The controlling shareholders are both 59 years old. The remaining shareholders range in age from 44 to 60.

A majority owner's perspective:

My partner and I purchased our shares from retiring shareholders, and we are fully committed to using the same strategy to perpetuate the agency. We have identified a group of employees who hold leadership positions in the agency and who are candidates for ownership.

Our most basic question is: How much is the agency worth? Do we need a consultant to value the agency? If so, what metrics will be used to establish the agency's value: a multiple of revenues or a multiple of cash flows? If we value the agency on a multiple of cash flows, how do we adjust for owners' compensation, including our compensation in the event of our retirement? Do we factor in savings that could be achieved in a third-party sale?

We recognize that we personally would receive more money if we sold the agency to outsiders rather than to insiders, but that is not our objective. The question becomes: How much of a discount should we accept for an internal perpetuation? Should it be 75% of the price of a third-party sale, 50% of that amount, or some higher percentage?

We also need to determine how the new shareholders will pay for their shares. The cost of our shares, regardless of the basis for the agency valuation, will be significant because of the size and profitability of the agency. The other four current shareholders and the prospective new shareholders lack the personal assets to acquire our shares. Will they be able to obtain outside financing? It appears that current conditions in the credit market will make outside financing very difficult.

We appear to have two options. The first is to accept a note from the agency. Our shares would be purchased and the proceeds would be paid to us over an extended period of time, most likely 10 years. If the transaction is structured in this manner, the payments to us will not result in any favorable tax treatment for the agency. We also have considered a structure where, in lieu of a note, we would receive pension payments over a period of time. This would allow the agency to receive a tax deduction for the payments. We, however, would be taxed at ordinary income rates.

We are also concerned about who will assume the future leadership of the agency. We currently have management control. Within the group of prospective shareholders, we envision that several new owners will want to assume control. It will be necessary for the new shareholders to act as a cohesive unit and manage the agency in the best interests of the group. Although we will no longer have majority control (or potentially no ownership interest), we will continue to be stakeholders as long as the note is outstanding or the agency has any payment obligation to us.

Sukay & Associates' (advisors) perspective:

Lakeside's situation is challenging even though the two majority owners have a clear idea of their goal. They are committed to internal perpetuation, so our first step is to establish the agency's value for the terminating shareholders. The conventional wisdom holds that an internal perpetuation valuation should be lower than the valuation for a third-party sale. We contend that the internal perpetuation valuation should be higher. In fact, it should be much higher unless the internal buyer is willing and able to fund the purchase of the shares at closing with personal assets or bank financing.

The most common approach is the issuance of a long-term note. Looking back over the last 10 years, it is obvious that the economic and business model in the United States has undergone significant changes. Does anyone have the slightest idea what is going to happen over the next 10 years? It is essential that a cost be associated with the undertaking of that risk. The risk can't be quantified, and the agency's value ultimately will be established by the price that the buyer is willing to pay and that the seller is willing to accept.

We recommend that Lakeside conduct a full agency valuation for the purpose of internal perpetuation. As part of that process, they should undertake the following steps:

1. Goal Assessment–The advisor should meet with the shareholders (both majority and minority) as a group and with each shareholder individually. The purpose would be to identify each party's goals. Individual goals often are different, even when the shareholders seem to have a consensus as a group. These meetings also would give the advisor an opportunity to assess the shareholders' personalities and ascertain whether there might be some unique challenges in completing the engagement. The advisor also can gauge the willingness and ability of the remaining shareholders to continue managing the agency after the sale.

2. Agency Analysis–To establish the agency's value, it is necessary to conduct a comprehensive analysis of all aspects of the agency operation, including its book of business, kinds and sizes of accounts, carriers, employees, production capabilities and any unique specialties.

3. Financial Analysis–Lakeside's previous 12 months' operating results must be thoroughly analyzed and adjusted for any factors that might affect those results. Based on the initial review, proposed adjustments to those results can be calculated. Common adjustments include shareholder compensation and personal expenses incurred by the business.

4. Valuation–The financial analysis will serve as the basis for the preliminary agency valuation on a per share basis. The ultimate goal is to establish a methodology for valuing the shares when internal perpetuation events occur. The challenge will be to get all parties to agree on the process to determine the value.

5. Funding–A critical step will be the agreement among the shareholders regarding the method used to fund the purchase of shares from retiring or terminated shareholders. Will the shares be repurchased in full upon termination, funded over a period of time through the repayment of a note, or will the retiring or terminated shareholders receive a pension in consideration for terminating their rights to their shares? If a note is issued, will the remaining shareholders provide personal guarantees? As pointed out earlier, each strategy has different tax consequences for the buyers and sellers of agency shares.

6. -----Legal–Legal counsel should review the written perpetuation plan and document the understanding among the owners through the preparation and execution of a buy/sell agreement.

AssuredPartners, Inc.–Third-party potential buyer's perspective:

The main issue in this scenario is to establish Lakeside's value for purposes of external perpetuation. In the marketplace, an agency of Lakeside's size with diverse ownership would command a premium from external buyers. Most buyers are looking for a cornerstone agency: an agency with critical mass in its market that can play a key role in helping the acquiring agency achieve its objectives. Given that only a small number of agencies fit the profile of a cornerstone agency, an external buyer would see Lakeside as a highly desirable target for acquisition.

When a cornerstone agency is purchased by an outside firm, the shareholders of the acquired agency can earn additional consideration from the organic and acquisition growth of the acquiring agency. The principals of the acquired agency who join the acquiring agency would be charged with finding talented producers and quality acquisitions to integrate into the combined operation. If they are successful, they can receive additional earn-out proceeds. They will be able to use the buyer's capital to attract new revenue and benefit from doing this in an efficient manner.

In contrast, an internal perpetuation cannot command such a premium. An internal perpetuation is tied directly to the agency's cash flow. In order to gain a premium, the shareholders must focus all cash flow on the purchase of the agency stock or assets and cannot use this capital for expanding the business. As a result, the agency must focus on paying down a fixed amount of debt and may experience a slowdown in growth over a period of time.

In most instances, the owners of an agency of Lakeside's size decide that it is not worth trading dollars that the shareholders currently receive as compensation and bonus for proceeds on debt that is repaid with after-tax dollars. The up-front money from an external buyer combined with the potential for earn-out will consistently exceed the proceeds from an internal transaction by 25% to 40%. When the principals have time to think about the risk and the discount, they typically begin to seek an external partner.


If the owners of Lakeside are serious about perpetuation, they need to make a strong commitment to the process. They may want to continue the tradition of keeping the agency independent and choose internal perpetuation. The only way to know for sure if this is the best approach is to have the agency valued. This will give all of the shareholders real numbers to work with so they can make an informed decision about their next steps. They must also evaluate the future management team to be sure that it will be able to run the agency competently and position it for continued growth and profitability.

The authors

Tom Sukay is president of Sukay & Associates, Inc. (, a financial advisory firm that represents insurance brokers, banks and other financial services companies. Paul Vredenburg is senior vice president of AssuredPartners, Inc. (, which was formed in March 2011 by two former Brown & Brown, Inc., executives.


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