MANAGING, TRANSFERRING, AND ACQUIRING FAMILY INSURANCE AGENCIES
by Carol Hammes
Independent insurance agencies are often family businesses. Many current owners took over the agency from their father or mother and they’d very much like to be able to eventually turn it over to their children. This goal seems to makes sense since the firm is their legacy and they might care about it more than other people will. Carol Hammes examines whether this is the best way to facilitate a perpetuation plan.
In reality, running and transferring a family business isn’t as easy as it might first seem to be. The intertwining of business and family relationships can make management and perpetuation issues even more difficult. In the past 23 years of consulting with insurance agencies we’ve seen some very sad situations in which poorly managed relationships tore apart the family and/or the business. We’ve also seen some phenomenal success stories in which family members joined together to create thriving and valuable agency operations. It takes careful management and planning but it can also be extremely rewarding to bring family into the firm and have them be the basis of the perpetuation transfer process.
Firms wishing to acquire a family agency need to carefully examine the background of family members to make sure that they’re actually getting what they think they are. It’s attractive to see one or two producers, and perhaps a manager, to fold into your agency. But it’s also important to delve into the background of these people to make sure that they are, in fact, producers and managers. Because they’re family members they might’ve received books of business without doing much production on their own. Likewise, they could be managers simply because of their name, rather than their ability to lead effectively.
It’s important for parents or siblings to recognize that their family members might resent the pressure of an obligation to come into the agency and the insurance business. They could arrive with a chip already on their shoulders, particularly if they’re members of the 'new' generation that seem to have an exaggerated sense of entitlement. The situation might become even worse if they come directly out of school without any previous job experience. In that case, resentment among other employees will make it even harder for them to become productive team members.
With careful training processes and appropriate management, the first five or so years of a younger family member in the agency might often go smoothly. But, if this person succeeds as a producer or manager, they might start to become dissatisfied with their level of authority, compensation, or both. And if the family member hasn’t been doing a good job, the parent/sibling principal can become upset or uneasy and start to wonder what to do about the mess. This is particularly critical for larger agencies in which key non-family employees are also becoming concerned about the situation.
We’ve observed that the third generation of family members often creates the biggest problem. The second generation generally has the same entrepreneurial drive as the first, perhaps because they grew up watching their parents work long and hard with little short-term financial return. There can be a positive outcome to eating macaroni and cheese every night for a week. But, once the second generation takes over and makes the agency even more profitable, their children might grow up with a 'silver spoon syndrome.' Because all of their needs are met as children, they don’t see why they should work hard to get economic rewards. Receiving a lucrative job in the family business, rather than having to work in a normal job environment to earn a living, perpetuates this sense of entitlement. They simply don’t understand that they have to produce results in order to enjoy the rewards. The impact on morale can be devastating and endanger the possible success of an internal perpetuation plan. The agency can then end up on the market for lack of any other solution. Let the buyer beware.
There are some good reasons why many larger agencies have developed anti-nepotism rules and why most management consultants advise against bringing family members into the agency. It’s tough enough to run an independent agency as a business without adding another set of emotional problems to the equation. Having said this, it can also be highly rewarding to have your children or siblings flourish professionally and personally.
This article offers a number of observations and recommendations for principals in family agencies. Prospective buyers should use these guidelines as part of their due diligence process.
- Have the family member work somewhere else first. It’s not absolutely necessary that it be in an insurance company or agency, although this would be helpful. They must prove to themselves, to you, and to the other employees that they can succeed on their own. It’s also far healthier for the business to have them come in with some fresh ideas.
- Don’t expect more or less of them than you would of any other employees. Family members might try harder — or they might not try at all. They need motivation from the boss, just like any other employee. Apply all agency rules to family members and adhere strictly to performance evaluations and salary administration. Give family members responsibility and authority as they become ready for it. Give them enough rope to prove themselves and don’t second-guess their decisions within the parameters of authority that you’ve granted. This is difficult to do with any employee and much more troublesome with family members, especially children.
- Don’t create a job for a family member. Either you have an opening for which they qualify, or you don’t. If there’s no suitable opening, wait until you need to hire someone and/or they have the appropriate qualifications.
- Keep family and business issues separate. Never discuss family matters in front of other people in the agency and try not to call each other 'Dad', 'Mom', or 'Junior' during business hours. Do everything that you can to de-emphasize the family relationship when around other employees. Don’t discuss business at family gatherings since this can put a strain on personal relationships.
- Keep open lines of communication. Let family members know your perpetuation plans so that they know what you expect from them long before they’re old enough to come into the agency. Don’t expect them to read your mind. And be careful with children who’ve grown up resenting all the time that you’ve spent with the agency. If they feel that they’ve been short-changed for your affection they might be harboring destructive tendencies toward the business that could surface down the road.
- Never leave the agency to two people (family members or not) on the basis of 50/50 ownership. The buck always has to stop some place. And two siblings can already have some built-in differences of opinion that make decisions more difficult to handle effectively.
- If possible, develop an organizational chart that has family members reporting to people other than you or other family employees. Make sure that the other employees understand their relation to the family members and to whom they’re responsible. Just because someone has the same last name of the owner doesn’t mean that they have the same level of authority — and everyone needs to know this. Unclear relationships can cause confusion and dissension and can cost the agency some good employees.
- Create a board of directors that includes non-family members. When you need advice on dealing with sticky issues, it’s important to have someone involved with no familial emotional attachments.
- Make family members pay for ownership, even if it’s at a discount. They’ll appreciate it more and will do a better job of running the agency if they have to sacrifice something for it. Also, if there are children who aren’t associated with the agency it’s unfair to them to give them part or all of what’s probably your major asset. And, of course, keep the IRS in mind. You must properly value the ownership that you’re turning over to family members either through gifts or cash transactions. Otherwise you could face serious tax consequences. This is one time when investing in an outside appraiser can be well worth the fee. To get a rough idea of the agency’s worth, multiply the last 12 months’ pro forma profit by six and add or subtract the balance sheet value.
It’s important that the current owners of family agencies play a key role in the perpetuation process. If it appears that the younger family members won’t be ready to take over the reins when the current owners want to get out, accept this fact and make other plans for selling the agency before the situation deteriorates to the point that the value has gone down. At that juncture, everyone in the family loses. And remember that the more successful the agency, the more difficult it is to pass onto another generation. This is a reality that has dismayed many agencies. Success can create a number of problems that no one contemplated when they developed and executed the marketing and sales plan. As the agency gets larger, the shoes to fill grow far too big and the value becomes so great that the transfer of ownership is simply too complex and too expensive.
A number of consultants who deal with family businesses offer advice on perpetuation that’s similar to the guidelines we’ve provided. For example, in Success and Survival of the Family Business Pat Alcorn lists four stages in perpetuating a family business.
Stage One lasts for the first four years when things are pretty good. The children appreciate the fact that the father or mother has provided the opportunity for them to be involved and the parents are happy that their heirs have chosen this as their profession.
Stage Two, generally from years four through ten, is termed 'trouble on the horizon.' This is the period in which the younger people become less cooperative. They tend to want to change things in the operation while their parents remain in the mode of 'if it’s worked for 50 years, don’t change it.' We’ve often seen this attitude in the agency. As the marketplace continues to change, the failure of parents or other older family members to listen to the younger people can be deadly. Because change is essential today not letting younger voices be heard could actually destroy the agency.
Stage Three generally occurs during years 10-16. Alcorn dubs this period as 'something has to give.' This is when the younger family members have to decide whether to stick with the agency or strike out on their own. They might have produced far more business than the older family members and feel that they’re being exploited. They’re also increasingly insistent on having a say in how things are run. This period often generates open hostility, which can be fueled by the parent’s perception that the child needs to work long and hard for very little money to pay their dues, regardless of their success in the business.
In Stage Four the major personality conflicts and power struggles have been resolved and the younger members are clearly directing the destiny of the organization. Success in this stage comes from both parties recognizing their psychological dependence on the business and the ability to work together to deal with natural and inevitable separation anxieties. Most successors will be impatient, while the current owners will be reluctant to let go of the reins. It’s essential to recognize these facts early on for the successful perpetuation of a family business. And if the decision is made to sell to a third party, a calm and rational atmosphere will go a long way to increasing the value of the agency.
Jerry Kleiman, PhD, is the co-founder of Optimal Resolutions, Inc., a consulting firm for family-owned businesses. He has developed a set of seven rules for family businesses that have succeeded in perpetuating themselves. Dr. Kleiman’s list mirrors and reinforces the guidelines outlined above:
- Set clear boundaries around the business and the family. The key to success in a family-owned business is clarity on where the family ends and the business begins. Relationship issues and personal needs that might not have been attended to in the family can often play themselves out in the business.
- Develop a succession plan. Successful family businesses plan for their succession. When the owner decides to pass the baton it means that they’re getting ready to enter into a new stage of life. It’s not just a question of what they’re leaving or retiring from but what they are retiring to. Succession planning is a major issue because business and family transitions intersect. Successful succession planning is a long-term project and the ability to take long-range perspectives is one of the advantages of having a family-owned business.
- Formulate a business and strategic plan. A family business is more likely to have the flexibility needed to anticipate and adapt to changes in the marketplace. Developing job descriptions, entry criteria and a compensation formula is helpful. Problems often occur when family members perform multiple tasks without a clear delineation of responsibilities. Sibling issues can often arise when leadership fails to address the issues of job descriptions, compensation, or succession.
- Hold regularly scheduled business meetings. No matter how small the firm, schedule regular meetings with an agenda that includes only business and not family items. These meetings provide a good opportunity to clarify expectations so that resentments don’t smolder. They also give the younger generation an opportunity to begin taking responsibility for corporate initiatives.
- Plan regularly occurring family gatherings. We believe that 'better family means better business.' These gatherings help insure that emotional needs are gratified within the family without using the business to fulfill these needs. Focus on developing and maintaining healthy family relationships to prevent business roles from enveloping the more basic familial roles.
- Develop conflict resolution skills. It’s impossible for mature individuals to coexist in perfect, total, and perpetual harmony. Both family and non-family members must feel free to express their thoughts and feelings. This might mean that there will need to be constructive arguments. Communication is necessary — and it might become heated at times. All parties need to develop the skills to fight constructively.
- Appoint an outside board of directors. Outside advisors are critical in helping to establish succession, compensation, entry criteria, developing marketing strategy and, if necessary, helping diffuse sibling rivalry. Unbiased professionals who aren’t members of the family can give input and help you make decisions that might be emotionally laden. No successful family-owned business should be without an outside board.
For more information, call Optimal Resolutions, Inc. at (516) 365-7192 or visit www.optimalresolutions.com. We appreciate Dr. Kleiman’s willingness to share his comments.
Reproduced from The Middleton Letter with permission from Carol A. Hammes, CPCU. Carol Hammes can be reached at The Middleton Letter, P.O. Box 459, Pine, CO 80470, (303) 838-7385, (303) 838-7387 Fax, e -mail [email protected], or Web site www.middletongroup.com.