THREE PERSPECTIVES ON PERPETUATION MISTAKES
'What is the most common mistake agency principals make during the perpetuation process-and how can they avoid it?'
Douglas C. Moat, Jr.
The Manhattan Group,
New York, New York
It's hard to believe, but most agents don't have a perpetuation plan. For the few who do, their planning is often too little, too late. The result is a disappointment: personal disappointment when they can't realize expected values or when their life-styles can't be sustained and personal needs go unfulfilled; tragic disappointment when the untimely and unanticipated death of an agency owner deprives surviving family members of continuing security.
I think most agents lack the motivation to plan because they misunderstand the true purpose of a perpetuation strategy. Perpetuation of the agency, of employee jobs, of the customer base, are not the primary objectives of perpetuation planning. Its real purpose is to ensure that agency owners can fulfill their personal wish lists when it comes time to withdraw from the business. If agents only recognized that they were planning how to get out on their own terms, get the most for the agency, and how best to provide for the continuation of a desired life-style, then I think many more would undertake the process of timely, adequate planning.
Failure to plan usually results in unreasonable expectations as to the value of the agency; a critical underestimate of the difficulty of identifying the most appropriate successor; and the imposition of legal, tax, and time constraints which often limit the value of their firms, sometimes very significantly.
What's a person to do? First, start thinking about the planning process now; it's never too early. Think in terms of your personal wish list. What do I want? Do I want completely out, and if so, when? How much money do I need to live comfortably? What benefits will I need? Would it always be nice to be able to write a piece of business?
Always remember: The key to a successful perpetuation plan is a clear idea of your needs and wants. Be selfish; be honest. Once defined, write it down and look at it from time to time. Second, get good feedback. Discuss your objectives with people who understand the business, have the necessary technical (legal, accounting, and tax) expertise to suggest appropriate action, as well as proven experience in structuring effective solutions. Finally, make the reviewing of your plan and your progress in achieving it a regular part of your management activities.
Catherine C. Oak
Oak & Associates,
San Francisco, California
The most common mistake made by agency principals in the perpetuation process is that they don't start planning early enough, if they start at all. It would be safe to say that at least 90 percent of independent agencies and brokerages have not defined a strategy to buy out the majority stockholders, or even the stock of the minority owners, unless there is death or disability.
Early on, a structured plan for agency perpetuation must be developed. Undoubtedly, the best time to establish such a plan is while the owners are still young.
The key to determining whether the perpetuation plan should be an internal buy out of stock (using one or more perpetuation vehicles) or an external sale to a third party is whether or not a viable perpetuation candidate exists in the firm. Without such a candidate, groomed by the time the shareholders are in their late 50s or early 60s, the firm wil most likely need to sell to a third party or will need to locate a potential merger candidate with younger owners.
The key is to have candidates groomed and in place in time to transfer market and key account relationships, as well as management responsibilities. If the candidates exist, various perpetuation vehicles can be used in combination or alone, depending on the desires of the owners and the number of candidates.
If you are not ready to establish your perpetuation plan today, at least have a contingent buy-sell agreement with a friendly, respected competitor, in case the unexpected happens.
You can't afford to wait to properly plan for and manage the perpetuation process. Do it today!
Robert M. Anderson
The Berkshire Group,
Wellesley Hills, Massachusetts
The most common mistake made in a perpetuation agreement is the desire of the principal to state a value or a multiple for determining the value in the agreement, and then to mandate that the agency redeem the owner's stock at this value. The owner wants to state a value for a variety of reasons:
- It provides a justification for Life insurance
- It eases estate planning by assuring a value for the business
- It provides a defined, ready retirement plan for the owner
- It tells the future buy-out team what they'll need to raise
- It gives the agency a value on the owner's personal financial statement
- It guarantees that the owner's stock will be purchased
Over time, this stated value or formula invariably gets out of line with the market value. Forcing the agency to repurchase the overpriced stock then compounds the problem. Consider the following problems, which can result from a stated value or formula in a perpetuation agreement higher than the market value.
1. The principal's spouse sues for divorce. The spouse's lawyer successfully argues that the value of the agency is not the lower market value presented by the agent, but the much higher value agreed to in the perpetuation agreement.
2. One of the minority principals suddenly decides to retire. The payments to this principal under the formula leave no funds to buy out the other principals. The other principals are not able to retire when they had planned, and they don't receive what they expected, since the principal took it all.
3. The only principal is suddenly disabled. The agency redeems his stock at the agreed price, paying him out over five years. At the end of the first year, the agency realizes that it can't afford the payments. The payments stop, the former owner sues, and the agency becomes mired in litigation.
4. The owner reaches retirement age and decides to retire. The agency's bank refuses to lend money to the agency to finance the stock repurchase, claiming the price is too high. Owner decides not to retire. Key people all leave and the agency dies.
The solution to the problem is that if the agency is mandated to repurchase the stock, the value must be set at the time of repurchase to market value. Market value is the only value that is affordable to the agency and its new management team.