PERPETUATION IN FAMILY-OWNED AGENCIES: PROBLEMS AND OPPORTUNITIES
By Paige Proctor
Perpetuation through family members is one of the most common forms of extending an agency into the future. If we're honest, most of us will admit that the insurance agency business has been good to us. Some of us have become very well off; most of us have made a good living as agency owners.
Even after we agree that things are a little bit difficult in the business right now and maybe we can't see the future quite as clearly as we once did, nevertheless we must admit that this is still a good way to make a living. Therefore, it becomes logical, not to mention emotionally desirable, to pass along this business to the kids.
There are special problems that we are likely to encounter in the family perpetuation process. The first problem is the question of ability. Obviously you want your successors to be capable of continuing your agency successfully. This will be, after all, your retirement. It is often harder to judge the capability of people to whom you are close.
To solve this problem requires an absolutely impartial assessment of their capabilities. You must be totally hard-nosed in judging whether they can or cannot run a successful insurance agency. It's not just your future-it's theirs as well. People are never happy to be thrust into a job they cannot do well.
The entrepreneurial spirit and drive must be present in your child. You would expect that quality from any good business owner or any other person you would choose to carry on your business.
You must also assess your relationship with the child honestly. Can you work together through the critical steps of moving the agency from your control to his or hers? If you've gotten to the point of deciding how to perpetuate, you probably have a track record of some period of time on which to base this decision. How you have worked together in the past is now the best basis for a decision as to how you will work together in the future. If, up to now, the relationship has been authoritarian, with you calling the shots and expecting the children to jump when you say jump, you had better decide if changes are possible in the relationship.
Another critical assessment you must make is the reason for the child's involvement in the agency in the first place. If he or she came into the agency out of a sense of loyalty to you or because of parental pressure, the agency may be headed for trouble in the future if the perpetuation plan is forced into place with that particular child.
On the other hand, there are benefits and rewards to passing along a business to our children that are absent in any other sort of perpetuation. Probably the biggest benefit is that both sides want this thing to work for more than intellectual reasons. All of the emotional reasons are working for you in this issue as well. From the child's point of view (aside, of course, from financial reasons), he or she wants to prove to you that he can succeed. Often in family agencies this is the third generation of your family to enter the business-and a lot can be said for family pride.
Once you have honestly and unemotionally assessed your child's potential and arrived at a conclusion, you can begin the process of developing a perpetuation plan to take you and your offspring into the future.
The action plan steps you will follow are these:
1. Make the decision about how to perpetuate.
2. Set up a five-year plan.
3. Provide an interim protection plan.
4. Develop a two-year training program for your successor.
5. Assess the training plan at the end of two years.
6. Begin the two-year trial management period.
7. Assess the two-year trial management at the end of the fourth year.
8. Make the final transition in the fifth year or, if the management period has been unsuccessful, arrange for an alternate perpetuation arrangement.
Once you have completed Step 1, assessed your child's potential for being your successor, and made your decision as discussed earlier, you must set up your plan to get the job accomplished.
I recommend that you plan at least five years ahead of your retirement so that if things do not work out as you plan, you will have time to make alternative arrangements.
THE INTERIM STEP
Because all kinds of things can happen in five years, it is important that you protect both the agency and your family until such time as the child or children are ready to take over the agency. You must have an interim plan to protect the agency in case something happens to you on an untimely basis.
Our first recommendation is that you enter into a standby agreement with a friendly competitor. Your arrangement may be such that the friendly competitor takes over the operation of the agency and pays to your estate on a retention basis (not a guarantee basis) whatever he or she is able to retain in business. At the same time, you could come to an agreement that the friendly competitor will give your child as near the same opportunity as you might have given the child yourself, assuming favorable circumstances.
This interim (or standby) agreement should be guaranteed with a Life insurance policy payable to your spouse's estate, etc., so that the full value of the agency is received by the remaining family members. What the friendly competitor pays for the agency on a retained basis then becomes much less of a serious or critical need.
Don't forget that you should also buy a very good Disability Income policy as the owner so that there would be money available to continue your paycheck while an arrangement is made for an interim manager until you are back at work, your son or daughter is ready to take over, or some other arrangement can be made.
Now that you have agreed that the perpetuation potential is there and have made an interim arrangement, we need to look at the specific steps necessary to complete your plan.
TRAINING PROCESS
We can begin by assuming that the child has been working in the agency and that he or she has learned the basics of the insurance business-product technical knowledge, sales, and the management of paper related to both sales and service responsibilities. If there are any weaknesses in those areas, they should be included as part of the training.
The training program should take a minimum of two years and will cover the first two years of your five-year plan. As you begin to look at what the training program must be for the plan to succeed, the first word of caution is never to have two family members with exactly the same responsibility. As an example, you as the parent or owner can be training the child how to manage while the child learns and succeeds in the area of sales. Conflict often develops when parent and child attempt to manage jointly.
The areas critical to training consist first of technical excellence in systems and procedures. In addition, a future owner/manager should have a very thorough understanding of the agency's finances, including how to clearly understand the agency's balance sheet and profit-and-loss statement along with the numerous other reports that come off of a typical automation system. Also high on the list of training needs is a very thorough understanding of how to negotiate good company contacts and maintain an excellent working relationship between the agency and the companies it represents.
There are no real hidden secrets to good training. It is a matter of breaking down into steps each of the individual tasks that are to be the subject of training, actually teaching the information, and then following up to make sure that what has been taught is very thoroughly understood. This may sound very dull and tedious to you, but there is really no other way to insure that training is complete.
TRIAL MANAGEMENT PERIOD
Once you have reached the point at which, as an owner/parent, you are certain that your son or daughter is fully trained and qualified to run your agency, you are ready to begin the process of turning the agency over to the child. The third and fourth year in your five-year plan should be devoted to the trial management period. In the third year of the five-year plan, you must turn the entire operation of the agency over to your son or daughter and let him or her run it. I would recommend that the only time you intervene is to prevent a disaster or answer questions when asked. Keep in mind that you have made many mistakes in your career and it would be unrealistic to suppose that your children will not make mistakes as well. At this point, you will find out how well you conducted your training.
At the end of the fourth year, you must make the most crucial decision of the entire process. Is your perpetuation candidate capable of running your agency in such a manner that shows every indication of success? You must make a good decision at this point. Your future and the future of your family and agency depend on it.
If, after two years of training and two years of running the agency, you reluctantly come to the decision that the situation will not work out as you had hoped, you still have a year remaining in your five-year plan to work out some alternative solution, such as a merger or even the actual sale of your agency.
THE FIFTH YEAR
Assuming, however, that everything has worked as you had expected, you should begin the process of preparing the buy/sell agreement through your attorney with the use of your financial counselor. You have the final year of your five-year plan to accomplish all of the legal and technical work so that at the end of the fifth year you are prepared to turn the reins over entirely to your son of daughter.
The perpetuation procedure I see working most effectively in family agencies is the most common form of buy-sell agreement, in which the parent puts the child in a position of minority ownership in the agency by giving him or her a small portion of stock. Then the agency corporation buys the remaining stock of the parent and retires it as treasury.
If the parent/owner had the foresight to fund his or her own retirement through some form of deferred compensation plan, the buy-sell agreement would consist of the children paying the book value for the agency and the parent receiving the benefits from the deferred compensation plan.
It is important to have an outside expert establish the value of the agency through a well-recognized appraisal approach. An impartially established value can eliminate considerable conflict regarding agency value that may arise among family members. If your child or children are faced with buying all or a sizeable portion of the agency, a substantial amount of money is involved and they will be responsible for paying this value. You must satisfy everyone involved that this is a fair price and good investment.
If there had not been previous funding of the retirement, then the stock of the parent is usually purchased on an installment basis spread somewhere between five and 10 years. Our observation has proven many times that the agency's cash flow cannot support the acquisition in fewer than seven years without some borrowed money.
You should also be aware that you will be bought out with the money that is freed up by your retirement in the form of your regular paycheck and possibly some of your benefits. You may not like that. However, the alternative is for your child or children to borrow the money to buy you out on a cash basis. Then they will still use the paycheck you have given up to repay the bank loan (and at a much higher rate of interest.) We recommend that you-not the bank-earn that interest.
In eight years of working with agency perpetuation, I have participated in family situations 64% of the time, internal employee perpetuation 19% of the time, merger as a solution to a perpetuation problem 16% of the time, and an emergency sale only once. It has been my experience that family perpetuation has worked more smoothly and with fewer problems than any other type of agency perpetuation.
Handing on family ownership is still a most desirable method of perpetuation despite concerns about the industry. If this is an option for you, I strongly suggest that you begin planning immediately even if your retirement is years in the future. It is just good sense to protect yourself and your family against the unknown.
THE SIXTH YEAR IN A FIVE-YEAR PLAN
Once you have completed your perpetuation plan, you do not have to end your involvement in the insurance business. For your own mental and physical well-being, you should stay involved in the agency on some basis doing the things you like to do. Just because you have sold your interest in the agency to your child doesn't mean that you have to discontinue your involvement in the industry. The insurance industry business is, after all, a great business and it has been very good to you. Stay involved as long as you feel physically fit and have the desire.