Are You A Deadbeat Shareholder?

Caution-don't answer the following question too quickly: Are you a deadbeat shareholder?

Deadbeat parents have gotten a lot of heat in recent years for not meeting the financial responsibilities of parenthood. Similarly, we see a lot of agency principals who are deadbeat shareholders-they reap the rewards of agency ownership without accepting the value-building responsibilities of ownership.

But how in the world do you know whether you're living up to your responsibility to create value? How much value should each shareholder be responsible for creating? And how do you measure value creation?

Many agencies have one or more principals who aren't pulling their weight and have no plan to do so in the future. Many of these deadbeat shareholders mistakenly believe that agency ownership is a reward for past performance. It isn't. It needs to be recognized for what it is: the most precious currency a privately held business has to motivate and reward future performance.

Other shareholders are taxed when any shareholder in an agency isn't creating value in proportion to the percentage held. Many agency principals suffer from high 'tax rates' imposed on them by such partners, but they can't quite identify the problem or the way to fix it. Well, it's time for a tax cut!

If you're a principal in a privately held insurance agency, establish a value creation quota for each shareholder. Here's how: A month before your next planning retreat, provide each shareholders with a statement showing the value of his or her share of the agency's stock. If you don't have an appraisal, simply use your best estimate. Put the desired rate of agency growth under that value-and if you don't aspire to growth exceeding 5%, you're in trouble. Then apply that percentage to the dollar value of the shareholder's interest. The product is the value creation quota-the amount of value the shareholder needs to develop in the coming year. Assign shareholders to bring ideas for achieving their value creation quota to the planning retreat.

If you used this approach as your strategic planning framework, it would create quite a stir! It might be like tossing a hand grenade into your next shareholder meeting-and if it is, so be it. The more disruptive it is, the more it's probably needed and the more your overtaxed partners will thank you.

Here's what a value creation quota statement would look like for hypothetical agency principal Donna, the 20% shareholder of a $5 million-value agency:

Before the shareholder meeting, Donna would need to consider how she might generate $100,000 in value in the coming year. In Donna's case, since she's a producer and has grown her commission income by $75,000 in each of the past three years, she simply needs to develop a plan to repeat her past performance: Net growth of $75,000, if valued at 1.3 times commissions (a decent estimate of value for this particular agency), would generate the $100,000 quota. Even so, Donna needs to understand that each year, as the value of her equity position in the agency grows, so will her value creation quota.

Let's contrast Donna's situation to that of John, the agency's CEO and 40% shareholder. Since John's equity interest is worth $2 million, his value creation quota is $200,000. To achieve his quota by producing new business alone would require net growth in his book of roughly $150,000 -- something he would be hard pressed to accomplish. John realizes this and becomes frustrated. 'How can I ever live up to a value creation quota so high?' he may ask.

At this point, a value creation quota computation pays off. John realizes, perhaps for the first time, that he must reach beyond personal production to be an effective steward of his agency equity and avoid taxing his partners. After some soul-searching, he concludes that to create $150,000 in additional value, he must set his sights beyond building his book of business. He needs to focus on building the organization.

Here's the crucial application: Any shareholder whose day-to-day efforts won't meet the value creation quota needs to do one of two things-increase efforts to build agency value or consider reducing his or her equity position in the agency by selling stock to employees who are consistently exceeding their value creation quota.

Assuming that the shareholder will choose to increase efforts (selling off stock generally isn't considered an attractive option), how can he or she know which activities to focus on? In our valuation and consulting work over the years, we've observed a Value Creation Hierarchy. Some activities are more potent value creators than others.

Here's a list of value-building activities, listed in descending order in terms of greatest to lowest impact on value. Your largest shareholders should engage in activities near the top of the list. A shareholder trying to create increased value can concentrate on becoming more effective at current activities or migrate up the ladder and focus on higher levels of value-creating activities.

VALUE CREATION HIERARCHY

This list isn't all-inclusive. For example, it doesn't cover a chief financial officer or a chief operating officer. They build value in many ways and might fit into several categories in this hierarchy, depending on their particular talents.

We also acknowledge that measuring the value created by shareholder efforts isn't a task for the faint-hearted. It can be extremely difficult, for example, to measure the value created by a sales manager or a chief operating officer.

That misses the point, though. The compelling benefit of this approach, despite some of the practical difficulties, is that it focuses all shareholders on the all-important task of building the organization. Ideally, in a value-focused agency, stock ownership will fluctuate over time, with value creators being rewarded with the right to buy additional shares from those consistently falling short of their quota.

In recent years we've witnessed the power of a tax cut to stimulate economic growth. I think that many agencies could benefit in the same way from their own kind of tax cut. So if some of your shareholders are being forced to pay high taxes to support their underperforming partners, declare a tax cut by implementing a value creation quota-and let the fireworks begin!