No one expects the current frantic pace of merger and acquisition activity to last forever. When it does cool off, more agency owners will start looking more closely at internal perpetuation-that is, transferring ownership to employees and/or family members. Even in this merger-crazy environment, more than 60% of Best Practices firms still expect to perpetuate internally.
Whether this is your plan or you intend to perpetuate your agency by selling to or merging with a third-party, some serious planning is a must if you want to do it successfully. Do you have a written plan in place to transfer the ownership of your agency in an orderly fashion and at a reasonable price when you decide to move on? If not, your likelihood of perpetuation success is greatly reduced.
For many agency owners, their insurance agencies are their largest single asset-so it's surprising that they don't give more attention to protecting and maximizing this investment. If not properly prepared for, the transfer of ownership can be frustrating and disappointing. Unless options and objectives are evaluated well in advance (we recommend beginning perpetuation planning at least five to seven years before the actual transfer), you probably won't be able to accomplish all your desired objectives, and the departing owner(s) will be disappointed with the results. Simply put, if you wait until the last moment to prepare to transfer ownership, your options will be very limited.
Best Practices' Business Perpetuation and Management Succession Study showed a surprising fact: Only 20% of independent agents have formal agency perpetuation plans in place. Although 50% of the agencies surveyed reported they had such plans, a deeper look revealed that most of these agencies simply had buy-sell agreements in place. A buy-sell agreement is a legally binding agreement in which the mechanics for ownership transfer is explicitly stated. It's a must for any privately held business with more than one owner. A perpetuation plan, on the other hand, is developed as an adjunct to the buy-sell agreement, detailing the ownership transfer far beyond its mechanics.
A properly prepared perpetuation plan will address the following crucial issues:
- The current owners' objectives. Needless to say, any perpetuation plan should be oriented to meeting the current and future owners' objectives. Is it your desire to sell to family members or to current employees? What about selling or merging with another agency-or possibly with a bank? What are your own personal financial needs? Do you want (or need) to maximize the purchase price received, or maximize the income that you will continue to receive for some period of time?
- The perpetuation options available. Who are the likely successors or third-party buyers? Do they show an interest in buying you out? Who are the future leaders for the agency? How will the ownership actually be transferred? Will it be sold back to the corporation or partnership, to individuals, or to an Employee Stock Ownership Plan?
- The timing desired for the ownership transfer. When will the ownership transfer(s) begin? Over what time period will the payments be made? Will the transfer begin in advance of the shareholder's retirement? Are the owners of roughly the same age, making their simultaneous retirements a burden on the agency? What about the next generation of agency leaders: If they're not in place, how long will it take to develop them?
- The capabilities and desires of employees and/or family members. To whom do you plan to transfer your ownership stake? Do they have the desire to buy you out and run the agency? Do they have the financial resources necessary? Do they have the talent to lead the agency after you've gone? Since it may be necessary for you to receive payments over time for your ownership interest, are you confident you have identified successors who are capable of keeping the agency viable? This can be an especially difficult question to deal with when an agency owner must assess the leadership abilities of family members.
- How to value the ownership stake(s) to be transferred. Once you've identified who it is you'll be selling your ownership interest to, how will the purchase price be determined? Options include:
- a negotiated price (which can be unpleasant for a widow or an estate to deal with)
- a multiple-of-revenues formula (an inexact way of determining value)
- a multiple-of-pro-forma-profits formula (a better idea, but difficult to identify the real profit number properly)
- a third-party appraisal (the best alternative)
It's also important to recognize that the value of the organization can and frequently will vary, depending on who the buyer is. For instance, the value to a group of employees may be very different than the value to a publicly traded buyer, who can derive other benefits from the acquisition.
- The financing to be used. Another important piece of this puzzle involves the financing to be used to facilitate the perpetuation plan. Has the agency retained earnings over time to use for repurchasing stock? Are departing owners able or willing to finance the purchase of their interests? Does third-party financing make sense, and have you arranged for it well in advance? What financial resources does the next generation of owners have? Do you plan to use the agency's future cash flows to repurchase stock from departing shareholders? If so, have cash flow projections been prepared that validate the viability of this plan?
- The transfer mechanism and resulting tax consequences to buyers and sellers. As they say, 'The devil's in the details.' Getting the price right is only half the battle. The structure of the deal must also support the objectives of the involved parties. Careful consideration must be given to the mechanics of the ownership transfer so that the tax liabilities can be minimized for both buyer and seller. A transfer of ownership can be structured in a number of different ways (purchase of stock or selected assets, payments for noncompete covenants, deferred compensation, consulting arrangements, brokerage agreements, and so on). These all have different tax implications to understand and account for.
It's obvious, I hope, that these issues should be addressed well in advance of any ownership transfer. But take heart: Developing a perpetuation plan can be difficult but it isn't rocket science. Anyone bright enough to build and run an agency can do it. However, it requires a concerted effort and willingness to work through some tough issues. Remember, too, that a perpetuation plan is dynamic-not something that is done once and then forgotten. Once drafted, it should be revisited regularly to ensure that internal or external changes haven't rendered it obsolete or in need of an update.
A good starting point in addressing your own perpetuation planning would be to get a copy of the Best Practices' Business Perpetuation and Management Succession Study, available from Independent Insurance Agents of America by calling (800) 221-7917. It will serve as an excellent resource as you begin to prepare or update your perpetuation plan.