When considering the long-term potential of divesting an enterprise while preserving its operation, the principals have a lot to consider. Succession Plans take on many forms. In the insurance brokerage industry, most Perpetuation Plans fall into two categories, Internal or External Perpetuations. An External Perpetuation is a sale to an outside third party. The number of third party buyers seems endless and seems to grow on a daily basis. Just yesterday we received a call from an individual starting a new agency with private equity backing.
The External Buyers range from your competitor down the street, large publicly traded brokerage firms, financial institutions and the aforementioned private equity backed agencies. Although no statistics are maintained, most agencies of any significant size are perpetuated through the sale to a third party.
Most agency owners seem to want to perpetuate their agencies internally. The most successful perpetuations are when the owner sells to a legacy. Many agency owners acquired their ownership in this manner. Agencies can be sold to anyone within the agency including a significant producer or a management group. Internal Perpetuations are difficult to accomplish for two primary reasons. The first reason is that internal buyers expect to receive a significant discount on the value of the agency. Another very significant reason why internal perpetuations fail is that the current owner expects to receive the purchase price up front. Internal buyers often lack the resources or they are unwilling to take the risks associated with outside financing.
In any event, many other variables will impact the price that is received and the ease or difficulty of the perpetuation plan.
Time Frame
The timing of the Perpetuation Plan involves many elements. The most interesting development is that most owners take years to decide how they want to proceed. They know that perpetuation is inevitable. They know they prefer to sell internally. Selling your agency is just a very emotional decision. Many owners make the decision to sell their agency and then later decide to work for “just one more year.” I’m sure this sounds familiar to many of you.
Internal perpetuations take much longer to accomplish. The opposite would seem to be true. This is not the case because all buyers today are very sophisticated and have a process that allows them to close their deals in a very efficient manner. Think of all of the decisions that have to be made in an internal perpetuation. Who are the buyers? What is their ownership split? Who has management control? How is the deal financed? Does the seller take a note from the internal buyers? What happens if they default on the note? What happens if the internal buyers seek financing? Are they willing to give personal guarantees?
There are other timing issues that are important in any perpetuation plan. If the agency is sold internally, most sellers leave the agency very soon. If not, the situations becomes more difficult for the new owners. In addition, the new owners want to decrease their expenses. An external sale is just the opposite. All sellers remain with the new company through the Earnout. In fact, most buyers are not interested in buying an agency where the owner does not want to make a long-term commitment to the new company.
Succession Partner
One of the most important aspects of perpetuation planning is the succession team or partner. The selection of the partner in a third party sale is the single most important aspect of the deal process. We currently have a client who understands how the right partner can significantly enhance the revenue of the agency and has made this factor their most important criteria in selecting a partner. Our job is to make every attempt to make sure that the right Buyer also has the highest proposal.
In an internal perpetuation, the management succession team is crucial to the company’s continued success. The three elements Warren Buffett recommends in a management team are intelligence, energy and integrity and not necessarily in that order. Who is the best person to manage the company? Is it the biggest producer, the largest shareholder or the best leader? Very frequently, they are not the same person.
Transition Time, Accountability and Method
We insist that all internal perpetuations include a formal perpetuation plan. This comprehensive document gives us the opportunity to assess the skills of the new team and how well they will be able to manage the agency going forward. If they can’t work together to develop a perpetuation plan, how will they be able to run the agency? Then an entire exit plan must be developed around that, complete with a timetable and a checklist. There needs to be accountability listed for everyone involved in the succession or sale, and perpetuation requires that the company continue having people with all of the relevant skills to operate successfully. Too often, principals forget that their skill sets are not fully quantified on the org chart. While having systems is important, having the people with skills necessary for staying accountable is equally so.
Business Structure
After an internal perpetuation is completed, it is also important for the principals to “fire” themselves in the sense that they need their company to consist of more than a set of advisors and workers. The company must be seen as a system where every person is a replaceable part, including the executive team. Internal perpetuations can be difficult for the employees of the agency. Many of their loyalties remain with the old owner, but they know that the ownership and management structure has changed.
External perpetuations are much more palatable for the employees. Once they realize that they will remain employed and that their benefits won’t change significantly, it often seems like business as usual to them. This will not be the case for the owners who now are also employees and have budgets to follow and bosses to be responsible to. Most agency owners have not worked in a corporate environment and the transition from owner to employee can be difficult. However, most people transition quickly and enjoy their new business relationships.
Company Value
Value is a function of cash flows plus or minus the net value of a company’s assets. The owners need to ensure that the company’s assets and liabilities are in order, even if a sale is not imminent. Unfortunately, we have seen many situations where owners were forced to sell their agency because of balance sheet issues. The success of an agency is dependent on overall solvency, and even the best succession management team cannot bail out the Titanic. Knowing any potential problems on the balance sheet and minimizing them is a solid step to ensuring that the perpetuation plan will result in success.
Summary
We all have three choices. We can sell our agency internally or to a third party. Our third choice is to die at our desks. Our life is not defined entirely by our work. I hope none of you choose option number three.
The Value of Your Agency
As a firm, we believe an accurate valuation is part of our responsibility and the foundation of a great working relationship – even if that is further in the future. Because of this we, unlike most firms, offer free insurance agency valuations for those who qualify. Click below to apply!
