The 10 Percent Solution: An approach to internal perpetuation

Today, there are plenty of deals where the owners of an agency sell to an outside party, such as another local agency, a large national firm or a bank. On average, most former agency owners last about two years working for a publicly traded firm, regional broker or a bank.

They simply are not used to the politics involved and having to report to others, especially if the head office is many states away. Or, they get frustrated if the person they report to has a drastically different approach, philosophy or perhaps is not of the same caliber as the former owner. Independent agents are just that … independent!

Consider first selling within. It seems that most owners of privately held independent insurance agencies would like the business they built to remain under private ownership. The entrepreneurial spirit shudders at the thought of former owners and key people being beholden to a publicly traded national or regional broker or a financial institution.

Internal perpetuation allows the owner to fulfill a dream of having his or her lifetime’s work continue on with many of the same people and sometimes even the same name or names on the door. That approach can provide employment for their own children and those of the long-term employees in the firm.

Why not internal?
There are many very good firms today that don’t have the “ideal” perpetuation plan in place. Some agencies still don’t have the “right” person employed. For others, the intended perpetuation candidates are not yet capable to take over or if they are, the owners may feel they just don’t have the money to buy them out. We sometimes see firms with the “right” people in place with the skills it takes to be an owner, but there is lack of confidence either by the perpetuation candidate or the seller.

In those situations, the only missing ingredient is a plan that will pull both sides together and get the business succession done. How are the owners/sellers going to be paid by the internal buyers? The problem is that most of the time owners and the candidates don’t have the ability to come up with a financial plan that is a win-win for all. In those cases, the owners take the path of least resistance (and sometimes most money) and sell the business to an outsider.

Internal perpetuation can be easily done if the principals aren’t looking for top dollar and they are willing to be paid over a longer period of time. The perpetuation candidates must be willing to put some money into the deal, their signatures on paper and their assets on the line for the payments to the sellers.

To kick-start the process, the buyer(s) purchase a minimum of 10 percent interest in the company. If they do not have the capital themselves then they must obtain a bank or insurance company loan. Now everyone has some skin in the game.

Once that first step is taken, the rest is just simple planning. The sellers need to agree to a timetable to sell the rest of the stock. They also need to agree to limit their income at some point and turn over control to the new owners. The new owners need to be willing to work harder, for longer and perhaps get less pay during the transition. The longer the transition for the sale, the less dramatic the changes require, but the more impatient the buyers get.

It is important to remember that payments to the sellers will come from the cash flow of the business. The same thing occurs with many outside buyers as well. Essentially, the seller is exchanging income for payments. Buyers need to be willing to reduce their income as well.

Keep in mind that it might take at least two people to replace one retiring owner. Someone will need to take over not just the management, but a book of business as well. The new owners will typically already have a full plate, so this part of the planning will require some thought.

Summary
Consider the 10 percent solution before you sell your agency to a third party. If there is a good middle management team in place and some viable candidates for perpetuation, an internal perpetuation can be very rewarding.

Bill Schoeffler and Catherine Oak are partners at Oak & Associates based in Glen Ellen, Calif. The firm specializes in financial and management consulting for independent insurance agents and brokers. They can be reached at (707) 935-6565, by e-mail at bill@oakandassociates.com, or visit: www.oakandassociates.com.