A heartfelt vision for perpetuation is one of the prime beliefs that principals must embrace as part of the process. It is at the heart and soul of the firm, the essence of the business.
We have heard over the years from many agency principals that perpetuating the private ownership of the firm is one of their primary objectives. If true, why do many firms fail to survive and make the transition from one generation to another?
The answer is deceptively simple, although difficult to execute.
To successfully bring the agency from one generation to another, principals must have a heartfelt vision for the perpetuation of the firm. This means committing to develop the right people, exercising proper financial discipline and trading the equity interests of departing owners at a reasonable value. It isn’t an event, but a process.
A heartfelt vision for perpetuation is one of the prime beliefs that principals must embrace as part of the process. It is at the heart and soul of the firm, the essence of the business, and it is the vision at the very core of all major business decisions. However, only a handful of agency principals can honestly say that internal perpetuation and maintaining private ownership is a key part of their heartfelt vision.
Every successful internal perpetuation plan requires three inextricably linked components: the right people; proper financial discipline; and a reasonable value. That is the “three-legged stool” from which just one weak or missing leg will doom the plan to failure.
The most important leg is people, although that does not mean any warm body will do. The right people represent a blend of leadership, production and executive management talent, with each person possessing sufficient risk tolerance. That is a rare combination that requires an objective assessment of the talent level of the next generation. If deficient, the next generation must be developed and nurtured
Financial discipline means the firm is and has been profitable, and consequently has a solid balance sheet and capital structure. It also means the firm has sufficient capital to allow for reinvestment in people and infrastructure. Lastly, it requires being very smart about capital investment in people and acquisitions.
A reasonable value is influenced by some of the same drivers as people and capital. However, that element has some key complicating factors: value may be influenced by the principal’s ego and unreasonable expectations, and that can be fatal. Value resides in the firm’s cash flow, not in gross revenues. Very few firms actually trade for two times revenues or some other unsupportable multiple. High cash-flow multiples, if true and almost exclusively in third-party transactions, are significantly affected by major strategic factors. An internal succession plan is a tactically driven financial transaction without true strategic value-added, as may be utilized by a third-party buyer.
The only way to make an internal plan work is to have a reasonable value supported by the actual results of the firm. Internal transactions are primarily sustained and financed by the firm’s cash flow. Departing owners must accept a realistic value supported by the numbers.
Tragically, too many principals are unwilling or unable to nurture this heartfelt vision. Experience indicates that successful plans are centered on developing the right people, exercising proper financial discipline and establishing a reasonable value. Those principals have nurtured and fostered a heartfelt vision for perpetuation from within. They have built a firm that is ultimately and, on balance, more valuable than the competition.
The value paid to a departing owner sharing the heartfelt vision may not appear to be as high as purported in some of the third-party transactions. However, quality of life, rewards of ownership, control of destiny and continuing the firm’s legacy will minimally be equal, or significantly higher, by maintaining the private ownership of the firm than by selling to a third party.
Firms best positioned for perpetuation are frequently sought as acquisition candidates because they have the first two legs of the stool: financial discipline evidenced by real profits and a solid cadre of people. The great irony is those firms are often not for sale, much to the dismay of acquiring organizations. Although rarely articulated, the principals of those firms would say they’re having too much fun making money and building value to give up the business.
Do you want to maximize the real value of your firm? Make the three-legged stool a heartfelt vision.
Timothy J. Cunningham is a principal with OPTIS Partners, a Chicago-based consulting firm providing valuation, merger-acquisition and financial and management consulting services to firms in the insurance distribution sector.
Was this article valuable?
Here are more articles you may enjoy.