How transferring ownership in phases works
By Scott Freiday
The need for independent insurance agency leaders to plan their exit from the business combined with the desire of up-and-coming producers to take over ownership creates a rich environment for a succession plan. One lesser-known strategy—a staged perpetuation—can spread out the need for capital over time, rather than all at once. Longtime owners seeking to ease into retirement while still influencing the culture and direction of their agency can stay involved via a well-mapped plan that transfers ownership of the agency in phases, rather than selling in its entirety.
The use of staged perpetuations is accelerating in the insurance marketplace for several reasons. According to the 2022 Future One Agency Universe Study, conducted by the Big “I” in collaboration with independent agency companies, the average agency principal is 54 years old, and 17% are age 66 or older. Ownership in independent insurance agencies is a reflection of those statistics.
In addition, 40% of those agency principals expect some level of ownership change in the next five years, and the number of agencies with in-family perpetuation plans declined by 10% between the 2020 and 2022 studies. Owners who may have imagined gradually stepping back as a family member was groomed to succeed them may be forced to rethink their retirement options.
Stocking up
Staged perpetuations, planned carefully well in advance of the agency owner’s retirement or withdrawal, enable owners at or nearing retirement age to leave gradually and on their own terms. They also offer ownership opportunities to valued producers within the agency or talent identified elsewhere.
Selling shares in the agency maintains continuity and stability. Agents with stock are not only likely incentivized to grow the agency to increase their investment, but are less likely to leave. This diversified ownership reduces agency risk by spreading ownership and investment beyond the business. At the same time, the agency’s legacy and culture are preserved.
Structuring an exit plan also avoids “buyer’s remorse.” Some lenders have worked with owners who sold their agency in its entirety then approached the lender a year or two later because they weren’t ready to be fully retired. They were looking for financing to buy their agency back. Perhaps that child who showed little interest in taking over the firm had a change of heart. Or the owners did not enjoy retirement as much as they thought they would. Or, if they continued to work for the firm after selling, they didn’t like the direction or culture new ownership put in place. The owners may find the buyback to be more costly than if they had sold shares of the company while maintaining majority ownership.
How a staged perpetuation works
Various approaches can be taken depending on the agency, such as working with lenders or consultants, to create a shareholder-loan program. This program could involve a formal agreement solely between the owner and the successors whereby shares are sold over time, providing the owner with income while retaining ownership in the agency.
Meanwhile, with the energy and effort provided by these incentivized new owners, the agency’s value is expected to grow along with the value of the owner’s remaining shares. This allows the owner to sell another fraction or percentage to current or new employees, thus perpetuating the agency’s growth and value while expanding ownership.
What is “early?”
It’s crucial to identify potential equity investors within the agency as early as possible and initiate these discussions sooner rather than later. The potential investors might be family members, producers, or key employees in non-sales roles such as accounting. Until the question is posed, it may not be apparent which employees are interested in equity ownership.
In general, these conversations should start at least a year or two in advance of stepping back, but the exact timing depends on the owner’s circumstances and the agency’s trajectory. An owner 15 years or more from retirement could start diversifying ownership over the next decade by initiating these conversations.
Conversely, an owner who is closer to retirement and didn’t engage in such discussions earlier may be in a more reactive than proactive position.
The number of agencies with in-family perpetuation plans declined by 10% between
the 2020 and 2022 [Future One Agency Universe] studies. Owners who may have
imagined gradually stepping back as a family member was groomed to
succeed them may be forced to rethink their retirement options.
STAGED PERPETUATION BENEFITS
Example 1: A $4 million commission agency with a $1.6 million cash flow receives an outside offer to purchase it for $12 million, which is 7.5 times its cash flow. It seems too good to pass up. But here are some things to consider:
- Are the earnout targets achievable?
- What is the seller’s timeline?
- Are there experienced and qualified buyers internally?
- What will the impact be to the agency’s legacy and culture?
Example 2: What if, rather than selling to an outside buyer, the ownership of the agency is restructured by selling 30% to three valued producers, discounting the value of the shares to accommodate the partial interest sold internally?
The owner receives $2.4 million in cash at closing (which the three investors could finance) and still owns 70% of the agency. Assuming modest annual growth of 2%, maintaining expenses and staff levels, the agency is projected to achieve top-line revenue of $4.4 million over five years, valuing the 70% interest at $6.2 million. With a 5% annual growth rate, the total investment over five years would amount to $16 million, with the investment breakdown as follows:
- Cash Down Payment: $2.4 million
- 5-Year Cash Flow: $6.0 million
- 70% Interest: $6.2 million
- Total Investment: $14.6 million
Retention tool
From the buyer’s perspective, there are many benefits, too. An opportunity for equity ownership often changes the way the staff thinks. When an employee has the opportunity to buy into the agency, it greatly improves business growth and allows agencies to compete for talent. Stock opportunities can be a good retention tool, keeping key performers grounded within an agency rather than moving place to place.
Younger agents hungry for equity ownership may seek out an agency that offers the possibility of such equity. Once those newer or younger agents arrive, they’re going to work as hard as possible to grow the agency because they’re investing in themselves.
There is a lot of value in bringing either key employees, producers, or family members under the mentorship of the owner so that they can be trained to run the agency properly. In smaller firms that could be one or two people. For larger agencies, there may be stockholder loan programs in place that reward individuals who meet certain targets. Not all producers are cut out to be business owners, however. They might be good at selling, but they may not necessarily have the fundamentals to operate a business.
The current employment market is quite competitive, so it’s challenging to hire the right people. A little bit of ownership, in addition to having access to good markets, could make the difference to the job candidate and allow the agency owner to mentor the next generation of owners as well.
Staged perpetuation also preserves an agency’s legacy and culture, and it nurtures intangible values, such as quality of life and future investments. These factors, along with the potential for increasing agency value over time, can make staged perpetuation more valuable than an outright sale.
The author
Scott Freiday is senior vice president and division director of InsurBanc, a division of Connecticut Community Bank, N.A. He oversees the bank’s commercial lending and cash management operations and has nearly a quarter century of experience in domestic and international banking and financial services. InsurBanc specializes in financial products and services nationally for the independent insurance distribution community. Started in 2001 as a vision of the Big “I,” InsurBanc finances acquisitions and perpetuations and helps agencies become more efficient by providing cash-management solutions.
