Agency Financial Management

Transition planning: Don't "wait and see"

The future is closer than you think

By Rick Dennen

Many people hate going to the doctor. They avoid going at all costs, whether it's for a routine physical or even to address an illness or ailment. This can especially be true as people age. The rationale is often: "If I go to the doctor, they might find something wrong; I'd rather not know." In essence, these people don't want to address any health issues until they reach the do-or-die stage. They prefer ignorant bliss to facing the inevitable realities of getting older.

Many agency owners feel the same way about facing the realities of business. They know taxes aren't going down and interest rates are going up. They know they are aging and need to plan for succession. They know that the market and carriers can change the agency game at any moment. Yet instead of facing these issues, they wait to see what happens and put off making any decisions or changes.

Running any business involves a series of constant challenges, frequent setbacks and frustrating surprises. The longer an owner operates a business, the easier it is to become complacent. But complacency can be deadly to the long-term health and value of a business, especially when you start thinking about an exit strategy.

In today's marketplace, independent agents can't afford to take a "wait and see" approach to perpetuation and retirement. If you ignore market trends and economic changes, you may miss windows of opportunity. If you aren't actively working at growing the business, it's probably shrinking. If you aren't focused on developing new talent, you may find yourself with an agency that's essentially worthless. And if you think you'll "know" when it's time to walk away, you'll probably wind up with far less than you expect for your years of sacrifice.

Gambling on hope

Everyone knew that the capital gains tax rate was set to increase in 2013. As a result, 2012 saw a record number of mergers and acquisitions as sellers scurried to get as much profit as possible. Tax rates have a major impact on profitability and the ability to buy or sell a business. The math is simple: As taxes increase, selling an agency will yield less money for retirement. As rates increase, it becomes costlier to obtain capital for acquisitions or growth.

Owners who took a chance on the hope that the capital gains tax cuts would be extended beyond 2012 are likely kicking themselves right now. Others who were considering an exit but never really prepared are probably just as frustrated. They may have kept telling themselves that there would be time to implement a strategy later, only to realize that "later" has come and gone.

Be sure to keep a watchful eye on economic and industry trends and forecasts. Choosing to ignore them or delaying a response can place you in a vulnerable position and cause you to miss attractive opportunities.

Just as it's easy to take your health for granted and believe your body will always have the same youthful functionality, it's easy to become complacent and assume you can live off renewals after you've built a sizable book of business. Typically, though, failing to move forward doesn't mean you stay in the same place—it means you actually lose ground. This is because even when your revenues remain generally flat, your costs of doing business continue to climb. In this era of low inflation, that may not be particularly noticeable, but each year inflation carves away at your profitability.

In addition, revenue from a stable book of business really doesn't remain flat. There is always some degree of natural attrition as clients die, move away, or give in to your competitors' more aggressive sales efforts. Client relationships are like their romantic counterparts: If you don't make clients feel special and wanted, someone down the street will.

There's another reality that many agency owners don't grasp. When you stop working at growing your business, clients can sense it. If they feel you're no longer enthusiastic, they'll lose their enthusiasm for working with you. Carriers know when you're not trying, too. They may claim to be loyal to you, but their real loyalty is to your book of business and the premium income it produces. If they think that income is in danger because of your inaction, they may take away your appointment and start doing business with an enthusiastic competitor.

Build your talent

You probably take great pride in what you've been able to accomplish. But keep in mind that none of us lives forever. Although it's human nature to cling to what we've built, sharing our successes with current or future employees can actually be far more rewarding, both financially and emotionally. By making it possible for trusted employees to create their own success and wealth, you can strengthen your business and enhance their loyalty to you.

There's often a temptation to wait until we're ready to retire before we start thinking of passing the business along, but that's far too late. Providing opportunities earlier in employees' careers is more beneficial. Their motivation to succeed will improve their quality of life, and the revenue they create will increase the value of your business.

Have you heard other owners complain that their employees just don't understand what's involved in owning a business? The most effective way to teach them is to help them become owners. Something funny happens when employees begin to notice the relationship between the work they perform and the financial results it produces. They see that working just a little harder pays off, and working a lot harder and smarter pays off handsomely.

When you extend ownership to employees, you also give them motivation to remain loyal. As the business grows, your credit risk improves, along with your ability to withstand economic downturns. As their shares of the business grow, employees eventually may be able to obtain sufficient credit to buy you out and facilitate your comfortable retirement. Or, if you choose to sell the agency to someone else, their presence will enhance its value.

Sell at the peak

Vibrant and growing agencies command the keenest interest and the highest prices. Most acquirers prefer to buy agencies where the owner's age (or the weighted average of multiple owners) is closer to 50 than to 60 or 65.

There are two primary reasons. First, many acquirers want the present owner to stick around for several years, and someone in his or her early 50s is far more likely to do that than someone closer to the traditional retirement age. Second is the tendency of many agents to slow down and start "taking it easy" as their exit nears.

That lack of energy and enthusiasm has a negative effect on the business and can depress its value. In addition, carriers expect to see consistent new business, or they may end their relationship with the agency. A third factor is the increased likelihood that the agency's primary owner will encounter health problems that will distract from daily business operations. Unfortunately, many agency owners stubbornly wait until these factors have eroded value before putting their agencies up for sale.

The sale of a business takes a significant amount of time, too. If the current owners fail to remain engaged in day-to-day activities, such as building new business, the value of the agency can decline dramatically from the opening of negotiations to the actual close. Owners cannot allow a pending sale to distract them from what they should be doing for clients and carriers.

Proactive preparation

Agents who take the "wait and see" approach risk losing control of their future. They're likely to find themselves in a situation where they are forced to sell because of circumstances outside their control (such as health). Or they'll have to settle for far less than they might have received had they taken a more proactive approach. Their golden years may not be as bright as they hoped.

Whether you're 30 or 50, you should be planning for the day when you're ready to turn ownership over to someone else. Develop a time horizon and a plan to ensure that your investment of hard work and other resources will provide the greatest return when the time comes. You may not be able to "take it easy" for quite some time, but you'll face far less stress along the way.

The author

Rick Dennen is president and CEO of Oak Street Funding, which provides commission-based lending for independent agents who need capital to buy, build or sell their agency. Dennen is a licensed agent in the State of Indiana for life, accident & health products and a licensed certified public accountant in the State of Indiana. In addition, he is an instructor of venture capital and entrepreneurial finance at the Indiana University Kelly School of Business. He can be reached at rick.dennen@oakstreetfunding.com.