A third-party sale typically results in at least a 25-to-30 percent higher selling price than an internal sale, and that difference is hard for many sellers to leave on the table.

Well-capitalized banks and regional/national brokers the most active acquirers are willing to pay the higher price because, long-term, the economics work. They know they can bring resources to the table that will enable the acquired agency to increase earnings, thereby justifying the higher price.

Internal buyers, on the other hand, are constricted by the realities of the agency's cash flow. It must be able to service the debt of buying out the seller. For the economics to work internally, the seller usually has to be willing to take a lower price.

The current merger-and-acquisition market, where demand for well-run agencies exceeds supply, has caused many agency owners to put their commitment to internal perpetuation on hold.

Owners feel they must consider the opportunities presented in this type of environment. Doing so, however, can irrevocably damage perpetuation plans by creating uncertainty for the key employees who are anticipated as future agency buyers.

Without a clear message as to what the perpetuation plan is and the sure promise of ownership ahead, certain key employees might lose their commitment to maintaining the health and viability of the agency or may decide to leave. Internal perpetuation then becomes very difficult to achieve.

Too many agency owners fail to start their perpetuation planning in time to execute it properly and are forced to take a different course of action.

The key to success is starting early enough to make sure that the right people are in place and equipped to assume the ownership and control of the agency, and that the funding will be available and sufficient when the time comes to make the transfer.

Five-to-seven years is a bare-minimum time frame for developing leadership and management skills, building the agency's assets, and employing various methods for transferring ownership. For example, deferred compensation to make a transaction more affordable to the employee-buyers and “gifting” to put stock into the hands of family members are very useful tools, but both require significant time to be used effectively.

Unfortunately, many owners wait until they are nearing retirement to begin the process. By then it is usually too late.

Staying Internal

In spite of today's opportunities and barriers, many agency owners are committed to, and do achieve, internal perpetuation. For those who want to pursue this option, a well-thought-out plan is essential. It will go far beyond a buy-sell agreement. It will map out the long-term process for meeting the needs of both the sellers and the buyers, for the actual transfer of ownership, and for the succession of the agency's management.

A few years ago, the principals of Reagan Consulting worked with the Independent Insurance Agents and Brokers of America to develop and publish the “Best Practices Perpetuation Study.”

Although changes in the tax laws have affected some aspects of ownership transfers (for example, a lower capital gains tax rate), the information and worksheets contained in the study are extremely useful resources. Because the planning process described in the study and the critical issues it addresses are so relevant, they are worth summarizing again.

These are just a sample of the questions you need to answer.

o As the current owner, determine what your objectives are.

You have determined that you want to sell to family members or current employees, but what are your personal financial needs?

Do you want/need to maximize the purchase price received or maximize the income that you will continue to receive for some period of time?

Over what period of time will payments be made? Are you willing to take less to maintain the vitality of the agency?

Are you able and willing to finance the purchase of your interest?

When do you want to transition the ownership? Do you want the transfer to begin before you actually retire?

Consider the options available to you for transferring ownership and leadership.

A variety of ways can be used to actually transfer ownership purchase of stock or selected assets, payments for covenants not to compete, deferred compensation, consulting arrangements, brokerage agreements, etc. all of which will have different tax, funding, legal and risk implications. You will need to weigh each based on your objectives.

The financing to be used must also be considered. Has the agency retained earnings over time to use to repurchase stock? Realistically, what financial resources does the next generation of owners have? Preparing cash-flow projections can help validate whether the agency's future cash flows will be sufficient to repurchase your stock.

For the succession of management and leadership, consider the capabilities and desires of employees and/or family members to whom you hope to sell. Since it may be necessary for you to receive payments over time for your ownership interest, are you confident you have a group of successors who are capable of keeping the agency viable after your departure? If not, can you recruit talent? If the talent is there, how much development will need to occur?

Based on your objectives, weigh your options.

Will the options you have identified work in your agency? If not, what needs to change to make them work? If the options are implemented, will they still meet your objectives? You may find that you will need to revise your objectives and go through the process again.

Once you have weighed your options, determine the most appropriate plan and commit it to writing.

Putting your plan in writing will help you to communicate clearly to the involved parties your intentions for perpetuation. Since it will incorporate legal documents such as a buy-sell agreement and will, as well as your strategic business plans, a written plan provides a basis for making decisions when internal or external factors impact your objectives.

With your long-term plan in place, take the steps required to prepare for perpetuation and management succession.

Implementing your plan might involve such big-picture items as identifying and training future leaders and building the agency's value, but can also involve actions steps such as securing life insurance, getting appropriate contracts in place and changing the organizational structure.

Periodically review your plan and adjust as needed.

Although you have defined a preferred course of action, recognize that change may be necessary. Leave the door open for various contingency options by making sure the agency is managed to continuously enhance its value.

By taking these steps, you have a much higher likelihood of a smooth transition and success in meeting your objectives and those of your buyers. And remember thisit is never too early to begin planning for an agency's perpetuation and management succession.

Bobby Reagan ([email protected]) is the chairman and CEO of Reagan Consulting, an Atlanta-based financial and management consulting firm serving the leading insurance agents, brokers and financial institutions. For more information, go to www.reaganconsulting.com.

Reproduced from National Underwriter Edition, May 28, 2004. Copyright 2004 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.