John Wepler, president of MarshBerry, whose keynote speech opened last month’s Peak Performance Insurance Ski Conference, had a wake-up call for us: It was time to get out of survival mode and begin to set into motion a plan that invests in the future by looking to the next generation. Many agencies, according to John, are beginning to get out from under the economic battlefield of the last few years and are figuring out what needs to be done today in order to ensure a tomorrow that is financially fruitful.
ProgramBusiness followed up with John about why it’s important to look at your own staff to perpetuate an agency, what are the typical reasons agents resist doing this, and the steps to take to make it a success.
Annie George (AG): John, it looks like based on what I heard you say last year at our conference that we’re now beginning to look to the future and some of us at least are doing what’s needed to ensure a good retirement.
John Wepler (JW): “For the past few years, we’ve experienced a difficult economic recession and a prolonged soft market, with commercial businesses seeing their staff and payrolls decline and unemployment remaining a real challenge. But things do appear to be at an inflection point where the economy is beginning to slowly pick up, and things are looking more favorable than in past years.
“During this time period the vast majority of independent agents, program managers, and program underwriters have focused on staying in business, trying to preserve revenue, clientele, and profit. Because of the circumstances, many insurance distributors have gone through layoffs, experienced declining revenue, repackaged their value propositions, and put into place more sophisticated sales tracking systems to hold salespeople accountable. Most agencies focused on short-term solutions, and now for the first time are looking three to four years ahead and realize that they need a strategy to sustain the business long term and perpetuate ownership internally. The challenge, however, is that most entities stopped reinvesting because they had their heads down and were in a survival mode. They’re now waking up and realizing that if they’re going to perpetuate internally, it’s time to reinvest in the next generation and start to move some stock around to those who are worthy of becoming shareholders.”
AG: What has prompted this ‘awakening’ so to speak?
JW: “When you look at the last 12 years, the average agency owner went from 50 years old in 1998 to 55 in 2010. This trend proves that agencies overall have not been reinvesting in the next generation as much as they should and many have simply waited too long. There are two things that need to be considered: First, those that perpetuate internally systematically reinvest in the next generation, and second, if reinvestment doesn’t occur, then the valuation of the entity consistently declines. If you look at an insurance agency with a 70 year-old average owner age and an insurance agency with a 45 year-old average owner age, there is a considerable difference in the valuations of their businesses. While the buyer market is robust today [it’s a seller’s market], buyers are attracted to and place high valuations on entities with bench strength, which translates to sustainability of the organization in terms of how predictably it can grow top line revenue and produce a bottom-line profit. If the owners haven’t reinvested in a next generation capable enough to deserve ownership, their agency is worth considerably less in the eyes of a buyer. There is a significant valuation difference and most owners have their head in the sand on this issue. It is very common to see an agency with owners in their mid-40s sell for seven times EBITDA guaranteed plus earn out… and those with a weighted average owner age of 65 sell from a position of weakness and a discounted value that can fall to as low as 4.5 to 5 EBITDA times guaranteed. There is an inverse correlation between the average owner age in an insurance operation and agency value.”
AG: What would you recommend?
JW: “For those that want to take this reality seriously, first it is critical to understand that high-growth, high-performance agencies have a process and a transfer mechanism in place where stakeholders that succeed have an opportunity to buy stock in the organization. Perpetuation is not an event. It is a continuous process that is incorporated into a perpetuation plan and in turn influences decision making on a daily basis. If you compare high-growth vs. average agencies, you will see that 74% of high-growth agencies offer producers/salespeople an opportunity to own agency stock. In the average agency, only 37% have an opportunity to buy stock. To the extent that you provide a key person with an opportunity to succeed and buy stock, you will attract and retain a breed of individuals that are focused on more than their individual performance. Agencies with broad ownership are filled with stakeholders that often become champions to achieving best practices, driving agency value and ensuring long-term sustainability. They consider themselves partners, not hired help. This distinction creates an environment where key stakeholders have a vested interest in embracing change versus an environment where employees resist change and in turn circumvent leadership’s attempt to evolve. And they have pride in ownership which is infectious.”
AG: What then is the fundamental reason why owners hesitate to give up some ownership, if in the long run it will drive growth and up the value of the business?
JW: “There are philosophical and practical reasons why owners hesitate. Philosophically, there is the inaccurate belief that once you make someone a shareholder he/she will automatically want to or will feel the need to become part of the major decision-making taking place in the organization. But that isn’t so. If you own stock in IBM, for example, you don’t automatically have a seat in the executive dining room. A functional business has a board of directors that makes major decisions and an executive committee that runs the business on a day-to-day basis. It is critical prior to expanding ownership that you define shareholder roles, responsibilities, and rights so that shareholders don’t have the misconception that they now will be involved in every strategic aspect of the business. While it is often the case that individuals strong enough to become an owner are often strong enough to eventually become part of that core decision-making group, it is not guaranteed; it must be earned.
“Another hesitation stems from the fact that many owners saw their personal net worth decline significantly through this tough economic period. And even though the stock market is doing better, many have yet to recoup their losses. Many have lost assets in real estate holdings and have suffered multiple years of depressed compensation. Many owners feel vulnerable now…they thought they had money for retirement that they now don’t have, and as such have kept their talons in their stock ownership for too long. Ironically, the value dilution suffered from holding the stock too long is generally much greater than the value that would have been built had there been a willingness to broaden ownership systematically over time. In short, a hesitation to broaden ownership typically backfires to the detriment to an owner’s value.
“There is a misconception that if you let someone buy stock and the business grows, that you’re giving up value. An agent may think, ‘If I own an insurance operation that is worth $10 million and I sell 5% of the stock and the agency grows to have a $20 million value, I lost $500,000 on the increase in agency value. But what these same owners frequently don’t realize is that it is often the broadening of ownership that will be help create the environment that secured an increase in the owner’s value of $500,000. We can cite endless cases where such a decision was not made and value remained stagnant. Broadening ownership is one of the ingredients of the secret sauce that creates sustainable growth and profitability, which in turn creates agency value and also the ability to perpetuate internally.
AG: And the practical reasons….
JW: “While bank financing is at times available, most internal deals are done with seller financing. If a bank is willing to loan funds for perpetuate, it is almost always the case that the owner or the business itself will need to cosign the note. Owners realize that the only way a young producer can purchase stock is by borrowing on a note where the seller is providing the financing or taking the risk by cosigning. Owners don’t want to get stuck dealing with a note that is in default. For the above reasons, forward thinking owners allow key stakeholders to buy stock over time to teach debt tolerance and to witness whether a stakeholder is of the character to handle a larger note in the future. The second issue is that owners often claim that in the above situation, the buyers are paying for the purchase of their stock with their own money. Owners constantly claim that ‘If I don’t sell stock, I will have 100% of the profit in my pocket. If you are going to buy 10% of the stock, get 10% of the profit and use the net to cash flow the note that I am holding or taking risk on, I am buying my stock with my own money and I took the risk.’ While there is definitely some truth in this, owners need to consider the evolution that stems from the above: a much higher long-term value on the stock retained, the ability to attract and retain a next generation of stakeholders that have been taught to service debt, and a group of individuals indefinitely tied to the business that represent a built-in market for perpetuation.
“The final practical reason is that some owners plan on selling in the near term and to sell stock internally now will net them less money when they sell. Their time horizon is too short. An owner that plans on selling in the next couple of years recognizes that the value will be more by as much as 25% in an external sale versus an internal sale. Owners as a result often make the decision to hold on to their stock. Owners with a longer time horizon will not only enjoy a lift in their agency value by broadening ownership overtime but will also compound their value in an external sale should that eventually become the desired direction. The cold hard reality is that owners who run their businesses with the objective of perpetuating internally will put themselves in a position to maximize value.
AG: What do you do to address these practical concerns?
JW: “One recommendation is to establish both subjective and objective criteria so that key employees understand how they need to mature to earn the right to buy stock. Sit down with your key people and explain what needs to be accomplished in order to become a company owner. It’s not just a promise. It is a roadmap that outlines the personality characteristics and performance that must be achieved in order to qualify for ownership. Once an individual becomes ownership material, it is critical to get key players in a stock position early, even if it’s at a very moderate level.
“For example, if you have someone that by their late 20s has demonstrated the ability to writing notable new business, has strong core values, represents the company well in the community and is meeting the criteria you’ve established, sell that person stock at an early age, even if the amount is small [i.e., $50,000 of stock]. This may seem like a small amount of stock, but not to a 30-year-old. If he or she buys the stock with a loan, there will be debt service payments, which can be paid by earned compensation or profit distributions. But it’s important to start early, so that two years later another $100,000 can be purchased, and three years after that another $500,000. By the time you want to retire, it may be a $10 million note, and you will hopefully have a group of individuals who have been using profit to pay down debt for a decade and who have consistently been doubling down on their ownership while becoming more and more focused on growing the business. This structure enables the next generation to learn to live with leverage, has taught debt tolerance and, perhaps more importantly, to keep their lifestyle in check. A decade of trials and tribulations regarding the relationship between the amount of stock they own, the debt they are maintaining and have serviced, the profit distributions that have or have not materialized, and the accumulation of their personal wealth in the agency all serve to teach some key employees to become entrepreneurs. Some will have demonstrated to you that they are not a default risk and will build the stomach and personal wherewithal to buy more to effect perpetuation. Owners in such a situation often are very comfortable holding a note for their own buyout because they have been able to witness the next generation learn financial responsibility and commitment.
“When we meet with an agency that is interested perpetuation but has done nothing to effect perpetuation, we often ask the owners to leave the room so that we can talk to the people that have been identified as potential owners. The first question we ask is “how much money can you come up with by Friday”. The result is almost always the same. You will have a whole cast of characters but the one key person that most have considered as “the” solution is broke. The stories are plentiful. Invariably you have an individual who has made over $500,000 a year for the past ten years but has four cars, three kids in college, a race horse, a summer home on the beach, and a 10,000-square-foot house. It’s too late. Your ace in the hole has no liquidity and has personal leverage to the point where no bank would provide financing. You go down the list and it’s the same…collectively the group that makes $2,500,000 of income a year can only raise $200,000 of cash by Friday and their debt capacity is pitiful. Then they start talking about sweat equity. It happens time and time again because lifestyles have become too significant and it’s too late to change that. To the contrary, if you started widening ownership to individuals at an early age and those same individuals can visualize the wealth-building opportunity in front of them, they will keep their lifestyles in check and keep some gunpowder available for future transactions. This process will also expose those that are not willing or able to manage their personal life and will provide an owner with incredible clarity as to who can and cannot be counted on as perpetuation candidates.”
AG: As you mentioned, there are those producers who are making a lot of money who feel they deserve ownership. How do you address this?
JW: “Yes, good producers often feel that they have “earned” sweat equity in the agency. This is often a byproduct of the fact that owners haven’t addressed early on how you go about purchasing an ownership position. As a result, producers start to feel entitled and believe that they deserve ownership…ownership that they don’t believe they have to purchase. Owners need to educate the next generation and allow them to buy stock before entitlement sets in. If you worked for IBM and you were a quality salesperson, would you go into the boardroom and ask how much stock you are entitled to simply because you are a good employee? Producers are paid very well through very lucrative commission splits and other perks. If they want ownership, they need to buy it. This is clear to a person if you start early. If you wait too long, this attitude builds upon itself until the agency is sold or the owner gives away value to a person that is not a responsible perpetuation candidate. Once stock’s given away, you might as well install a revolving door, as the producers will start lining up. And an agency owner cannot retire on stock that has been given away as a gift.
“There are ways to supplement ownership with stock bonuses, stock options, stock appreciation rights, and the use of other stock equity incentives. These and other tools can be very useful. However, these tools should be reserved for those that have demonstrated a willingness to manage leverage, keep their nose clean, and act in concurrence to strict corporate values. If such tools are used, they must be accompanied by a process to allow producers to buy stock so that they understand that to become a big owner you must have the proven ability to be a good credit risk and a willingness to maintain considerable debt. Providing any kind of ownership opportunities without interlacing leverage along the way will create a monster.”
John reinforced that a tidal wave of agency owners are now recognizing the need to focus on the future by looking three to five years ahead versus at the next six months. “Many now recognize that the world is not perfect and perpetuation cannot wait for the world to become perfect because it will never happen. Regardless of the market and the economy, perpetuation will only occur if owners get their eye back on the long-term game plan,” said John. “Owners are concerned that they may be forced sell the company as opposed to perpetuating or selling for opportunity. Being forced to sell because of waiting too long to reinvest results in a low valuation that will not be acceptable and can be avoided. We have seen a awakening from owners who are now looking ahead and are convinced that they need an end game and are committed to figure out how to get there.”
About MarshBerry and John Wepler
John joined MarshBerry in 1991 and is President and a senior shareholder. He is a vital resource nationally in organic growth management, valuation enhancement solutions, mergers and acquisitions, strategic planning, ownership perpetuation and financial management. John is nationally recognized as one of the industry’s leaders in merger & acquisition advisory having personally closed over 175 M&A transactions since joining the firm.
John is a frequent key note speaker at national conferences, agent association meetings, insurance carrier elite meetings and executive leadership forums, including Chubb Wharton Executive Leadership Training, Selective Executive Symposiums, Bank Director Magazine investment banking conferences, SNL Financial investment banking training workshops and CIAB Executive Leadership conferences. He is a prolific author for leading insurance publications, including SNL Financial, Best’s Review, American Agent and Broker, National Underwriter and M&A Scoreboard Magazine.