Successful Succession Financing for insurance professionals a complimentary whitepaper for agents and brokers Develop a plan to reward yourself for years of hard work Are you ready for the next step? You may greet every new workday with a smile, a spring in your step, and the satisfaction that you re doing exactly what you want in life. Or, you may look at that first cup of coffee as the fuel that gives you just enough energy to drag yourself into the office in the morning. Either way, you ve probably given some thought to what comes next. There will be a day when unlocking the agency s doors isn t going to be part of your daily routine. When that happens, what will you do? There s no right or wrong answer. Some insurance agency owners envision a relaxing life with a daily stroll on well-manicured fairways, or taking time to find the biggest bass in a favorite lake. Others may see the next step as a second chance to do something they ve always wanted to do or envision a gentle transition, with a family member or employee gradually picking up a bigger share of the responsibility. Selling your agency is an obvious solution if you are planning to retire or want to start a new venture. It may also be an attractive choice if you are in your 50s or 60s and are thinking ahead to retirement, but do not want to end your career abruptly. Other common reasons for giving thought to the next step include the following. You want to scale back the time you spend on the business. You re unable to risk personal capital or generate the capital required to take your business to the next level. You want the advantages of being part of a larger company, such as greater management depth, more advanced technology or better financing. You want to provide your management the opportunity to take the agency to the next level. No matter what your personal motivation may be, you ll probably want to exit your business somewhere along the way. It s something that demands serious thought because it can have big implications for your family s financial health, your employees, your valued clients, and how much of your hard-earned work ends up in Uncle Sam s hands. That s why it s important to have an exit plan. As business succession expert Bob O Hara notes, having a plan doesn t mean that you must chisel, in stone, a departure date from your business. Instead, he explains, exit planning involves taking steps to make your company increasingly valuable whether you plan to stay or leave. Why do you need a plan? You may already have a good idea of what you want that next step to be, so what s the point of developing a formal plan? As with so many things in business, if you don t manage a situation, it may end up managing you. Instead of being in control of your exit, you may find yourself in a crisis situation. The U.S. Small Business Administration says that most business owners who approach exit planning unsuccessfully do so largely because they don t take the time to develop a written plan that: www.oakstreetfunding.com
Selling your agency is an obvious solution if you are planning to retire or want to start a new venture. Spells out the specific objectives and how they ll be achieved, Considers finances and other aspects (such as business value and employees), Includes a detailed list of tasks that must be completed as part of the plan, and Identifies specific dates for each task and the individual who must complete them. For most agencies, the best type of exit plan is a succession plan. After all, your book of business won t disappear the day you walk out of the office for the last time. You may transition the business to a family member or a trusted employee, or you may sell it to another agency. To ensure that those actions achieve your objectives, you need a succession plan that addresses: How you ll transfer control of the agency to the next owner(s). How you ll transfer the agency s assets to the next owner(s). Who the owner(s) will be and how they will be chosen. How you ll determine a fair value for the agency. How you (or your heirs) will be compensated for that value. Rick Dennen, President and CEO of Oak Street Funding, says that many agency owners create succession plans as a way of continuing their dreams for the business. They can enjoy the reward of passing the agency to the right people who can keep the culture and values intact. They can also be sure that their customers, who oftentimes are their friends as well, will continue to be treated well. When should you start planning? Remember when you were in elementary school, and the teacher kept imploring you to take your time and be careful so you d make fewer errors? That advice also holds true when it comes to succession planning. Giving yourself enough time to plan means that you ll be able to think through all of the aspects carefully. It also reduces the risk that you ll be backed into a corner by external events, such as a serious illness in the family. Once you develop your plan, a gradual transition will protect the health of the business and reduce the stress of everyone involved, including your employees. When people know what is going to happen and when they tend to worry less, so they re more productive and better focused on the objectives you ve established. According to a study by NFP Advisor Services Group, merger and acquisition consultants say that the ideal amount of time for transitioning ownership of a financial advisory practice can be as long as ten years although in practice owners assume that five or fewer years is sufficient. Oak Street Funding s Rick Dennen says that it takes a minimum of two to three years to properly prepare an insurance agency for a transition. There are a variety of concerns to consider, including the tax consequences of various methods for transferring the business. Should you use an ESOP or a restricted stock plan, a leveraged buyout, an earn-out, or a seller-assisted plan? In each case, there are tax consequences that should be reviewed by a team of advisors with experience in the agency business, including tax consultants, attorneys and CPAs. 866-625-3863 www.oakstreetfunding.com 2
No matter how long your timetable may be, review it periodically to make sure that you re accomplishing all of the goals in a timely fashion. You may need to adjust your activities as a result of changes in the business or your life. Who will succeed you? People may tell you that you can never be replaced, but it s a fact that someone can succeed you. That brings up two other advantages of a succession plan: you can have some say in who that successor will be, and you can build in time to prepare that person for the eventual transition. According to an American Family Business Survey (conducted by Mass Mutual Financial Group, Kennesaw State University, and the Family Firm Institute), just over 45 percent of the owners of closely held businesses who planned to retire within five years had chosen a successor. That number drops to 29 percent among those who expect to retire in the next six to eleven years. No two agencies are exactly the same. That s why it s important to take the time to envision the future you want for your agency. Should it stay in the family? Should you sell to employees? Your situation will help you narrow your options. Family Member? It s common to look at a child or other family member as the logical successor, but as some agency owners have discovered, children may have plans of their own. Or, it may be that your child s personality or skills may not be well-suited to the tasks associated with running an agency. (And trying to force the development of those skills by throwing an unprepared individual into the proverbial fire rarely ends successfully or pleasantly.) So it s important to be sure that the family member is both qualified and eager. A caution: only about 30 percent of family-owned businesses survive in the second generation s hands, and less than 15 percent make it to a third generation. Partner? If your business is already a partnership, one of your partners may be interested in acquiring your share. In fact, your partnership agreement may already include language that facilitates a transition. Employee? Perhaps there are one or more employees who have served you and your clients well. Giving them the opportunity to become owners is a way to reward them for their commitment and a way to ensure that your clients will continue to be served by familiar faces. As with family members, it s important to ensure that employees are both qualified and interested. Outsider? Another local agent may have an interest in expanding his or her business. Or you may find a complete stranger who wants to buy you out. Some agents contract with qualified business brokers. One particularly handy (and free) resource to consider is Oak Street Funding s Agency Exchange (www.osfagencyexchange.com). It s an online marketplace that allows 866-625-3863 www.oakstreetfunding.com 3
you to list your business for sale and potentially allows you to connect with thousands of motivated buyers. Oak Street s team can also refer you to advisors who can help. You can have some say in who your successor will be, and you can build in time to prepare that person for the eventual transition. What s your role in the plan? The fact that you ve been able to sustain (and maybe even grow) your business in a tough economy says a lot about the leadership you ve provided. As you implement your succession plan, that leadership will continue to be important, whether that s in terms of making sure that your successor develops the knowledge he or she needs to succeed, helping employees through the inevitable changes, or making sure that current clients continue to be comfortable. But be careful of how much value you attach to yourself and your professional reputation. As exit plan expert Bob O Hara notes, If you are irreplaceable, then your business has little value to a third party and cannot be continued by insiders. For a business to have value in anyone s estimation, it must be able to thrive without you. That s why part of your succession plan involves increasing the value of your company while simultaneously reducing its dependence upon you. For example, O Hara suggests efforts to diversify your customer base, sustain cash flow, and develop your team s management skills all steps most businesses should already be taking. Assemble your expert team Successful businesspeople usually become that way because they know how to tap into knowledge and advice from a variety of experts. That s especially important when it comes to creating and implementing a succession plan. Build a team of experts you trust, including your CPA and attorney, and keep them involved throughout the entire process. They will provide additional viewpoints and identify issues you may not have considered on your own. Your CPA is a particularly valuable member of that team, because the income tax-related implications of a business transition can vary widely. A good CPA can offer guidance on the best way to structure the transition and ensure that you get the greatest benefit from the proceeds. Create a transition strategy Once your succession plan is in place, and you know your timing, it s time to start moving toward making that transition a reality. The first step is to take an honest assessment of your agency s strengths and weaknesses. For example, do you have state-of-the-art technology? Strong producers under contract? Great carrier relationships? Exceptional customer service? An excellent reputation? Look for ways to enhance what you already do well, and develop strategies for resolving other issues. Next, develop a clear understanding of your agency s fair market value not what you might want to sell it for, but what it s actually worth in today s marketplace. Even if you re planning to transition ownership to family members or employees, you need to know the underlying value. Today, most agencies are sold at a price that s driven by projected earnings, risk and availability of financing, according to Michael Mensch of Agency Brokerage Consultants. 866-625-3863 www.oakstreetfunding.com 4
Earnings. The common benchmark for earnings is EBITDA, which refers to earnings before interest, taxes, depreciation and amortization. To reach this important number, add your net profit, interest on debt, income tax paid, depreciation and amortization, nonrecurring expenses and your salary and benefits. Next, subtract projected expenses such as rent, employee compensation and any costs associated with your departure. Mensch reports that the average small agency may sell for up to four to five times its adjusted EBITDA. Risk. As an insurance agent, you have a better-than-normal appreciation of the role of risk. To a prospective buyer, understanding the inherent risk in a purchase is critical. Among the risk factors today s buyers may consider are the following: Declining revenue or earnings Revenue concentrated in a few carriers, producers, or accounts Revenue concentrated with non-rated carriers or substandard markets Low account retention or renewal commission base Employee issues High loss ratios Poor recordkeeping Financing. Few potential buyers (including employees) will have the full purchase price close at hand. If you can help the buyer access third-party financing, you stand a better chance of receiving the full value for your agency. Financing also opens up the sale to a larger pool of prospective buyers, which is essential for competitive bidding. Typically, the more money that can be borrowed to finance an acquisition, the more likely it is that you will obtain the best price and terms for your agency. Profitability. Another important factor in assessing the value of your agency to a buyer is how your profitability and performance compare to that of your peers. Joseph Totah, a former agency principal who now heads AgencyEquity.com, recommends developing a confidential summary that includes information such as: Reports by client and by carrier on the book of business Average policy count per household Average premium per policy Breakdown by line of business Location of accounts Accounts by premium size and by revenue size Largest clients Supporting documentation from carriers such as loss ratio reports, commission statements and schedules. You ll also need to provide pro forma financials, which project future revenue and profitability. Be sure these numbers don t include one-time (non-recurring) transactions. 866-625-3863 www.oakstreetfunding.com 5
Knowing best practice financial ratios for your organization can be very helpful in maintaining a sound financial status. Structuring the transition Before you negotiate a price and terms, it s time to work with your attorney and CPA to identify and develop the sale/transition structure that best fits your objectives and tax situation. Three common approaches are: Leveraged Buyout. The buyer acquires a controlling interest in your agency s stock and finances most of the purchase price with a loan. The agency s assets are used as collateral. Earn-Out. The buyer typically pays 60 to 80 percent of the purchase price upfront, with the remaining 20 to 40 percent paid out over time as the agency achieves certain levels of revenue or profitability. Seller-Assisted. The buyer makes a sizable initial payment and gives you a note to cover the rest. You can choose to receive the buyer s regular payments on the note, or resell it at a discount to a company that specializes in note purchases. The buyer may need assistance in locating funding for the transaction, and your business expertise may make the process easier (which ultimately benefits you). While many prospective owners look to local banks as their first potential funding sources, most banks are hesitant to lend money to insurance agencies. Banks normally base their lending on balance sheet financials and collateral such as real estate and inventory. An insurance agency s primary asset is the future cash flow that s embedded in its book of business. A more practical alternative is a lender that understands and focuses exclusively on the insurance industry. With a loan from Oak Street Funding, the buyer can borrow against the future commission stream from the agency s in-force book of business. It s a solution hundreds of agency owners have used to finance acquisitions and other strategies for growth. Access to affordable capital is the key to taking advantage of those opportunities, and Oak Street Funding has money to lend. Oak Street can customize a loan for the buyer s specific needs and situation, from $25,000 to $20 million, with a term of one to 12 years. The goal is to help insurance agents finance growth with minimal out-of-pocket cost by leveraging the power of their agencies cash flow. Learn more or request a free quote at www.oakstreetfunding.com or 1-866-OAK FUND. Making the actual transition The work doesn t end once the papers have been signed. The transition between owners is full of make-or-break moments involving carriers, customers, and employees. Employees who aren t buyers will want to know that their jobs are secure and that they re not facing significant changes in the work environment. The more time you devote to sharing your plans throughout the succession process, the less uncertainty they ll face. That s important, because their moods and statements will have a significant effect upon what your loyal clients think of the new owner. 866-625-3863 www.oakstreetfunding.com 6
Overall, clients want to be assured that their protection will not suffer any disruptions, and that the acquisition won t create any hassles for them. If the employees are well-liked, customers will also want to be reassured that they ll continue to deal with the same friendly faces. In addition, be aware that successful transitions often take less time than anticipated. Before you know it, your former agency may be a well-running machine that doesn t need much of your time or advice. While it s a common reaction to feel unwanted and depressed, don t. It simply means you did a great job of planning for the succession, your plan succeeded, and you can now focus on your dreams! Oak Street can customize a loan for your needs and situation, from $10,000 to $10 million, with a term of one to 12 years. The goal is to help you finance growth with minimal out-of-pocket cost by leveraging the power of your agency s cash flow. Learn more or request a free quote at www.oakstreetfunding.com or 1-866-OAK FUND. The growth opportunities available to agency owners through smart, sound, strategic acquisitions are limitless. Access to affordable capital is the key to taking advantage of those opportunities, and Oak Street Funding has money to lend. About Oak Street Funding Since 2003, financial services professionals have benefited from hundreds of millions of dollars in loans from Oak Street Funding, a direct, non-sba lender that understands their business model and appreciates their most valuable assets even though they are intangible. Our strong financing expertise, innovative technology, proprietary actuarial models and experienced niche-lending team align to develop new products to meet the growing demand for insurance lending. To learn more, call 844-343-1417 or visit oakstreetfunding.com/sell-succession-ia. The materials in this paper are for informational purposes only. They are not offered as and do not constitute an offer for a loan, professional or legal advice or legal opinion and should not be used as a substitute for obtaining professional or legal advice. The use of this paper, including sending an email, voice mail or any other communication to Oak Street, does not create a relationship of any kind between you and Oak Street. Loans and lines of credit subject to approval. Rate may vary at any time. Potential borrowers are responsible for their own due diligence on acquisitions. CA residents: Loans made pursuant to a Department of Corporations California Finance Lenders License (#6039829). 866-625-3863 www.oakstreetfunding.com 7