How to Retire from a Lifetime’s Work

Oak & Associates often provides advice to agency owners that are considering retirement. A common problem is that people in their 60s and beyond have devoted their lives to the job of running their business, often at the expense of a lot of personal enjoyment. They may find it difficult to distinguish between work and their outside life. For some, the end of work equals the end of a part of the meaning of their lives. They are not sure what they would do if they did not go to work. Thus, there is a lot of emotion involved in implementing a perpetuation/retirement plan. This is true of many owners outside of the insurance business as well.

Perpetuation candidate dilemma
A number of owners know they need to do something about perpetuation and may need to even sell the agency, especially if they do not have good internal perpetuation candidates. Some of them may have candidates in mind. Unfortunately, many of these “candidates” are not the types of individuals that the owners should trust to take over their management and production responsibilities. Nor should the retiring owners rest their retirement income on these individuals’ ability to pay. Family members can complicate the whole situation. Just because they are family does not mean they can take over and properly run the business, especially if they have no insurance background.

Key employees usually do not have any money for the purchase of the owners’ stock. Without strong skills, they most likely will not be able to run it profitably. Even if they promise to pay off the owner over time with the agency’s money, the lack of an entrepreneurial spirit can cause a lack of cash flow even with growth.

Sometimes retiring owners that fall into these scenarios described have a very hard time selling their agency. Often a merger is easier for them, as they may not be required to give up all management control and retire right away. Time can help people prepare for the transition into retirement.

Defining agency value and terms
Another problem is related to the value that sellers feel they should receive for their stock from an internal or external sale. Individuals who are over 60 have probably bought books of business and/or the existing agency from retiring principals for multiples of revenue in the 1.5 to 2.0 range over the years.

Today, it is rare to find an agency receiving a sale price of 1.5 times revenues or above, unless the agency offers the buyer some unique items it really needs, such as special niches or markets, great producers, a desirable location, or a stable, very profitable book generating above a 30-percent profit margin. It is even less likely that the terms will be a fixed price under five years, which was more common decades ago.

Most aging principals do not want the risk of a retention purchase or the thought of a long-term buyout, especially if they are told they cannot stay very long after the purchase.

There are ways around reducing the risk of a retention purchase by having a floor negotiated in a deal. For example, the floor could be 75 percent of the agreed earnout value, or just have the risky portions of the book/commissions paid for based on retention, rather than the whole book. Retention deals are often done today without interest being paid on top of the purchase price and without these floors.

Contingents and interest income should also be incorporated into the value of the buyout, not just a multiple of commissions. These are revenues that increase the bottom line and should be paid for in a deal.

Selling assets versus stock
There is also the likelihood that the agency may be a “C” corporation. Buyers can only write off an acquisition if they buy the assets versus the stock. The goal of the seller conflicts with the buyer’s goals. If the agency’s assets are sold versus the sale of the stock of the corporation, under today’s tax law, the seller may be hit with a double tax. He or she would first have the proceeds taxed corporately, and then the balance is taxed at the individual capital gains level.

There may be ways around some of the impact of this double tax, such as through a deferred compensation plan established way in advance. Changing to an “S” corporation will keep any increase in value after the switch to an “S” from being double taxed. A valuation should be done at the time of the change, so the value can be established if ever questioned by the IRS. The “S” corporate tax rate when selling a business fully kicks in 10 years after the change from a “C” corporation. Contact a qualified CPA prior to making this change to make sure it fits with the agency’s situation.

If an owner is close to retirement, another option can be to make the sale a merger first, and then have it agreed that maybe a year or two after the firms merge, the retiring owner will indeed sell the stock. The price may even be pre-set based on the merger value or a price the parties had negotiated. In this way, the sale of stock will be at capital gains rates and not a double tax as an asset sale of the “C” corporation would have been. Be careful, so that the IRS cannot consider that the merger was done to avoid paying taxes.

A wish list
It is very important to specifically identify what is important to a seller. Do they want to stay on? Do they want a private office to go to for a number of years? What role do they want to play, if any? What is fair compensation for the work performed? Which key employees need to be kept (especially family members who might need an ownership interest)? The time to do this wish list identification is right in the beginning before the list of “qualified” buyers is developed.

This is usually much more important than determining the price. If the book or firm is good, there is usually not a problem finding a party that will pay the seller a fair market value.

It’s a seller’s market
Today it is a seller’s market, even though agency values are still somewhat conservative. Values today are typically in the 0.9 to 1.4 times revenue range. Despite today’s lower profit margins, prices of insurance agencies may be driven up by the lack of supply of good agencies for sale. The demand has traditionally been caused by the insurance companies’ pressure on independent agencies to have more and more volume with them. Many new deals today are done for strategic reasons, such as adding new lines or getting new staff.

The hard market that we are currently in makes a seller want to wait until they feel they are at their peak, which also has an effect on supply. There is less motivation to sell when principals are finally making money, as compared to the real lean years and years of soft market pricing.

When someone is represented for sale today, a number of “qualified” buyers should be determined. Instead of a bidding war between the parties, it is better to work with the seller to prioritize the buyers as respects their compatibility with the seller and how closely they match the seller’s “wish list.” Then the prospective buyers should be approached one at a time. This is the approach we take and other professional business brokers should also follow.

Other options
If an owner is not ready to sell and wants to “hang on,” it is important to have a contingent buy/sell agreement with an agency in the same city that is respected by the owner. This will allow more time for the seller to develop an effective perpetuation plan.

If family is involved in the business, the owner may want to consider options to lessen estate and/or gift taxes. A Grantor Retained Annuity Trust (GRAT) is an excellent vehicle for perpetuation when family members are involved. The GRAT makes the payments deductible to the corporation, as long as the seller stays alive during the buyout, which is usually over 10 years. Some of these options allow an owner to “freeze” the value of the stock until it is passed on to the children. These options can work well if implemented properly, and accountants are often not aware of them.

Summary
A good consultant will help owners to plan the appropriate steps for retirement and should help make the process as painless as possible. The owner’s “wish list” needs to be met. Many of these items described in this article need to be properly negotiated and addressed when the right party is found.

If an external sale instead of internal perpetuation becomes the right avenue, the key is to find a compatible party, unless the owner only cares about taking his or her money up front and running. Most owners will continue to live in the same town and are concerned that their employees and clients are well cared for. A sale to them is the sale of a lifetime’s work.

There will always be a greater fool—one that might pay more for an agency than an astute buyer would. The problem is that if all of the money is not received up front, or if the owner cares about the treatment of the clients and future employment of his/her employees, the owner will want to make sure that the buyer is fair and astute.

Bill Schoeffler and Catherine Oak are partners in the international consulting firm Oak & Associates based in Northern California. The firm specializes in financial and management consulting for national and international insurance agencies, including valuations, mergers, acquisitions, clusters, sales and marketing planning, as well as perpetuation planning. For more information, call (707) 935-6565,
e-mail catoak@sonic.net, or visit www.oakandassociates.com/catoak/.

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