When it comes to planning for your agency’s internal perpetuation, there are numerous factors to consider, each requiring careful consideration and strategic discussion. This article, the second in this series by IA Valuations, will provide deeper insight into these elements and hopefully shed light on some of the complexities in these situations. Having a deeper knowledge of all these various components going into the sale will allow you to have deeper conversations and help facilitate a smooth transition that aligns with the goals of both parties.
The first article in the series discussed the importance of having a documented internal perpetuation plan and what questions to ponder as you approach this decision. Our experience shows that agencies that have a documented perpetuation plan can command a premium in the marketplace for several reasons:
- Ownership has bought into the plan and its execution
- Ownership is operating with an exit in mind and is running the agency like a business, not a lifestyle
- Ownership has delineated the next steps needed and the milestones to achieve to facilitate their exit
- Ownership is meeting regularly to discuss and fine-tune the plan and any contingencies
This installment of the series will examine the various internal perpetuation options available to agency owners as they consider their future exits. An agency looking to transfer agency stock to family members or key employees has many options to consider, and oftentimes a combination of methods is used to facilitate and optimize the transaction.
Gifting
If the agency transaction involves family members, gifting is likely to be one of the components. The IRS gift tax limit in 2024 is $18,000 per year to as many individuals as desired without paying tax. An agency owner and spouse could give each child, or other family member, a combined $36,000, tax-free.
Stock Bonus
In effect, a stock bonus is giving away agency stock. However, it can be a useful part of the perpetuation plan. To reward key employees, agencies can reward them and bring them into the perpetuation plan this way without costing them a large sum of money. The value of the stock bonus is typically deductible to the agency upon transfer, but taxable to the employee as ordinary income. The bonused employee would be responsible for paying the tax on the bonused stock. While this tax could be a substantial sum, it would still be cheaper than purchasing the stock outright.
Stock-Redemption
Some agencies have the corporation buy the outstanding shares and retire them to treasury stock. One deterrent of this option is that these payments must come from after-tax dollars. The goal of a stock redemption is to reduce the number of outstanding shares, increasing the ownership percentage of the remaining shareholders.
Personal Buyout
Personal Funds – In a personal buyout, agency employees can purchase the stock from the retiring shareholder(s), using existing salary or personal funds. Some agencies set up bonus plans tied to agency growth and profitability to instill the behaviors necessary for future agency ownership. If the employee meets or exceeds the goals, they are rewarded with bonuses that can be used to purchase the agency stock. These bonuses help employees purchase large tranches of stock if they cannot afford it outright or have risk aversion tapping into their personal family savings.
Bank Loans – An agency employee can take out a bank loan from a local bank that understands the nature of the business, or from a national bank that specializes in insurance agency transactions. In this type of transaction, the lender collateralizes the loan with the agency’s book of business, as they understand the recurring nature of the revenue stream. Oftentimes, the buyer will then use agency distributions or cash flow to service the debt.
Seller-Held Note – In some cases, an agency owner will hold a personal note for the loan, depending on their age, financial situation, and risk tolerance. A typical loan would have a five or ten-year payback, and would generally be serviced from agency profits.
Combination – Every situation is different, but sometimes owners will use a combination of personal funds, bank loans, and seller financing. Many owners want to see buyers, the future owners, have some skin in the game and will ask them to tap into personal funds or take out a bank loan. Before going down this path, it is critical for agency owners to understand if their future buyers are bankable. If someone is not creditworthy, this will remove bank financing from the question.
Which Options Are Right For Your Agency?
There is no “one size fits all” solution to perpetuating your agency internally. Each individual agency perpetuation will depend on the specific solution of the current ownership and the potential buyers. We recommend that agency leaders, along with future agency leaders, meet with CPAs, accountants, and financial advisors to determine the best approach. By understanding the available options, the key stakeholders can determine the best way forward for all involved.
Articles in this Perpetuation Planning series will explore the importance of perpetuation planning, the timing of the perpetuation, agency and stock transfer options, creating transition plans, and how to help incoming owners hit the ground running. Please reach out to Craig Niess, Director of Business Planning and Valuations at IA Valuations, if you have any questions or would like assistance with your agency’s planning.
By: Craig Niess, CVA, MBA
About IA Valuations and Agency Link – Founded in 2017, the IA Valuations team has performed over 220 valuations to independent insurance agencies across the U.S. Our advisors have 25+ years of experience guiding agency owners on maximizing their agency value, planning, and legal needs for ownership transition. In addition, IA Valuations has provided perpetuation planning, financial modeling and business planning for independent insurance agencies. Finally, IA Valuations has advised dozens of agency owners on selling their agencies through our Agency Link process. Agency Link is a platform that connects buyers and sellers together to further the growth and strength of the IA system. To learn more about IA Valuations, please visit IAValuations.com or contact@iavaluations.com.
The information provided in these documents is general in nature and shall not be construed as personal legal, tax or financial advice for your situation. Please contact@iavaluations.com to discuss your personal situation.
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