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Do You Have An Exit Plan For Leaving Your Agency?

"You've got to be very careful if you don't know where you're going, because you might not get there." — Yogi Berra It is not always easy to interpret Yogi. In this case, perhaps he is advising you to figure out just where you are headed in your business. As you near the time when you will leave behind the daily worries and stresses of business ownership, have you defined your successful exit? Do you know where “there” is, much less how to get there? Unless you set and prioritize your exit goals or objectives, you may have too many, or they might conflict, but in either case you may not make much headway. The clearest example of a failure to set objectives may be Bill Wilson, an agency owner who recently told us that he wanted: • To leave his agency within three years (although he was ready to leave right away) • Financial security, defined as a seamless continuation of his current lifestyle • To transfer the business to his management team A quick review of Bill's personal financial statement, however, revealed that most of the income required to maintain his lifestyle would have to come from the business. Unfortunately, his business wasn’t large enough to attract a cash buyer. And, since Bill had done no ‘Exit Planning’, his employees had no funds with which to purchase his ownership interest. A long term installment note seemed to be the only answer — a risk Bill was unwilling to take. Contrast this unpalatable solution with Bill's objectives — objectives which could have been achieved had he taken the time (well before he wanted to leave the business) to establish and to prioritize his exit objectives.
If, for example, an owner’s need for financial security prevails, selling a business to a third party for cash may be the best and quickest exit path. If, however, attracting a qualified third party is unlikely or undesirable, an owner may need more time to devise and to implement a transfer to one or more insiders (children or employees) that provides the owner adequate cash. On the other hand, if an owner’s desire to transfer the business to a specific person or group trumps his or her need for financial security, and his/her deadline for departure draws near, financial security in the form of "up-front" cash must take a backseat. As you can see, owners must consider—simultaneously—the three primary exit goals (listed below). Ask yourself which is your most important exit objective and rank your answers from 1 (most important) to 3 (least important): Financial security 1 2 3 Transferring the business to the person of my choice (may include key employees, co-owner or child) 1 2 3 Leaving the business when I want (could be immediately or never) 1 2 3 Prioritizing your objectives will help you choose your overall path and design your Exit Plan. For example, if you want out—soon and with cash—but your business cannot be sold today, do you wait until market conditions improve or sell now to your employees? While prioritizing your objectives is not easy, doing so gives you a framework for decision making. Start with the choices and priorities in the exercise above, but if you have any difficulty we can ask you some additional questions that will help you make your selections. When combined with an overview of some critical facts about you and your business, the Exit Planning solutions begin to crystalize. While we don’t have a ready-made Exit Planning package ready for you, we do have the background and the Exit Planning process that we believe will shine a spotlight on the Exit Planning solutions that are best for you. We’d like to sit down to talk with you about it sooner rather than later. Gathering your Exit Planning resources today can help you confirm your path to the future. You can contact us at alex@prospergroup.net

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Where’s the Incentive in Your Agency’s Incentive Plan?

Dustin McMahon spent many hours meeting with a local advisor who said he was an incentive planning expert.  They discussed various incentive plan structures and chose one that Dustin liked best.  Dustin gathered all of his agency’s management team together and announced, with great pride, the new plan.  That was two years ago.  Now Dustin is wondering what went wrong?  Nothing has really changed – the company still performs at about the same level and grows at about the same rate as it did before.  The key employees seem happy with the plan because they make a little more money, although a couple of them have left the company since the plan was initiated.  Dustin doesn’t see the changes that he expected would result from this incentive plan.  He doesn’t feel any closer to achieving his goals for the future of the business.  What went wrong? We have identified four characteristics common to successful incentive plans. A strong plan should:

  • be specific, not arbitrary, and in writing;
  • be tied to performance standards;
  • make substantial bonuses possible; and
  • encourage the key employee to continue working for the company.
Let's look at each briefly. Be Specific The most basic characteristic of a successful plan is that it is communicated clearly by the employer and understood thoroughly by the employee. Therefore, successful plans are in writing and are based on determinable standards. To be successful, employees know that the plan exists and how it works. Plans are explained to employees in face-to-face meetings, often with the owner's advisors present to answer any questions. Dustin’s incentive plan was in writing.  Employees were clear about what they would receive under the plan.  Dustin was not able to connect the terms of the plan to his personal and business goals for the future. Set Performance Standards The second characteristic is that the incentive plan’s compensation opportunity is tied to performance standards. Owners often work closely with their advisors to determine which performance standards should be used—perhaps net revenues or taxable income above a threshold amount or growth in a certain area of at least a minimum rate. The standards of performance that the owner chooses must be ones that the employee's activities can influence and that, when attained, increase the value of the company and move the business owner closer to his or her goals for the future of the business and his/her ownership of it. Dustin and his advisor had not clearly connected the plan and its anticipated results to Dustin’s goals for the future of the agency and his ownership interest.  Dustin had not addressed the fundamental planning question “What do you want or need from your business?”  Even though the plan appeared to include performance standards, those standards were not connected to Dustin’s targets. Include a Potentially Substantial Reward Third, the size of the bonus one receives under the plan must be substantial enough to motivate an employee to reach the stated performance standards. As a rule of thumb, a plan should create a potential bonus of at least 30 percent of a key employee's annual base compensation. Anything less may not be sufficiently attractive to motivate employees to modify their behavior to make the company more valuable. This is an area in which Dustin really fell short.  His employees did not make significant changes in their activities.  They did not develop and implement new and creative ideas or strategies.  They did not leverage the resources available to them in order to help achieve better-than-historic growth.  Because they received some bonuses under the plan, and the opportunity for substantial bonuses was limited, the employees did not adjust the way they carried out their duties in any significant way. Encourage Them to Stay Finally, a successful plan “handcuffs” the key employees to the business. The underlying premise is that we only implement these incentive plans if we believe that the company, and in turn the owner, are better off with each employee on the team and working hard to grow the company.  The goal here is to keep the employee with the company the day after, and even years after, a bonus is awarded. Owners typically use several techniques to create “golden handcuffs” for their employees. Dustin had not given any thought to using his incentive plan to retain key people, and his advisor did not mention it.  Dustin was surprised when several of his key people left the company.  He was a little offended that they were so ungrateful.  He had worked very hard on designing the incentive plan. Fundamentally, Dustin’s two fatal flaws were (1) designing an incentive plan that worked from his point of view, and not from the point of view of his key people, and (2) not following the guidelines described in this article to develop a complete and comprehensive incentive plan. If you’re interested in learning more about this important topic, we have a host of other tools in our incentive plan arsenals to help you design a successful employee incentive plan that contributes directly to the success of your business exit.

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Can You Afford To Sell The Agency You Built To Your Employees?

Agency owners often tell us that, in an ideal world, they would sell their businesses to their best, most loyal and/or most ambitious employees.  Agency owners frequently dismiss this option because their employees don’t have enough money to buy the business.  Is this the right decision?  Is there a secret ingredient that might allow you to sell your business to one or more employees and still get the value you want and deserve?

Take Steve Sampson, the fictional owner of fictional healthcare agency, Sampson Scientific.  Steve’s management team was capable and interested in buying the agency. The business had little debt and good cash flow.
When Steve confided in his advisors at an annual planning meeting that he had always hoped to sell his business to his employees but he just did not see any way to make that happen, one of their first questions was, “When do you want to leave the business?”
If Steve had answered, “Now!” a sale to employees who lack cash would have been fraught with risk. If Steve’s answer was, “I'd like to be out — both financially and as a participant in management — in five to eight years,” a well-designed Exit Plan would have made that happen—if Steve had started today.
Plan Goals  Any buy-out plan, regardless of the buyer, must accomplish three goals:
  1. Minimize the owner’s, the company’s and the employees’ risk, by keeping the owner in control of the business and the sale process until the owner receives the entire purchase price.
  2. Ensure that the owner receives full value for his or her ownership interest.
  3. Allows the owner to stay in control until full value is received.
Unless a buy-out plan meets these goals, owners would be wise to reconsider selling their agencies to their employees. If, on the other hand, owners plan and begin to execute a transfer plan well in advance of their departures, they can achieve these three goals. Of course, special planning is required to meet the income tax minimization goal. The Secret?  …Time A plan to execute an employee buy-out has two stages.
Stage 1: Sell incremental blocks of ownership for a reasonable, or even conservative, price over several years, each for a promissory note at a reasonable interest rate.  Employee purchasers pay down the note balances with some combination of earnings, bonuses and ownership distributions or dividends from the ownership they’ve acquired thus far.  After a few years (depending on the company’s ability to produce cash flow) the employee purchaser will own a portion of the company free and clear.  During this period the owner usually reduces involvement and delegates more responsibility to the successor owners.
Stage 2: Assuming the business continues to be profitable, paid-up owners of 30 to 40 percent of a company can present themselves as strong, stable and well-prepared buyers to secure bank financing to purchase the remaining balance of the owner’s stock.
Following this strategy, Steve’s buy-out plan kept him in full control of his business until he received all of his money. Because he maintained control, he significantly reduced the risk of not receiving full value. He successfully cashed out of his business because he did not wait to begin his Exit Planning until he was ready to leave. By starting before he was ready to leave he was able to choose his successor, exit on his timetable, and leave with the cash he wanted.
Caveats:
  • This plan does not work for all businesses, but can work well for companies valued between $500,000 and $5 million.
  • Executing the plan takes time, usually at least five years to allow the employees to purchase a significant chunk of the company.
  • This plan requires a cooperative bank aware of the owner’s intentions well in advance of the transfer.
  • This plan requires a strong management team interested in owning a company financially fit enough to allow most of the available cash flow to be used to pay off the purchase debt.
If you are interested in whether this type of plan is appropriate for you and your company, please contact Prosper Group

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GRAY TSUNAMI ARTICLE

A significant percentage of today’s agency owners were born between 1946 and 1964, and while no self-respecting Baby Boomer would genuflect to the traditional notion of retirement age, many are reaching a time of life associated with changes in daily focus and the realization of long-held goals. This group is part of an imminent, staggering increase in the aging population. The world’s population aged 65 and older will almost double in the next 20 years. That’s 1.1 billion people who will live and work longer than any generation, ever. For those who want to remain in the agency game, they will have many more years to do so. For those who don’t, the payout resulting from their hard work will have to be carefully planned to last even longer. Given demographic imperatives of the current generation of agency owners, the need for careful operational and strategic planning for exit has never been more compelling. And, the post-2007 “New Normal” of diminished economic growth rates, lower investment returns across the spectrum and creeping tax rates make this planning an imperative for a successful personal transition. The good news is that the kind of marketing, management, and creative skills that serve owners well often do not diminish with age. With time, owners begin to perfect their vision of an ideal “emeritus” role. The bad news: not enough of them engage in the careful management and financial planning ahead of time to facilitate such a transition or an exit. The freedom to determine when and how to exit is one of the rewards for a successful owner’s risk, hard work, and good decision-making during the life of her or his business. These owners have grown up watching the big financial holding companies expand to critical mass by gobbling up acquisitions as they put pins across the national and global agency landscape. Agencies with generalist capabilities, the right geographic and client coverage and solid financials were quickly consumed. Many successful independent agency owners could look forward to a similar holding company acquisition payday, because the multiples realized were typically attractive. Now, changes in blue chip holding companies’ expansion plans have altered the picture dramatically. Large buyers are much more inclined to consider only strategically key additions to their portfolios in the U.S. – typically deeply niched specialist firms with world-class capability in public affairs or digital specialties, for example. Yet, the “grey tsunami” will result in a larger number of agencies looking for a liquidity solution as their owners reach their individually planned exit times. In short, we are entering a period where more potential sellers will pursue fewer traditional buyers. There are still blue chip buyers looking to expand through domestic acquisition – but this group is now comprised of specialist private equity firms, smaller holding companies and larger independent agencies – as well as the dominant holding companies. So what does all of this mean for the agency owner seeking an attractive approach to transitioning ownership and realizing value?

  • The external sale “beauty contest” is getting more and more competitive. To receive top dollar for a sale, a firm must be viewed as an additive strategic acquisition (niche, digital, platform firm or a required specialty such as IR; crisis; etc.).
  • Buyers looking for “bargains” (and who isn’t) will have a considerable amount of leverage in this type of supply / demand situation.
  • Owners will need to consider a range of exit / liquidity options, including:
  • Increased operating performance to drive more wealth creation from ongoing operations
  • Internal sale to a successor leadership team.
  • ESOP
What are the actionable implications of all this? It comes down to the ability to answer several critical questions:
  • What is the agency’s unique value to a potential buyer in today’s – and tomorrow’s – market? If the agency is not already deeply niched, what can be done over time to make it more attractive?
  • In the event the agency cannot be sold in the short term, is it generating sufficient wealth for the owner from ongoing operations? What steps are necessary to consistently produce this level of profitability? Running the business for maximum profitability for a number of years increases owners’ exit options.
  • In the case of an internal sale or ESOP (which can involve a longer term payout to the owner) is the agency likely to continue as a successful ongoing concern after the owner steps away from active management, requiring a successor CEO and a solid second tier of management?
The answers to these questions will have a significant impact on the retention of key leaders, recruitment of key senior talent, operating culture, legal agreements, and a financial model and practices that ensure both payment to outgoing owners and rewards to those successor leaders who remain. Prosper Group’s Recommended Steps Run your firm as if you’re going to sell – even if you aren’t planning to
  • Find support to develop and implement financial and operational best practices in the firm
  • Set a minimum operating margin of 20% and manage the firm accordingly
Develop your ideal exit plan and determine your firm’s readiness to fund and sustain that exit path
  • Determine when to exit
  • Identify how much money you need the firm to generate to meet your expectations
  • Position a successor, or find one. Same with second tier team.
  • Lock in key leaders with compelling compensation
  • Set up key person insurance coverage to protect the transition
  • Set up sufficient time for operations to generate sufficient value to fund the plan
Prosper Group is ready to assist agency owners…by asking the right questions and implementing the right answers. Learn more at www.prospergroup.net.

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Five Principle Plan For Successful Insider Transfers

When Prosper Group ask owners who they would like to transfer their businesses to, a common answer is, “To key employees.” Yet few owners see this exit path as a real possibility because they don’t see:

  • How they can transfer a business to key employees who have no money.
  • How they can sell today when their businesses aren’t worth enough.
  • How they can transfer a business to key employees when they are not capable of running it.

    What owners see quite clearly are the risks of transferring their businesses to key employees. They just don’t understand how to transfer a business to these “insiders” while maintaining control, minimizing risk and receiving the value they need for their financial security. Without skilled exit planning advice, they can’t or shouldn’t.

    The real concern for these owners is simple: If they sell now, they’ll lose control and they won’t get paid. And they are dead right, unless you design a transfer plan that:

  1. Is founded on the owner’s goals.
  2. Keeps the owner in control until he or she achieves all goals, including financial security.
  3. Minimizes the income tax consequences of double taxation.
  4. Includes a backup plan that provides for an alternate exit path if the transfer to insiders does not work for any reason.
  5. Enable insiders to acquire ownership in increments over a period of years only if they:

 

  • Meet annual performance standards.
  • Agree to commit financially to acquire ownership. (Commitment includes personal guarantees and pledging personal assets as collateral for current business debt and for a bank loan to buyout the owner).
  • Demonstrate that they are capable of running the business successfully. (At outset of a plan, few incoming owners have the management experience necessary to operate a business without the owner).

2 , Five Plan Design Principles of Successful Insider Transfers

In addition to a well-designed plan, there are three conditions that support successful transfers to insiders: cash flow, time and the owner’s willingness to delegate.
  • Unless the cash flow of a business is relatively consistent and capable of growing, it cannot support a buy-in.
  • These transfers take five years or more just to grow the insider’s management skills and the company’s cash flow, transfer increments of ownership to the insiders (as cash flow grows), and enable the owner to use excess distributions from the business to accumulate wealth outside the business.
  • To create value the owner must be willing and able to transfer meaningful responsibility in all aspects of the business to the incoming owners. Certainly the owner doesn’t delegate all responsibilities at once, but must do so incrementally until his or her departure date.

    It is important to note that ownership transfer to insiders usually begin before the business has a value that would set up an owner for a financially secure post-exit life. That’s why the plan design includes a performance standard or formula that requires the business to grow in cash flow or value as a condition of transferring ownership.

    Also note that in designing a multi-year ownership transfer to insiders, we incorporate three guiding principles as a condition of transferring ownership:

  1. Minimize owner risk. This includes maintaining control and having a backup plan.
  2. Maintain control of the business until after the owner is certain of achieving all of his or her exit objectives.
  3. Obtain the value desired or needed from the transfer of ownership.
It’s important for owners to realize that–done right–a transfer to insiders can be a satisfying and financially rewarding exit path. Prosper Group is skilled in the design and execution of internal transfers of equity. Please feel free to contact us for further information.

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False Assumptions Sink Agency Owners’ Exit Plans

Basing an Exit Plan on false assumptions is a lot like building one’s house on sand, something none of us would ever do. But agency owners build their business exits on false assumptions far too often. Exit Planning is an owner-centric process. A plan’s sole purpose is to achieve the foundational, universal and aspirational goals of the owner. This sounds great, but the best laid plans of owners often go astray without planning based on solid assumptions and estimates. Many agency owners delay planning and are often more comfortable living in a fairy land of wishful thinking that a wealth generating exit will just happen. One of our jobs as advisors to agency owners is to replace false assumptions with stark reality. The Six False Assumptions As owners set their exit goals, the six most common false assumptions they make are:

  1. The amount of income they’ll need after they exit
  2. Their life expectancy and that of their spouses
  3. The expected rate of return on invested assets
  4. The value of their companies
  5. The likely rate of growth in business value and cash flow
  6. The net proceeds expected from the sale of their companies
The faulty assumptions agency owners make can lead to a series of consequences:
  • They underestimate the amount of capital required to achieve their needed post-exit income.
  • They overestimate the amount of capital they’ll have available to them at their exit. (See 3 and 5 above.)
  • They grossly underestimate the amount of time they really need to grow value, cash flow and income-producing assets to achieve their income goals. (See 1-6 above.)

    These consequences mean that owners cannot and will not leave their businesses when they want to, to whom they want, or with the money they need. But the most serious consequence of false assumptions is that owners who rely on them don’t feel any urgency to start planning.

    Overcoming the Six False Assumptions with the Six Realities

  1. Post-exit income: Research indicates that retirees continue to spend 70 to 85percent of their pre-retirement spending.
  2. Life expectancy of owner and spouse: Use this calculator based on the Social Security Period Life Table 2000:https://rslic.metlife.com/lic/corpLongevity.do?target=calculate. Example: A husband and wife, both aged 65 and both with normal blood pressure, non-smokers (quit smoking), two or fewer alcoholic drinks a day, and frequent exercise. There is a 50% likelihood of at least one spouse living to age 95 and a 25% chance of one living beyond age 101. While this is generally good news and doesn’t affect an owner’s annual spending calculation, it does affect the total amount spent and how much capital owners will need for their lifetimes (and that of their spouses).
  3. Expected rate of return. When owners expect a higher rate of return on income- producing assets, they lower their estimates of the proceeds they need from the sale or transfer of their ownership interest.

    From 1975 to 2000, the S&P 500 had an average return (dividend included) of 16.88 percent per year. Contrast that with this century: From 2000 to 2013, the average annual S&P 500 return (including dividends) was 2.324 percent.

    From 1975 to 2000, the yield on 10-year U.S. Treasury bonds was approximately eight percent (8.37%). During the past six to eight years it’s been less than four percent. In the first part of 2015 it is about 2%.2)

  4. Business worth: Agency owners should base an estimate of their business value on a valuation by an industry-specific expert. The expert can help identify the areas that will increase the agency valuation.
  5. Projected rates of growth of business value and cash flow. Let’s assume that most businesses grow at a rate similar to that of the national economy as measured by the Gross Domestic Product (GDP).

    From 1975 to 2000 GDP grew an average of 6.35 percent, per annum. Consequently, most businesses doubled their revenue about every ten years.3) Contrast that with the period from 2000 through today with GDP growth averaging less than three percent per annum. At a modest 3% annual growth rate a business will double in revenue/profitability/value roughly every 25 years or so.4) When the economy and your customers’ revenues are growing at three percent or less per year, it’s very difficult to grow your business by an annual amount necessary to experience significant increases in value. Unless, of course, you engage in business growth planning, which is at the heart of Exit Planning for agency owners.

  6. Net proceeds expected from sale of agency. Higher taxes affect the net proceeds they’ll take from the sale or transfer of their companies. If an owner sold their business before 2013 and, after taxes, had exactly enough cash to achieve financial security, they would have to sell that same business today by five-plus percent more to cover the higher capital gains taxes to end up with the same amount of cash in her pocket.
The bottom line is that agency owners need accurate information and it is our job at Prosper Group to provide it. The good news is that with accurate information and a reasonable amount of time before exit, all barriers to a wealth generating exit can be solved. For information about Prosper Group please see our website at www.prospergroup.net References 1) Adapted from Robert Burns: “best-laid schemes o’ mice an’ men gang aft a-gley.” 2) http://fortune.com/2013/02/15/10-year-treasuries-buy-today-cry-tomorrow/ 3) http://www.measuringworth.com/growth/growth_resultf.php?begin%5B%5D=2000

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