ACG - Agency Consulting Group

The PIPELINE

A national monthly newsletter for agency principals dedicated to agency management topic

OWNERS' COMPENSATION

Here’s a story – once upon a time there were two friends that wanted to start an agency. Since they are friends, they figured the best way of avoiding any animosity over compensation, production and management issues each would agree to equal compensation through the duration of the partnership. So they opened the agency. Both were key contributors to the agency, both were vibrant, talented and skilled, therefore the agency would comfortably grow.

Now, 33 years later, one of the partners needs to retire. The other partner can’t wait. Why? Back in 1997 the first partner had a heart attack. Since the heart attack, he hasn’t pulled his weight in the agency. The healthy partner continued to support the weaker partner because they were friends and because both fully expected the partner to recover and regain his position with the agency. But more importantly, when they decided to open the agency they agreed to equally be compensated -- and both were honorable men.

During the ensuing period, the agency grew from $700k in 1997 to $2.3 million of revenue, primarily on the back of the second owner. In many ways he considered his partner to be an obligation and a part of life. He didn’t begrudge paying his partner an ever growing compensation because of the agency’s success. But in the recesses of his mind, the fact that the intention of both to equally cause the business to thrive continued to fester.

Only when the partner suffered his second heart attack recently and decided that it was time to depart did the full ramifications of their original decision hit home for the surviving partner. The value of the agency was over $3.8 million. It continued to grow its client base even through the soft market and generated a consistent strong profit because of the conservative way the agency was operated by the working partner. The partner who was retiring was “responsible” for the L&H production of the agency about $150,000, and managed one person. For that he received over $300k/yr. and was now going to get an additional $1,900,000 over five years, draining the agency’s profits until 2019, one year AFTER the working partner wanted to retire, himself.

These are two fine people. The second owner offered to cut his compensation a number of times but, recognizing his partner’s financial situation, the healthy partner declined. He figured he was making a good living and should honor their agreement. He never thought about the situation that would ensue when the partnership ended.

Now, the second owner is no longer responsible for his own affairs. His attorney is not interested in doing “the right thing” for the surviving partner, only in maximizing the return to his client and/or his estate.

A productivity-based compensation program could have prevented this issue from arising in the first place, and would have been fair to both owners.

If the owners are going to be producers, they should pay themselves the same percentage of revenue that they would pay any other producer of the agency. If they take management roles, they should be paid the equivalent of what they would pay any manager to do the same job in the agency –multiplied by the ration of time they’ve had the position. And you don’t have to guess how much time is used. At the conclusion of the year, the compensation plan can be adjusted accordingly if the role is to continue.

We strongly urge productivity-based compensation for owners because of situations as cited in the example, above. Productive Compensation defines what you EARN as measured in how productively you perform your role, functions and duties within the agency. Owners Compensation, through any form of dividend distribution or bonus payments you wish to make, is a second source of income that is usually derived from ownership percentage.

So the agency owners who take some or all of their profits each year can continue to do so, but it is treated as a second source of income beyond their productive efforts. For the record, Agency Consulting Group does not recommend taking all profits out of the agency each year because that leaves nothing to sponsor the agency’s growth.

If the partners described above had implemented a productivity-based compensation program, they would have eliminated the excess compensation that derived from a perfectly honorable agreement.

What disturbs most agents is the need to pay out the ownership interest to an owner who has not been as valuable as their ownership indicates. But what these owners fail to understand is that if there is ANY obligation it is a contractual obligation to an investor, whether that investor is active, productive, or passive. If someone owns a percentage of your business and you have specified how that person will be bought out, you risk litigation if you try to change the price or the terms simply because the reality of the situation was not as you expected.

An agency using a proper compensation agreement will immediately save money that is not paying in compensation for a lack of productivity. Stated differently, employees are accurately compensated for their measured productivity in their job. Producers are measured against activity and sales based metrics, and non-producer employees, managers and owners are compensated through incentive-based compensation. The fairest way to properly compensate owners is to agree that each owner will take a compensation level equal to his or her contribution to the success of the agency as measured each year. Many owners will boast about how much they did historically for the agency, but unless that historical performance continues to benefit the business, it should not affect the current compensation.

In one recent case, a retiring owner had been responsible for a multi-million dollar commission book of specialty business written many years ago. By the time the valuation was done, most of that book was gone. But the owner still felt his importance was derived from that historical performance rather than the books current value.

Although the annual profit sharing in some agencies may still be equated to ownership interest, Agency Consulting Group has also aided agencies with multiple owners to alter annual profit sharing as a percentage of profit contribution of each owner instead of revenue contribution.

However, the issue that should remain sacrosanct is that the distribution of the agency’s value should always be sensitive to the percentage ownership of the departing owner at the point of sale of that ownership interest.