Reading the newspaper this morning there was an article suggested that a university President should earn no more than 10X the compensation of the lowest paid employee in the system. I was SHOCKED by this stupid observation by someone purporting to have studied the subject of compensation at institutions of higher education. I suggest that ‘just perhaps’ the value of a university President is better tied to how much funding he can achieve for the school, the level of professors he can attract and retain and the growth in the student body than by whether the 1st year janitor earns $22,000 or $30,000/year.
But it did raise the question asked to us by many of the agencies we serve in valuation or consulting capacity, “How much should an agency owner be paid?” They are looking for a simple answer, a fraction of revenue or of commissions.
You would be surprised how often that question is raised related to the hundreds of agency valuations we perform for estate planning, partnership stock valuation, mergers, acquisitions and sales and for the thousands of Perpetuation and Succession Plans that are being generated to provide some discipline to succession for both older owners and for prospective owners.
The ‘flip’ answer is always ‘as much as you can afford’. But that really doesn’t address the issue of fair compensation for agency ownership.
When asked the question: “What is fair compensation for an agency owner?” I typically ask the caller what the “fair compensation” should be for someone who owns a lot of stock in a Company such as Apple? The callers doesn’t think that’s a fair comparison, but I’m illustrating the point that the reward for ownership is increased value and dividends and profits while the value of an agency owner is substantially more because of his/her involvement in the operation of the business.
So my answer is a trick answer. If the Apple stockholder is a consultant who was lucky enough to get into the stock when it was cheap, the answer is that the reward is in the value growth of the Company. If, the stockholder is the CEO of Apple, his reward comes in two ways, the increased value of his stock and options AND in the market value of his efforts to keep the Company successful.
Of course, Tim Cook is among the rare breed of executives who can probably command whatever compensation he wants because there are so few people in the world who can do what he does. But there are tens of thousands of Joe Agencyowners with businesses generating from $200,000 revenue agencies to $50 Million revenue agencies. Each agency owner works differently and does different things to help the business thrive so there can be no Magic Number or Formula to dictate what percentage of revenue an agency owner should take from the agency coffers for his/her value beyond simple ownership.
What we can take home is that there are two forms of compensation that should accrue to every agency owner, 1) that which (s)he earns from efforts to manage and grow the agency, and 2) that which accrues to the owner because of the growing value of the agency.
Beginning with the value accrued to an owner by virtue of simple ownership, if you start an agency from scratch or purchase it and it is worth $1 Million more to a buyer when you wish to retire, that is one form of reward for which you work for your entire career. And it’s not even that simple. There are two components of agency value, the value of the intangible assets, the book of business, and the value of its Tangible Assets, its property, equipment and cash.
Some agency owners choose to empty the agency coffers every year. Their rationale is that it is their money anyway and if they need more for growth investment (people, marketing, acquisitions) they will fund it at the time that they need it or borrow the money and leverage their positions. The best of the owners will save and invest those profits and build a nest-egg outside of the agency to supplement their retirement someday. Unfortunately, a majority of agency owners take the money and spend it. When the time comes to sponsor growth, as consultants we commonly hear the plea that the investment in the future in “unaffordable” without debt and the owner prefers not to leverage debt. So growth rarely occurs in those agencies.
The agency owner had the first option to leave money in the agency with which to sponsor the agency’s future growth with the comfort and knowledge that the excess cash not taken and spent accrues value to the agency on a dollar-for-dollar basis even if not used for growth. So the agency whose book of business can be sold as an asset for $1 Million may be able to generate several hundred thousand more dollars in net income through a substantial Tangible Net Worth sold with the book of business in a stock sale or distributed to him as the principal stockholder in a dissolution of the corporate entity after a sale.
But the primary subject of this article is to define how to pay yourself for what you do in the agency as its owner!
We recently encountered a situation in which a 70 year old owner was in the process of selling the agency to his 50 year old protege. For the last five years the protege has been managing as well as selling insurance and is in firm control of the agency. It is a very friendly perpetuation and the only issue is how much it’s worth today and how long the terms will be to make it manageable for the new owner. The problem is that the old owner is still drawing $200,000/yr. from the agency. And the owner is a perfect example of RIP (Retired In Place). The younger owner is making a living. He sells insurance and earns commissions from those sales. He can’t take a salary for management because the old owner is drawing so much while doing virtually nothing.
So, the business continues to build value through the sales efforts of the younger person, but the value doesn’t reflect as well as it should in the agency valuation because you can’t have your cake and eat it, too!
It was left to us to explain to the old owner that he was taking all of the profits from the agency in compensation with no return of benefit to his efforts. He didn’t like us telling him that message and reminded us, several times, that he “earned” the right to sit back and let the youngster do the work.
However, he realized that his choice was to provide $200,000 worth of service to the agency OR to take less (still equivalent to service provided) OR to retire in order to get his full value from the agency.
This brings us to the “punch line” of how to determine an agency owner’s compensation
An agency owner should pay himself (or herself) EXACTLY what it would take to hire someone to do the same functions with the same degree of success that the owner is accomplishing. If you are the lead producer, pay yourself exactly what you would pay a producer to do the same production and retention. If you are a manager, pay yourself what you would pay ME or someone else qualified to manage your agency to do the same job you are doing. If you do both, pay yourself for production by commission and for management by the fraction of the average week that you spend managing (vs. producing).
If you win the lottery and no longer have to work, you will probably not padlock your agency. You would likely hire someone to do the role you have done. Pay yourself what you would have to pay someone else to do your job.
Some of you are now thinking, “I couldn’t live on what I would pay someone to do what I do!” A portion of you are simply not considering all that you do or are being modest. But some of you are absolutely correct. You are paying yourself more than you would pay someone else to do your job. The answer is to target your goals and objectives to justify the compensation level you are taking. If you are not able or willing to do so, you must understand that you are taking some of your AGENCY VALUE, your retirement benefit, each time you pay yourself $200,000 for a $20,000/yr. task. It’s O.K. It’s your money anyway – until that 50 year old successor realizes that he’s carrying the load and you are reaping the benefits. Then you stand to lose your potential successors because they feel a little cheated because of the unfairness of the compensation program in the agency.