THE GOLDEN HANDCUFFS OF AGENCY PARTICIPATION
Shadow Stock is the means by which an agency can reward a producer, manager or other employee in a form of deferred compensation, linked to the future success of the agency.
If you have an employee who has proven to be both valuable to your business in the past and has the potential of helping you grow and prosper in the future, Shadow Stock is one form of reward that should be considered.
The normal reward for employee’s efforts that help the agency move forward is fair and equitable compensation. Many owners feel that they should further reward those employees for their loyalty and dedication. That form of reward should come in the form of a pension plan that will further compensate those employees for their longevity and participation in the growth and success of the agency by sharing additional funding when they retire. These are the employees who are loyal and work for the agency ‘for a living’. The Pension Plan puts a set amount of money into the Plan, whether qualified or unqualified, that is available to pay to the employee upon retirement. It is, for all practical purposes, a savings account.
However, there is another class of employees that shows a promise to help the agency grow in the future. The agency owners feel that these employees could propel the agency forward even faster and will become the key players for the agency. The owners wish to establish a plan of action that would reward those employees for their efforts to grow and prosper the entire agency, not just a segmented book of business.
If the employee who falls into this category has already proven himself/herself and thinks of the best interest of the entire agency; if she/he continues to perform in the best interest of the agency not just of their clients and their own book of business and is the likely successor of the agency, then REAL stock acquisition is the appropriate method of cementing the relationship. The employee becomes an owner of the agency (albeit a minority owner) through market value or beneficial discounted value of the agency’s stock.
However, if you are not sure that the employee is ownership material now and if the employee has expressed an interest in ownership, certain traits you may want to observe before considering Shadow Stock. Does the employee prove himself/herself for leadership qualities? Has the employee become an important part of the production team or management team possessing and maintaining a large book of business and has earned the loyalty of the employees? If you have found these traits in that employee, and you want to tie that person to the agency to allay the possibility of his/her loss to a competitor or to starting his/her own agency then you know Shadow Stock is the right answer for you.
The awarding of Shadow Stock to an employee (always in a simple letter agreement) is akin to establishing a deferred bonus of that amount of money. The final reward is only paid in lump sum if the employee dies, becomes totally and permanently disabled or retires from the business of insurance.
The bonus is established in a variety of ways, usually tied to the successful attainment of growth markers for producers and of combined growth, retention and profit markers for managers. The amount granted in Shadow Stock is not “paid” as such into a deferred compensation program. Instead the value of agency stock (in terms of shares of Shadow Stock) that could be purchased with that amount is “granted” to the employee in a letter agreement. The value of the Shadow Stock shares change with the value of the agency, making the holder of that agreement sensitive to the best interest of the entire agency to protect his/her value. If the agency deteriorates, so does the value of the Shadow Stock. But if the participant can PROVE his/her value by continuing to enhance the overall business (by continuing to grow the book of business or by managing it to successful profitability) the value of the Shadow Stock will increase with the value of the business.
Shadow Stock is most often vested over a five year period thereby further investing the employee in continued performance to fully earn the Shadow Stock value. It becomes fully vested in the event of the participant’s death, total and permanent disability or of his/her retirement from the business of insurance. It is also fully vested in the event that the agency is sold, merged or has a change of ownership of 50% or more through owners not already with the agency.
The vesting further protects the agency from the potential of the participant’s premature departure. Since each year’s (or each granted Shadow Stock segment, if not done annually) carries its own vesting period, this forms the ‘Golden Handcuffs’ that protects the agency from the loss of valuable human assets except for under extreme circumstances. It simply becomes too expensive for the participant to leave, all other things remaining equal.
If a Shadow Stock holder does desire to leave the agency, the value of the Shadow Stock is paid out over a four year term at 25% per year (adding an interest rate, if appropriate, at Prime Interest rate at the time of departure). These payments are in sponsorship of a two or three year Non-Competition and Non-Piracy Agreement that is signed when the original Shadow Stock is granted.
Often, once the Shadow Stock holder sufficiently proves himself or herself to be of permanent value to the agency, the Shadow Stock is converted to regular stock of the agency and the holder becomes an agency owner.
Shadow Stock does not bear voting rights. That’s a primary difference between Shadow Stock and regular stock. It is a letter agreement between the owner of the agency and an employee that the employee has rights to a certain percentage of the value of the agency under certain circumstances. The employee or his heirs will hold that letter until it matures and relinquish it in return for the payments set out in the letter agreement. It should not be granted lightly nor should it be given to employees as a simple ‘bonus’. A bonus, even in deferred compensation, carries a set value. The Shadow Stock is valued with the value of the agency, itself.
Please be sure to consult with your accountant regarding the tax treatment of Shadow Stock in your situation and for your particular state. In some cases payroll taxes must be paid at the time of the award and in others none is due. In some cases, the value of the Shadow Stock is immediately recognizable for the employee while in others it is deferred until cashed. Your accountant or Enrolled Agent (tax specialist) is qualified to advise you and your employee about the proper tax treatment of this method.
Agency Consulting Group, Inc. can evaluate the performance of the agency and of its employees to determine if Shadow Stock is the right tool for their reward system. If it is NOT, we will establish an incentive compensation program that is fair to the employees, but not onerous to the agency. Of course, Agency Consulting Group, Inc. also provides Agency Valuation Services (and has done so for over 35 years) so can establish the current and future value of participating agencies to identify the value of either regular agency stock or Shadow Stock annually.