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 are key contributors to the agency, both are 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? Almost 15 years ago 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 are 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 nothing to $2.3 Million of revenue, primarily on the back of the second owner (it was about $700k at the time of the heart attack). In many ways he considered his partner to be an obligation and a part of life and 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 (nominally). 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 (from which his fee is derived).
We all feel badly for the partner whose health was affected. BUT A PRODUCTIVITY BASED COMPENSATION PROGRAM WOULD HAVE RESOLVED THIS ISSUE FROM THE START AND WOULD HAVE BEEN FAIR TO BOTH. Here’s how it works.
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. It can be judged AFTER THE FACT (once the year is over) and adjustments made to future compensation 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 for doing what you do productively in 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 (although we don’t recommend taking all profits out of the agency each year and leaving nothing to sponsor the agency’s growth), but it is treated as a second source of income beyond their productive efforts.
Doing this in the situation, above, would have eliminated the excess compensation that derived from a perfectly honorable agreement (that lacked the forethought of the results of that action).
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 they 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.
The savings to an agency of a proper compensation agreement is in not paying for lack of productivity, whether in a producer (see our Producer Compensation Programs), and employee (see our Incentive Compensation Programs) or in an owner. The truly fairest way to come together in ownership is to agree that each owner will take a compensation level that equates to his/her contribution to the success of the agency every year. Many owners will boast about how much they did historically for the agency, but unless that historical performance continues to benefit the business, that is truly past history.
In one recent case, a retiring owner was responsible for a multi-million-dollar (commission) book of specialty business that the agency wrote many years ago. However, most of it was gone by the time the valuation was being done but the owner still felt his importance was derived from that historical performance.
The annual profit sharing in an agency may still be equated to ownership interest (although we have aided many agencies with multiple owners to alter annual profit sharing to equate to percentage of profit contribution (not revenue contribution) of each owner.
On the other hand, the issue that should remain sacrosanct is the distribution of the agency’s value at the point of sale of an ownership interest. That should always be sensitive to the percentage ownership of the departing owner.