Many of our clients have contacted us in the last few months to help them figure out how to perpetuate their agency. The first thing that we hear is that they are totally against selling their business to a third party. They repeat some horror story they heard from a friend or colleague about their experience after a sale. Because of these stories, and a strong commitment to continue the independence of their agency, they are committed to an internal perpetuation.
Our greatest challenge becomes determining the value for the terminating shareholders. The reason for the challenge is that the market seems to accept that an internal perpetuation valuation should be less than a third party sale valuation. We would contend that the internal perpetuation valuation should be higher. In fact, it should be much higher unless the internal buyer is willing and able to fund the purchase of the shares at closing with personal assets or bank financing. The most common funding structure in an internal perpetuation is the issuance of a long term note. If we looked back over the last ten years, it wouldbe apparent how much the economic and business model has changed over that time. Do any of us have any idea what is going to happen over the next ten years? There needs to be a cost associated with the undertaking of that risk. In any other business transaction would you accept less and then agree to be paid over a risky long term period? This risk can’t be quantified and the value will be ultimately established by the price that the buyer and seller are willing to accept.
Understanding this risk puts the financial advisor in a very difficult situation. It is clearly a challenge for any financial advisor to recommend an internal perpetuation unless there is a way the internal buyers can at least match the market price of the agency. The internal buyer should also be able to finance the entire purchase or at least 80% of the consideration to the former shareholders. However, it seems that many owners are willing to accept a discount for an internal perpetuation. This discount often ranges from 25% to 40%. While we understand their willingness to take this discount, we believe they are not comparing the risk associated with an internal versus an external perpetuation. In the end, it is the owner’s decision to decide between a discounted internal perpetuation and an external sale. Our job to make sure they understand all the risks associated with any transaction.
Our advice is always that when listening to a colleague about a sale to a third party one should always apply the advice that was given to me by my dad. He told me, “Son, always remember that there are 3 sides to every story.” In this case the three sides include the buyer’s perspective, the seller’s perspective, and the truth! We believe that if the advisor spends time to understand all of the goals of the sellers, a cultural fit between the seller and the buyer can be created. The problem is that most financial advisors focus on price. After the money is deposited in the bank the owners need to focus on their clients and maximize the benefits of the new relationship with all parties. If the expectation were not properly set, then it becomes a very difficult marriage regardless of the size of the bank account.
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