In the past few years, I have received more phone calls than ever from the families and partners of agency owners who have died. The survivors have a buy-sell agreement and now realize the buy-sell agreement is not economically feasible and/or it is written so poorly that no one understands it. These are horrible situations. How can you avoid these issues for yourself, your loved ones, and your partners?
First and foremost, never, ever use boilerplate buy/sell agreements. They are the worst. I have never seen one that fits any agency. Buy/sell agreements have huge implications so they should be taken seriously and crafted to each specific agency's situation. I have seen people sign buy/sell agreements that apply to captive agencies when they have an independent agency. I have seen them sign agreements written as if the agency owns all of their accounts when the producers actually own the accounts. I have seen agencies sign buy/sell agreements that were meant for real estate!
Second, never, ever use a formulaic agency valuation formula! The IRS actually has a few good regulations. One such regulation applies to valuation formulas for businesses with regard to estate taxes, gift taxes, ESOPs, and quite a few other applications, and states that formulaic valuation formulas that are set and never updated are prohibited! Therefore, the idea of setting a valuation formula of 1.5 times into eternity is not allowed and for good reason because values change (and because that formula is wrong with which to begin!)
Additionally, these formulas never take into consideration the specifics of an agency. Is an agency growing 10% annually worth the same as one that is losing revenue? Is an agency worth the same if on the date the document was signed, the agency had a 30% profit margin and now has a 0% profit margin? What if when the contract was signed the agency had no producers and now it has producers but the producers have no restrictive contracts so they can take their customers to any other agency? The list goes on and on and on.
Now, if you are just two regular people unrelated to one another and not in an ESOP or some other regulated entity that requires adherence to standard valuation rules, then you can choose a simple and silly valuation formula. It is your life to ruin and many people choose to ruin their lives every day.
The third crucial point is that you should never, ever have a generic attorney draft your buy/sell agreement. The odds are extremely high that they will violate recommendations one and two. They will pull out their generic boilerplate buy/sell agreement, use a generic formula, charge you as if they wrote it from scratch, and you will be signing junk.
Or maybe you will need to pay to educate your attorney on how agencies work, something they are not likely to understand, which may result in a better document, but one that is still not correct. Several times I have seen attorneys write generic valuation formulas into buy/sell agreements without understanding the difference between commissions and premiums. Imagine a buy/sell that stipulates the price the surviving partner will pay is 2.0 times PREMIUMS!
Agency valuations are unique. I have written extensively about this topic and if you are interested, a quick internet search will likely present quite a few of these articles for your reading pleasure. A key component almost all attorneys and generic formulas get wrong is that agency valuations always have two parts. Right off the bat then, any generic formula that only has one part is WRONG! There is a book of business value and a balance sheet value.
If you want to draw up a buy/sell agreement correctly, here are some basic steps to take. First, hire a good insurance agency consultant who understands insurance agencies and how to value them. Then have the consultant work with a good attorney. You will need both because the consultant is not going to know all the applicable legal points and the lawyer will not know how to do the valuation clause.
The valuation clause is critical and different options exist. Some of those options vary by state and purpose which in my experience are typically overlooked even by the attorneys. As an agency owner you may be bored to tears by these discussions, but a lot of money is on the line if mistakes are made.
Buy/sell agreements should also take into consideration quite a few different triggers and whether the agency’s value should be affected by a trigger. For example, a good trigger to include is if a partner does something illegal, especially if that act diminishes the agency's value. Another example is if a partner leaves and takes customers with them. It would be nonsensical for the formula to still stipulate that the departing partner should be paid 1.5 times last year’s commissions. These are the kinds of issues that should be covered in the agreement.
Lastly, it makes sense to have your agency valued per the buy/sell agreement so you can see how it will really work. I have had a lot of disappointed clients over the years who never went through this exercise until they had a trigger and the value was far higher than they wanted or far lower than they wanted. The valuation I completed was a solid valuation per the buy/sell agreement. It is just that the buy/sell did not work the way owners anticipated it would work. Going through this process early can save a lot of pain, anger, and money later.
NOTE: The information provided herein is intended for educational and informational purposes only and it represents only the views of the authors. It is not a recommendation that a particular course of action be followed. Burand & Associates, LLC and Chris Burand assume, and will have, no responsibility for liability or damage which may result from the use of any of this information.
None of the materials in this article should be construed as offering legal advice, and the specific advice of legal counsel is recommended before acting on any matter discussed in this article. Regulated individuals/entities should also ensure that they comply with all applicable laws, rules, and regulations.