Dressing Up the Agency for the Wedding Part 1 – Agency Operations
Business owners have a lot to consider when running a successful business. Unfortunately, many do not consider an exit strategy, especially in the early years of the business.
Agency owners without an exit strategy will sometimes make decisions based on expediency, rather than following a long-term strategy. So, when the owners are ready to sell, too often the firm is not in the most optimum condition. This usually means the firm is valued at a lower price and the owners lose some potential equity.
For these agencies, the business needs to be “dressed up” before the “wedding.”
The axiom we like to follow is to “run your business like you are ready to sell your business.” This will require a change in thinking and managing.
This article covers some of the more common issues or weaknesses that agency owners might run into when selling or merging their business. These issues are typically systemic and ingrained, so correcting them will take time and commitment. However, for those that address these issues now, when the “wedding” comes, the firm and the owners will be ready to reap the rewards.
Be an S Corp or LLC for Tax Purposes
Buyers typically buy the assets of the firm and not the stock. For owners of a C corporation, this presents a double tax situation. In an asset sale for a C corporation, the proceeds from the sale would first be taxed corporately and then personally for the owners. This layering of taxes can cost up to 62% in some states!
It is best to become an S corporation or an LLC as far in advance of a sale as possible. There is now a five-year waiting rule after the conversion from a C corporation for the exclusion of all “built in gains.” Note — for a few years this was a 10-year period!
Keep in mind, every year after the S election or LLC conversion has been in place, the new growth/equity gain will not be double taxed, but instead will be treated just as capital gains for the owner. Make sure to have the business appraised to establish the basis for the built-in gains. As long as the agency is growing, it is worth converting the firm to an S corporation, even before five years! Some CPAs talk owners into not converting because they lose some write-off benefits, however, it is not worth the hassles in the structuring of a sale if this conversion does not occur.
Good Management in Place
A successful, valuable agency must have good management from the top down. But owners do not have to do all the managing.
Most owners are the firm’s best sales persons. So, if that is the case, it is better to hire an agency manager to oversee all departments, rather than impacting sales.
For smaller firms where that might not be cost effective, promote one of the CSRs to a supervisory role or office manager role.
A middle management team will take a big burden off the owners and usually makes sense when the firm has more than three account managers by department.
Cost for an overall agency manager to do all these things is in the 3% to 5% range of agency commission revenue and caps out at about $250,000, depending on the size and location of the firm. If a middle management team is also in place, the agency manger role is less complicated and thus less expensive. Also, an agency manager helps with the transition of the business when the owners are ready to retire.
Service Personnel Productivity
Many agencies are not staffed properly, especially with their service desks. Often owners don’t know or understand how to gather the correct information from computer reports in order to measure staffing requirements.
Third party buyers want to know the agency has the right level of quality staff for the workloads, based on the average size of account. If there are problems, it is not easy to repair, especially if there are too many people for the workloads, i.e., the staff “over-services” accounts. Account retention can be at stake in a sale if staff is cut.
The primary report for analysis is a Book of Business by Representative to establish the total number of accounts and the commission dollars. Extracting correct information from the computer system is not always easy. Sometimes account managers have not properly coded the accounts they work on themselves. Sometimes they can only access item numbers or policies, not customer counts.
There are also other Key Performance Indicators such as activity count, and subjective factors like the quality of work to also consider.
Good Communication and Morale
Buyers know that firms with high staff morale are worth more because of employee loyalty and productivity. A driver of employee morale is the quality and quantity of communication throughout the agency. Regular staff meetings are the foundation of good communications. These meetings are intended to clarify the direction of the agency and provide a format for the staff to discuss issues and concerns.
Employees tend to be happy when they are respected and know what to expect. Policies and procedures need to be established and followed consistently. Having rules but not following them or doing so inconsistently will kill employee morale. When people are treated fairly and respected, morale will be high. These policies and procedures also help with effective workflow and good customer service.
Pro Forma Profit Over 25%
The bottom line is the bottom line!
What can be said, except that sellers that have managed the expenses well, streamlined their organizations,
and have proper compensation plans deliver better cash flow. Firms with a high profit margin are more valuable and highly sought after.
Employee compensation, benefits and payroll taxes account for 55% to 70% of the firm’s revenue. Therefore, this is the first place to review. For firms with high employee compensation ratios, there are two common issues: 1) low employee productivity from overstaffing or poor workflow and 2) excessive producer compensation.
If the high expense ratio is the result of lucrative owner compensation, this is actually a good thing!
After compensation expenses, all other expenses account for 15% to 25% of revenue. It is still important to manage these expenses, especially the big ones like rent. However, if there is a choice between lowering the cost of supplies and improving employee productivity, spend the time on the latter because it will have a bigger impact on profits.
Summary
These are the typical agency operational issues that some sellers face when they are preparing to sell. None of these issues can get fixed overnight, but instead, will take a year or more to properly address and revise. Owners need to understand their agency’s weaknesses and fix them well before they intend to sell the business. Take the time now to work on your business so that it will be in optimum shape when it is time to sell.
When evaluating an acquisition opportunity, buyers usually first look at the agency’s book of business. Next month, we will address common issues with the book of business, sales and producers, as well as how to make them attractive to a buyer.