COMPENSATING OWNERS IN A CHANGING ENVIRONMENT
We visit many agencies every year in which the owners pretty much take all of the net income after expenses as their compensation. They take some as a salary or draw, some in benefits and perks, some as a bonus and any balance as a distribution at the end of the year. These are called ‘Mom & Pop Shops,’ many small but some surprisingly large, in which the agency is primarily the means for the agency owners to make a living for themselves and their families. Agency owners scrimp and save on agency spending and are fiscally conservative in order to maximize their compensation every year.
But when you don’t give raises in concert with performance and don’t invest in growth opportunities and young staff who will permit you to grow your agency, the short term benefits of maximum compensation are offset by less growth and lower value at retirement. There is nothing wrong with earning as much as possible and tens of thousands of agencies operate like this throughout the U.S. However, those ‘journeymen’ agents are not as much building a growing asset as they are making a strong living. And they expecting a residual value in their agencies when they retire as the result of opportunity value to the next owners.
We also visit many agencies that operate as professional businesses. The agency owners recognize that the ‘pot of gold at the end of the rainbow’ has less to do with maximizing personal income each year than it has to do with building a valued asset that will be perpetuated internally to family or staff, or externally through sale or merger. That valued asset will sponsor all or part of the owners’ retirements and estates. To the degree that the asset is built on a strong foundation, the annual financial needs of the owners as well as the long term goals of maximizing their agency value are both met. ‘Mom & Pop Shops’ also maintain a value, but, since they do not sponsor the kind of growth and profitability that maximizes agency value, their benefit is often less than the owners of these agencies have expected.
The difference is that in the professional agency, all employees, including owners, achieve their compensation based on the value of their jobs and on their performance in those roles. All legitimate business expenses are paid. Profits are dropped to the bottom line and, while some may be distributed each year, a part of the profit is designated as the funding for the growth of the business. A part of profit is reserved within their Strategic and Tactical Plans to fund new employees, marketing and operational programs and acquisitions. Any excess profits are distributed in accordance with ownership percentage.
‘Mom & Pop Shops’ also acquire, but they must borrow money from their owners, the banks or from the sellers to accomplish acquisitions. This requires payments in principal and interest and further binds the ‘Mom & Pop Shop’ to their status. ‘Mom & Pop Shop’ owners are anguished by any potential of spending money on planning, new producers and employees, marketing efforts or other costly growth-oriented expenditures since they perceive those costs coming directly out of their pockets.
What’s right or wrong about how you pay yourselves really depends on your financial condition, your short term goals and whether or not you’re concerned with turning the value of your agency into a retirement benefit or a part of your estate value. Many agents find a point in their lives - such as when they become ‘empty-nesters’ - at which they find that they are finally making “enough” money to support themselves and can now invest in the future. It is easy to do so once that point is reached. The true entrepreneurs are the ones who only ‘eat what they kill,’ meaning they only take home what they “earn” in their roles and through their productivity and individual success.
Many agents know that Agency Consulting Group, Inc. performs many hundred agency valuations each year and has done so for over 30 years for all value purposes (annual stock valuations, estate plans, ESOPs, buy-ins and buy-outs, mergers, acquisitions and divestitures, partner and marriage split-ups, etc). We have always been curious how similar agencies differ in value by large amounts. Most knowledgeable agents understand that agencies are not valued based on a set “multiple” of anything. We, and most other agency valuers, value your agency based on its future earnings potential to the entity for which the valuation is being conducted. That future earnings potential defines how much the sponsor of the valuation can earn from the business over a reasonable period of time. Why would anyone buy any business for more than it will generate in earnings over a reasonable period of time? It’s up to the specific valuation sponsor to determine what is reasonable for him.
So the trending of an agency in both growth and profitability is important when creating an asset value that will be returned to a retiring owner or to the estate of a disabled or departed owner. That trending is based on historical performance. If you choose to use some of your profits each year to sponsor growth (of revenues, geography, book of business, skilled employees, producers), you will, of course, grow faster than someone who maximizes his income each year but does not invest in growth.
So back to compensating owners, if the owners use agency funds to continuously sponsor growth and innovation, their businesses will grow faster and the profit margins tend to be higher, as a result. The owners still earn their keep, but do so based on their own performance in individual roles such as a producer or account executive, as well as in their management roles. Their guide is to pay themselves exactly what they would pay someone else who did that particular job or set of jobs and performed at the level that the owner performs.
One of the reasons to view your compensation and evaluation like this is in the event of an injury, disability or your sudden death. A replacement would have to be sought and your business continuity depends on a fair compensation for that role that does not impede your agency’s performance in your absence. Another, more positive, way of looking at this issue is in the event of your winning the lottery or coming into a lot of money in other ways. You may not be doing what you did in the agency after a sudden financial success, but most of us have enough business sense to not ‘give away’ a valued asset. We may hire someone to replace us and the amount of compensation for that role should be relatively equivalent to that which we paid ourselves for the same functions.
We’re not trying to fool ourselves or anyone else. We find that the agencies who pay their owners based on the owners’ performance in their jobs instead of paying for “ownership entitlement” enjoy much better relationships between owners and employees, between owners and clients and among the owners, themselves. Everyone has a sense of self-worth instead of welfare-like entitlement. Since the owners know that they work for a living, any profit or asset distribution is taken as a bonus for success ONLY WHEN THE MONEY ISN’T NEEDED TO SPONSOR THE FURTHER GROWTH OF THE AGENCY. And the strange thing is that the owners of professional businesses generally get paid more than the owners of the ‘Mom & Pop Shops’ anyway because their own and their agencies’ performance is driven higher by their investment of time, energy and agency profits.
Agency Consulting Group, Inc.’s Incentive Compensation Program - ICP is a way of paying ALL employees based on increased productivity and achievement of growth and profit goals instead of for longevity. It works marvelously for anyone from receptionist to agency owners. The recommendation for compensating owners based on performance can be carved out of the ICP or is a natural part of it. Call David or Al at (800) 779-2430 for more information and to discuss your particular situation.