When it comes to planning for your agency's internal perpetuation, there are numerous factors to consider, each requiring careful consideration and strategic discussion.

First, it's important to have a documented perpetuation plan. Agencies that have a documented perpetuation plan can command a premium in the marketplace because the agency owners have bought into the plan and its execution; the owner is operating with an exit in mind and is running the agency like a business, not a lifestyle; the steps and the milestones to facilitate the exit have been clearly delineated, and; agency ownership is meeting regularly to discuss and fine-tune the plan and any contingencies.

An agency looking to transfer agency stock to family members or key employees has many options to consider. Oftentimes, a combination of methods is used to facilitate and optimize the transaction. Here are five internal perpetuation options available to agency owners as they consider their future exits: 

1) Gifting. If the agency transaction involves family members, gifting is likely to be one of the components. The annual IRS gift tax limit in 2024 is $18,000 to as many individuals as desired without paying tax. An agency owner and spouse could give each child, or other family members, a combined $36,000 tax-free.

2) Stock bonus. In effect, a stock bonus is giving away agency stock. However, it can be a useful part of the perpetuation plan. To reward key employees, agencies can bring them into the perpetuation plan without costing them a large sum of money.

The value of the stock bonus is typically a deductible for the agency upon transfer, but taxable to the employee as ordinary income. The bonused employee would be responsible for paying the tax on the bonused stock. While this tax could be a substantial sum, it would still be cheaper than purchasing the stock outright.

3) Stock redemption. Some agencies have the corporation buy the outstanding shares and retire them to treasury stock. One deterrent of this option is that these payments must come from after-tax dollars. The goal of a stock redemption is to reduce the number of outstanding shares, increasing the ownership percentage of the remaining shareholders.

4) Personal buyout. There are three options in a personal buyout:

• Personal funds. In a personal buyout, agency employees can purchase stock from the retiring shareholder or shareholders using existing salaries or personal funds. Some agencies set up bonus plans tied to agency growth and profitability to instill the behaviors necessary for future agency ownership. If the employee meets or exceeds the goals, they are rewarded with bonuses that can be used to purchase the agency stock. These bonuses help employees purchase large tranches of stock if they cannot afford it outright or have risk aversion tapping into their personal family savings.
• Bank loans. An agency employee can take out a bank loan from a local bank that understands the nature of the business or from a national bank that specializes in insurance agency transactions. The lender collateralizes the loan with the agency's book of business once they understand the recurring nature of the revenue stream. Oftentimes, the buyer will then use agency distributions or cash flow to service the debt.
• Seller-held note. In some cases, an agency owner will hold a personal note for the loan, depending on their age, financial situation and risk tolerance. A typical loan would have a five- or ten-year payback and would generally be serviced from agency profits.

5) Combination. Sometimes, owners will use a combination of personal funds, bank loans and seller financing. Many owners want to see buyers, the future owners, have some skin in the game and will ask them to tap into personal funds or take out a bank loan. Before going down this path, it is critical for agency owners to understand if their future buyers are bankable. If someone is not creditworthy, this will remove bank financing from the equation.

There is no one-size-fits-all solution to perpetuating your agency internally. Each individual agency perpetuation will depend on the specific situation of the current ownership and the potential buyers. Current and future agency leaders should meet with CPAs, accountants and financial advisors to determine the best approach. By understanding the available options, the key stakeholders can determine the best way forward for all involved.

Craig Niess is director of business planning and valuation at IA Valuations.

The information provided in these documents is general in nature and shall not be construed as personal legal, tax or financial advice for your situation. Please contact@iavaluations.com to discuss your personal situation. 

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