by Kevin Stipe, January 2000

National Underwriter

Caution:  Don't answer the following question too quickly: Are you a Deadbeat Shareholder? 

"Deadbeat Dads" have taken a lot of heat in recent years for not taking the financial responsibility that accompanies the privilege of fatherhood.    Likewise, we see a lot of agency principals who accept the rewards of agency ownership without accepting the value-building responsibilities that accompany ownership.

But how in the world does one know whether or not he is living up to his responsibility to create value?  How much value should each shareholder be responsible for creating?  And how do you measure value creation? 

Many agencies seem to have one or more principals who are not pulling their weight and have no plan to do so in the future.  Many of these Deadbeat Shareholders mistakenly believe that agency ownership should be viewed as a reward for past performance.  It shouldn't.  It needs to be recognized for what it truly is: the most precious currency a privately-held business has to motivate and reward future performance.

To the degree that any shareholder in an agency is not creating value proportionate to the percentage he or she currently holds, their lack of performance taxes the other shareholders.  Many agency principals suffer from high tax rates imposed on them by under-performing partners, but they can't quite put their finger on what the problem is or how to fix it.  Well it's time for a tax cut!

A New Approach to Agency Planning

If you are a principal in a privately-held insurance agency, we would suggest you establish for each shareholder a "Value Creation Quota."  Here's how you can do it:  Thirty days before your next planning retreat, provide each shareholder with a statement that shows the value of their share of the agency's stock (if you don't have an appraisal, simply use your best estimate.)  Beneath that value, place the desired rate of agency growth (and if you don't aspire to growth exceeding 5% you're in trouble!) Then apply that percentage to the dollar value of the shareholder's interest.  The product (the Value Creation Quota) is the amount of value they need to develop in the coming year.  Their assignment is to bring to the planning retreat ideas for achieving their Value Creation Quota.

What if you used this approach as your strategic planning framework?  In many of the agencies we've encountered over the years, it would create quite a stir!  But if this approach would be like tossing a hand-grenade into your next shareholder meeting, so be it.  The more disruptive you think it might be, the more it is probably needed, and the more some of your partners (the overtaxed ones) will thank you.

A Value Creation Quota Example

Here's what a Value Creation Quota statement would look like for hypothetical agency principal Dave, the 20% shareholder of a $5.0 million value agency:

Value of Dave's 20% ownership stake:  $1.0 million
Agency target growth rate: 10%
Dave's Value Creation Quota: $100,000

Prior to the shareholder meeting, Dave would need to consider how he might generate $100,000 in value in the coming year.  In Dave's case, since he is a producer and since he has grown his commission income by $75,000 in each of the past three years, he simply needs to develop a plan for repeating his past performance.  This is because net growth of $75,000, if valued at 1.3 times commissions (a decent estimate of value for this particular agency), would generate the $100,000 quota.  But, he needs to understand that each year, as the value of his equity position in the agency grows, so will his Value Creation Quota.

Let's contrast Dave's situation to that of John, the agency's CEO and 40% shareholder.  Since John's equity interest is worth $2 million, his Value Creation Quota is $200,000.  To achieve his quota through personal new business production alone would require net growth in his book of roughly $150,000 - something he would be hard pressed to accomplish.  John realizes this and becomes frustrated: "How can I ever live up to a Value Creation Quota so high?" he asks. 

It is at this point that the computation of a Value Creation Quota pays off.  John, perhaps for the first time, awakens to the notion that he must reach beyond personal production if he is to be an effective steward of his agency equity (and avoid taxing his partners.)  After some soul-searching, he concludes that to create $150,000 in additional value, he must set his sights beyond building his book of business.  He needs to focus on building the organization.

Here's the critical application: For any shareholder whose day-to-day efforts will fall short of reaching his Value Creation Quota, one of two things needs to happen.  1) He needs to set his sights higher in terms of his efforts to build agency value or 2) He needs to consider reducing his equity position in the agency by selling some of his stock to other employees who consistently exceed their Value Creation Quota. 

Assuming a shareholder chooses to set his sights higher (since selling some of one's stock is generally the less-attractive option) how does he know which activities to focus on?  In our valuation and consulting work over the years, we have observed a Value Creation Hierarchy.  Certain activities are more potent value creators than others.  Below is a list of value building activities, listed in descending order in terms of their impact on value. 

Your largest shareholders should be engaged in activities near the top of the list.  For any shareholder looking to increase the value he creates, his focus can either be on becoming more effective at what he is doing, or on migrating up the ladder, focusing on ever-higher levels of value-creating activities.

VALUE CREATION HIERARCHY

1.  Rainmaking
      - Recruitment of producers and managers (raising "human capital")
      - Scouting mergers and acquisitions
      - Product or program development
      - Jumbo account selling

2.  Production
      - Sales leadership and management
      - Client generation

3.  Support
      - Top-tier technical support (account executive)
      - Middle-tier technical support (customer service rep.)
      - Administrative support

Clearly, the above list isn't intended to be all-inclusive.  Not covered here, for example, is a chief financial officer or a chief operating officer, both of whom help build value in myriad ways, and may fit into several different categories in the hierarchy depending on their unique blend of talents. 

And we also acknowledge that measuring the value created by shareholder efforts is not a task for the faint-hearted.  It can be extremely difficult, for example, to measure the value created by a sales manager or a chief operating officer.  But that misses the point.  The compelling benefit of this approach, despite some of the practical difficulties, is to get all shareholders focused on the all-important task of building the organization.  Ideally, in a value-focused agency, stock ownership will fluctuate over time, with value creators rewarded by earning the right to buy additional shares from those consistently falling short of their quota.

Conclusion

We have certainly witnessed in recent years that a tax-cut can be a powerful stimulus for economic growth.  In the same way, we believe that many agencies could benefit greatly from a "tax-cut."  So if some of your shareholders are being forced to pay high taxes to support their under-performing partners, declare a tax-cut by implementing a Value Creation Quota - and let the fireworks begin!

Kevin M. Stipe, CPCU, is senior vice president and principal of Reagan Consulting, an independent Atlanta-based management consulting firm working with insurance agents, brokers and companies, as well as financial institutions. Additional information is available at website www.reaganconsulting.com.