Stock Ownership Versus Deferred Compensation

One of the topics an agency owner will often have to discuss with a new or existing producer will be “ownership.” When we ask a producer what they mean by ownership, stock ownership is often what comes to their mind. What they are usually looking for is security and that they are building something for their efforts and retirement.

Stock ownership can conjure up visions of importance and respect. Producers feel that having the word “owner” on their business card will improve sales. Often, only the benefits of stock ownership are understood by the producer and not many of the drawbacks.

Agency owners are often unclear themselves whether or not they should offer stock to a producer. They think about it either when it comes up in an interview with a new producer prospect or when an already employed producer is about to walk out the door and may not come back. The owners feel they are forced to offer stock in order to entice the new producer to join the firm or to retain the currently employed producer and the book of business.

Minority ownership has its pluses and minuses. Being a minority owner means the producer has no control over how the business is run. A minority owner may not qualify for profit distribution. The value received by a minority owner may be discounted. The value of the producer’s sales efforts is diluted since they only own a small percentage of the firm. Additional stock would need to be purchased by the producer, who often does not have the money to do so.

It is often better to offer the new or existing producer a deferred compensation plan or vesting plan. The producer has direct control over the growth of the equity, based on their production efforts.

Based on surveys we have done, about 60% of firms responding indicated they give producers vesting in their books of business. Also, only about 44% of firms will allow a producer to purchase equity in the agency.

What Is Deferred Comp?

Deferred compensation is a method for producers to build long term value for their efforts directly related to their books of business. The plan is often phased in over time until the producer is fully vested in the plan.

The agency benefits by having a system that encourages the producers to build their books and remain with the firm, as well. It must be noted that a deferred compensation plan creates a contingent liability for the firm, which does negatively affect agency value.

However, deferred comp is also “consideration,” which helps uphold the covenant not-to-compete in a producer contract. This is another good reason to have it for producers.

How Does a Producer Qualify?

A producer will qualify for the deferred compensation plan by either time employed by the agency or by the size of the book of business or both. For example, a firm may set the qualification limit at three years of employment and a minimum $250,000 to $300,000 commission book of business. This is what we recommend.

How Does it Work?

Once the producer qualifies for the plan, there is often a phase-in period, typically three to five years. At the end of the specified period of time, the producer will be considered fully vested in the plan. If a producer leaves during the vesting period, they would only be entitled to a pro-rated portion of the fully vested plan.

A producer that is fully vested in the plan is entitled to deferred compensation equal to a percentage of their book of business. The typical plan sets deferred compensation at 50% of the size of the book of business.

The producer receives the deferred compensation after they leave the firm. The payout is usually paid over time (five to 10 years typically) and is usually based on account retention. We suggest one times commission as the price paid for the deferred compensation, based on 50% of the size of the book of business.

Other Issues

The agency retains the ownership of the accounts. The producer is just qualifying for a deferred compensation program. If the agency chooses to sell the business to a departing producer, the deferred compensation can be used to offset the purchase price that the two parties set for the book of business.

When an agency sells stock to a producer, the producer’s deferred compensation can be used to offset the purchase price of the stock. Once the producer is an owner, they no longer qualify for the producer deferred compensation program.

Note: When the deferred compensation is paid out, it is taxed as income as the producer receives it. When deferred comp is exchanged for stock, the entire value is taxed at the time the stock is received.

Summary

Consider deferred compensation as a part of the firm’s compensation plan, for those producers that qualify. It will set the organization apart from its peers and should assist in attracting and retaining good producers for the firm.

Topics Talent