In this article we look at succession planning strategies to consider, pitfalls to avoid, and real-world examples of manufacturers’ representative firms that have successfully transitioned to new ownership.

But first, a disclaimer. I am not a lawyer. I am not an accountant. This article will share with you some strategies to discuss with your lawyer and accountant, but this is not legal or accounting advice and it is not intended to replace the advice of the legal or accounting professionals who will be crucial to the success of your succession plan.

And we can’t start until we discuss the elephant in the room. It’s a little bit embarrassing even to bring this up, but it still happens sometimes, so we have to talk about it. The elephant in the room is reps who don’t have a succession plan and just gradually slow down until their principals get frustrated and terminate them.

And, sometimes, rarely, even worse things happen.

I have a sad, true story to tell.

I represented a line of terminal blocks in Illinois. I was doing a great job in Illinois, so the sales manager eventually asked me if I could take over the Wisconsin territory. He sheepishly explained that the representative in Wisconsin had not returned his phone calls for months, and that a year or two ago the representative had spun a convincing yarn that convinced the principal’s bookkeeper to mail his checks to an address in Florida.

When I started making calls on Wisconsin customers, no one had seen the representative for years. And the rest of us who represented that manufacturer suffered because that sales manager kept all his reps on a much tighter leash thereafter.

What happens when there is no succession plan?

• It’s unfair to the representative’s principals who were expecting the representative to grow their sales.
• It’s unfair to the representative’s employees, who know their employer is headed straight for a cliff.
• It’s unfair to other representative firms and the representative profession because it gives manufacturers’ representatives a bad name.

And it’s also a risky move to take for the retiring representative. Principals may look at an aging owner with no succession plan, assume the worst, and terminate that representative firm abruptly.

Looking at this from the principal’s side, what the representative calls succession planning, the principal calls business continuity planning. Replacing a representative is a tremendous amount of work. Recruiting. Interviewing. Evaluating. Training. So, it’s understandable that if a representative firm with no succession plan looks like it is declining, the principal is going to execute business continuity planning to protect sales in that territory. And the principal’s business continuity planning is going to be on the principal’s timetable — not the representative’s.

Getting Started

So, let’s get into what you need to do to get started on a succession plan.

Your first question might be, “When do I need to start this process?”

Let me put it this way. Say that you became a grandparent on the same day that you decided that you wanted to retire. On the same day you have completely retired, handed over your set of keys, and walked away from the business, you can probably walk that grandchild to his or her first day of kindergarten.

That’s right — five years from the day you decide you want to retire to the day you are actually 100 percent out of the business.

Why does it take so long? Because if you leave abruptly you risk losing your principals, and once you have lost your principals you no longer have a representative firm to sell.

At the end of a successful succession transition the representative firm will have continued on without anyone even noticing you have left, because you gradually faded from sight instead of suddenly disappearing. Not being missed may not be great for your ego, but it is excellent when it comes to helping insure that representative firm’s revenues and your monthly buyout checks continue uninterrupted.

How do we start?

First you need to find a prospective buyer, which should be right up your alley, right? You’ve been a salesperson for 25 or 30 years, or longer. Finding buyers for your principals’ products is in your DNA, so finding buyers for your representative firm shouldn’t be too great a challenge.

The most common and successful way to find a buyer for your representative firm involves even more planning. You make a point to hire some younger people who seem like they might be candidates to take over the firm someday, and at least one of them turns out to be a likely successor. (One representative jokingly claimed that his succession plan involved having a child 35 years ahead of his planned retirement date; but a 35-year time horizon is impractical for most of us!)

Another way to find a seasoned candidate is to consider a direct salesperson, district manager, or regional manager from one of your principals. Two risks to consider are:

1. Could that direct employee perhaps launch their own representative firm and take that line with them?
2. Would the principal consider that to be poaching and terminate you for stealing their employee?

Time to tell another true story.

One of the best regional managers my representative firm ever worked with was about 15 years younger than I, a degreed-electrical engineer, had a great work ethic, and a perfect personality for sales.

Twenty years ago he came to me privately and said he was resigning his current job to take a better-paying regional sales manager position at another company. He’d still have heavy travel and had young children, but the money was good.

I told him that I couldn’t recruit him while he was working for my principal, but once he gave notice, I’d like to make him an offer. I could match the pay he’d be getting at his new employer and I also could offer him no overnight travel. Staying close to his children was important to him, and he agreed to give me a heads-up as soon as he gave notice.

Making the Right Choice

As soon as he gave notice, I called my principal’s national sales manager and asked permission to recruit my ex-regional manager. The national sales manager was thrilled at the prospect at keeping an excellent regional working his product line, and everybody won.

Other candidates to buy your representative firm might be a representative in an adjacent territory who you share lines with, or a representative in your own territory who has complementary non-competing lines. To oversimplify, if you sell nails, a representative who sells hammers might be an excellent candidate.

Once you have identified a prospective buyer, it’s time to negotiate a valuation for the firm.

How do you value a firm with no inventory, few physical assets, and income tied to representative agreements that often are subject to termination on 30 days’ notice?

Generally, most of the value of a representative firm is the stream of income from future commissions. The valuation formulas discussed in this article are different ways that have been used to value that stream of future commission income.

Here’s how I valued my representative firm:

First, you should know that my firm got more than half its income from one principal. As long as that principal stayed with my firm, that stream of income would be very healthy. If that principal ever terminated its agreement with my firm, the new owner would face some significant financial challenges.

So how do you arrive at a price? I wanted to participate in the potential for commission income growth, and the buyer wanted to be sure he was not locked into a monthly payment he could not sustain if that major principal terminated the firm.

We agreed on a multiplier of 1.0 of the firm’s commissions, but which commissions were we going to base that on? The past calendar year? The average of the past three calendar years? And what happens to the payout if the big principal terminates the representative firm?

As long as we were valuing the firm as a future stream of income, we decided to tie the selling price on that future stream of income. And the agreement we struck was that every month for five years the firm would pay me 20 percent of its gross commission.

Five years times 20 percent per year works out to 100 percent, which is the 1.0 multiplier. If the big principal stuck with the firm for all five years, I’d have a very nice payout. If the big principal terminated the agreement shortly after the sale, then the payout would drop accordingly.

That certainly seemed fair. Neither of us could predict the future, so we set a percentage of gross income instead of a specific-dollar figure.

Valuing the Firm

The way I did it is just one of many ways representative firms get valued. But generally, the valuation tends to hover around 1.0 to 1.5 times commissions with a payout over seven to 10 years. Just like with a credit card payment, the longer the buyer stretches out the payments, the larger the total amount of those payments works out to be.

In my case, setting the payout over five years turned out to be too aggressive so we ended up renegotiating the payout so the representative firm would not be starved for cash.

After choosing a valuation formula, you may need to go back and adjust the final price based on factors such as these:

• Did the buyer personally guarantee the payments or did the guarantee come from the buyer’s corporation?
• The value of any equipment or inventory being sold with the representative firm has to be added to the price.
• If the representative firm has shaky relationships with any of its principals, some discount of the selling price should be considered.
• If some of the principals are financially shaky and might not be able to pay earned commissions, some discount of the selling price should be considered.
• It is reasonable for the seller to ask that commissions received after the representative firm is sold on orders that were closed before the representative firm was sold should pass through to the seller.

Sometimes two representative firms that plan to merge have competing principals on their line cards. Because the merged firm can’t have competing lines, one or more competing lines will have to be dropped from the merged firm’s line card.

After dropping those lines, the merged firm initially will have less income than the total income the two representative firms had when they were separate. This is a case where one plus one equals one-and-a-half. This reduction in the revenue stream for the combined representative firm may need to be factored into the price.

Considering an ESOP

For larger representative firms, another way for the owner to convert the value of his or her share of a representative firm into retirement income is to establish an employee stock ownership program or ESOP. An ESOP is a defined contribution plan that must meet IRS requirements for a retirement plan and is regulated by the Employee Retirement Income Security Act (ERISA). An ESOP buys back employees’ shares when they retire, and can even take out a loan to buy back those shares.

Costs to establish an ESOP can range from $50,000 to $100,000 the first year, and annual maintenance of the ESOP can range from $15,000 to $30,000 in subsequent years.

Zink Foodservice, a representative firm in the food service industry, recently announced that it established an ESOP for its 75-strong workforce. Zink reports that the ESOP provides employees a sense of stability and makes them stakeholders in the company’s success, and they consider it a tool for employee retention.

And of course a principal who is concerned about business continuity planning will also take comfort in the degree to which an ESOP addresses representative firm succession planning.

Now that we have a seller, a buyer, and a selling price, it’s time to look at some of the terms of sale:

• Claw-back provision: If the new owner is running the company into the ground (as evidenced, perhaps, by missing payments to you) you want to regain control of the company quickly to minimize the impact of that mismanagement.
• Life insurance: During the transition, both the buyer and seller have significant investment in the process. Life insurance on the buyer’s life and the seller’s life can cushion the financial impact on the surviving party of a deal that could not otherwise go forward.
• Sale of assets or sale of stock: Topics for discussion with your tax professional should include topics such as:
  • If just the assets are sold to a new representative firm, the new firm has to convince the principals that wrote representative agreements with the seller to transfer those agreements to the buyer. Also, in an asset sale the seller generally pays more tax than would have been paid if it had been a stock sale.
  • If stock is sold, the buyer faces tax consequences that the buyer would not have faced in an asset sale.
• Covenant not to compete: The buyer will want assurance that the seller won’t get restless in retirement and open a competing representative firm, so the seller will be asked to sign a covenant not to compete.

Now that the seller and the buyer have agreed on the price and terms, it’s time to get buy-in from the principals. Because if the principals are not happy, nobody is going to be happy.

So it’s time to get on an airplane and introduce the buyer in person to every important principal. The principals need to know:

• You are executing a succession plan that ensures business continuity for your principals.
• You are committed to a smooth transition and you will remain involved with the company for years to come.
• You have vetted the buyer thoroughly, and that the buyer is a talented manager who will continue to grow the principal’s business.

In closing, if you have any doubts that succession planning can work, this list of manufacturers’ representatives who have represented Eriez Manufacturing of Erie, Pennsylvania, for at least 50 years, and through at least one successful succession of management, should put those doubts to rest:

• 70 Years — Dominion-Carolina Sales, Inc., High Point, North Carolina — second-generation family
• 68 Years — BLW Group, Inc., Memphis, Tennessee — second-generation family, third-generation management
• 63 Years — Merrifield Co., Cincinnati, Ohio — third-generation family
• 61 Years — B&H Industrial LLC., Indianapolis, Indiana — third-generation family
• 55 Years — D&L Engineering Sales, Halifax, Nova Scotia — second-generation management
• 54 Years — Adams Brothers, Inc., Atlanta, Georgia — second-generation family, third-generation management
• 50 Years — Vision Process Solutions, Montreal, Quebec — second-generation family, third-generation management.

With these many successful succession plans executed by the representatives of a single principal, it’s clear that a carefully executed plan can make it possible for a representative firm to enjoy decades of commission revenue, fund its founders’ retirement, and even fund the founder’s successor’s retirement.

For more information about succession planning, visit www.manaonline.org or e-mail [email protected].

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Success Story #1

Sam went to work for a representative firm in 1982 and bought it in 1996 using MANA resources to help value that firm.

April owned a representative firm that represented the same major line as Sam in a sales territory adjacent to Sam’s territory. In 2006, April approached Sam about buying her out. Sam had reservations because April’s income was very heavily concentrated with that principal.

Sam completed due diligence with the principal, and what he remembers most about that meeting was what the principal told him: “As long as you take care of April we’ll be happy.”

And Sam was also reassured that the principal was privately held and planned to stay that way.

Five years after Sam made the final payment on the five-year payout to April, he reports that the transition went extremely smoothly. He’s 61 now and reports it’s his turn to start the process of being the seller instead of the buyer.

Says Sam, “That principal is a stand-up guy, and I made my decision based on my discussion with him.”

Success Story #2

Sandra and Joe were both direct-factory salespeople until 1995 when they formed their own agency, DEF Reps. Recently, they executed their plan for Sandra’s retirement and to bring in a successor. Sandra remains involved in the business, selling to key accounts.

DEF exemplifies the value of advance planning.

Sandra gave Joe 10 years’ notice of her intent to retire, and they started looking for Sandra’s successor five years ago.  Joe bought some of Sandra’s shares so he could be the majority stockholder, and the new owner bought a minority share. Sandra stayed on salary for 18 months and went on straight commission thereafter.

Here is how Sandra put it: “From day one, when Joe and I decided to go independent, we always had a 50/50 buy/sell agreement, 50/50 with first right of refusal when shares were sold.”

It took some real work to find and recruit the right successor, which is one of the reasons advance planning is so important.

Another part of advance planning was that Sandra and Joe met with major principals in advance to get their blessing.

Their largest principal offered to support the transition with extra training and back up for the successor, because that principal says a successful transition benefits everyone.

Success Story #3

XYZ Reps has represented its largest principal for 15 years, but George has represented the principal for 35 years if you include his time as district manager for that principal.

After working as the principal’s district manager in a major market, George started his own representative firm to represent that principal in 1994, and ultimately merged his firm into TUV, a larger firm that represented that same principal in 2002.

TUV was founded in 1974, and is now thriving under the management of the founder’s nephew.

TUV’s founder’s passing highlighted the importance of succession planning, which is an area where the TUV has really set the gold standard.

TUV’s plan establishes a share value annually for the firm’s stock redemption agreement, and had key-person insurance to be sure that the value of each owner’s share is covered to compensate the estate for that share.

When I spoke to TUV’s president, he put it this way: “We have a structure. And we check our egos at the door. Any one salesperson may have a great year and others not. Everyone knows what their monthly income will be and any excess is dispersed in proportion to each owner’s shares.”

MANA welcomes your comments on this article. Write to us at [email protected].