Three key components to perpetuation
In our last two ViewPoint articles we discussed the impact COVID-19 could have on your firm’s valuation and whether there is any debt capital available for firms looking to either transition ownership internally or potentially acquire other firms. Today we turn our attention to the concept of perpetuation.
Perpetuation of a firm should be viewed as a continuous process – not a single event. In most cases, perpetuation should include an intentional transition of three key components:
- Ownership in form of stock or member interest;
- Producer/Owner books of business; and
- Leadership/Community relationships.
All three areas are important. Consider them each like a component of a three-legged stool. If anyone fails, the stool could fall. The process of perpetuation could be significantly impaired.
As we consider these different components, let’s focus in on the first component above. In order to have the orderly transition of an equity interest, you need to have both a willing buyer and a willing seller. The term “willing” usually assumes you agree to a fair valuation of the equity. Unpacking this in today’s environment, consider the vantage point of the two main parties of the transaction.
Most internal transactions in 2020 will likely be based off the valuation of the firm as of 12/31/19. As we continue to evaluate what impact COVID-19 will have on brokers across the country, we hear a common perspective that business could be anywhere from 5% up to 15% down. If a business were to shrink in 2020, it is possible that its valuation could go down in 2021. As a potential new shareholder would you buy stock in a company that you think could be worth less in 12 months? Maybe, but most likely no.
Now, think about how this might impact a potential seller’s psyche for an internal transaction intended to take place in 2021. Let’s assume a limited number of potential buyers decide to buy stock in 2021. If you are a seller, would you want to sell a portion of your stock in 2021 based upon what is now a depressed value? Again, maybe not unless you need liquidity. You would be better off waiting for a potential rebound in value based on results in 2021.
So, where does that leave us?
The reality is that we expect very few internal transactions to happen in the industry in 2020 or 2021 unless as part of an already staged transaction that is outlined in a robust perpetuation plan. For firms initially thinking about perpetuation, they need to ensure they stress the long-term investment that buyers are making. Ownership in a brokerage has usually never been a “get rich quick” investment. Fluctuation in value should be expected at some level and investors should recognize that waiting another two years may put their firm’s long-term sustainability at risk.
If you have questions about Today’s ViewPoint, or would like to learn more about understanding the value of your firm, please email or call Phil Trem, President – Financial Advisory at 440.392.6547.
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