Episode 127

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Agencies are in an all-out talent war these days. New business is coming faster and easier. Your clients had a good year and so did you. But if you’re like many agency owners, you’re actually considering shutting down the biz dev spigot because you can’t find and keep the staff to service the new growth. When you see it in writing, it’s ridiculous, right? But if you’re struggling with staffing, you’re not alone. Agencies like yours are the training ground for other agencies, clients building an in-house department and corporations who are going to pay a premium for your best talent.

We have to find ways to attract and keep key hires or we’re going to be on a treadmill forever. We can talk culture, we can talk creative benefits like sabbaticals, and we can even talk about assessments that identify people who are born to work in an agency. As compelling as all of that is, it’s tough to compete with money.

That’s what intrigued me about Kevin Monaghan and his strategies to help protect, incentivize, and compensate minority owners and key employees. Kevin and his team at Intuitive Compensation Group work with businesses to create compensation packages that keep your people in place, feeling rewarded and valued.

Today, Kevin speaks all over the country and helps business owners, partnerships, business brokers (buyers & sellers), and key employees align their goals with workable compensation models that incentivize over time without running into some of the roadblocks of giving away equity or being stuck with a minority stake in a company where you can’t control dividend distribution.

Interestingly, while taking a break from the business sector early in his career, Kevin briefly worked as a writer’s assistant for two of NBC’s top comedies, “The Office” and “Parks & Recreation.”

 

 

What you’ll learn about in this episode:

  • Why giving equity to employees can be a dangerous situation
  • Cash value life insurance is a way to fund a golden handcuff plan that ensures you get money back if the employee leaves (the employee can’t touch this money for a certain amount of time passes)
  • Putting money behind compensation promises so that both the business owner and the employee knows what they’re walking away from if they decide to part ways
  • Different ways to structure cash value life insurance policies so that the burden of tax falls to the agency, the employee, or a combination of the two (and examples of times where each of these would be appropriate)
  • How to use these cash value life insurance policies to set up your agency to be sold when you’re ready to retire
  • Figuring out what matters to the seller and the buyer when heading into an agency sale
  • What happens when an agency owner sticks around after selling the agency
  • The right and wrong ways to compensate young employees that you want to keep but you know aren’t even close to being ready for any agency ownership
  • What benefits young employees really want
  • Why it doesn’t hurt to start planning for your retirement / selling of your agency early

The Golden Nugget:

“It's easy to walk away from an agency job if you’re young and haven’t learned the grass isn’t greener lesson. Put a quarter of a million dollars in between that decision, and they’re going to think twice before taking off.” - Kevin Monaghan Click To Tweet

 

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Announcer:

If you’re going to take the risk of running an agency, shouldn’t you get the benefits too? Welcome to Agency Management Institute’s Build a Better Agency Podcast presented by HubSpot. We’ll show you how to build an agency that can scale and grow with better clients, invested employees and best of all, more money to the bottom line. Bringing his 25 plus years of experience as both an agency owner and agency consultant, please welcome your host, Drew McLellan.

Drew McLellan:

Hey, everybody. Drew McLellan here with another episode of Build a Better Agency. Many of you are at an age where you are starting to think about succession or if you’re not thinking about succession, one of the things you’re thinking about is, “I’ve got a killer, fill in the blank, senior-level employee that I want to keep for a long time. How do I do that?”

And for many of you, the natural default decision is, “I’m going to make them a minority partner or I’m going to give them equity in the business.” So today, we’re going to talk about all of that, if it’s a good idea, how to do it well, and then dive deeper into sort of some best practices around that, and also some alternatives to that. So let me tell you a little bit about our guest.

Kevin Monaghan, interesting background. He started working on television shows like The Office and Parks and Rec, which my daughter is very excited that I’m actually talking for my first time in my podcast of someone she actually cares about. But anyway, so he did that and then he went into the financial realm and financial consulting.

And today, he owns a company called Intuitive Compensation Group. And what I find fascinating about this is Kevin’s sort of focus is using his skills in working with business owners to help them retain key employees, develop buyout strategies and even navigate family businesses in all of the buyout situations that happened and that lots of agencies are in that role.

He loves to teach entrepreneurs how to help, protect, create incentives and compensate other owners inside the company and key executives. His whole thing is why pay out more salary or give away ownership when there might be a smarter way? So this is going to be a fascinating conversation. Kevin, welcome to our podcast.

Kevin Monaghan:

Thank you, Drew. Thanks for having me.

Drew McLellan:

You bet. As I was saying in the intro, one of the things that happens with a lot of my agency owners is when they have a key, especially in this hiring environment where a lot of agencies, their best employees are being stolen by clients or corporations or bigger agencies. So they’re really concerned about hanging onto their talent.

For many of them, the sort of knee-jerk reaction is, “I know what I’m going to do. I’m going to offer them equity to get them to stay.” Good idea or not so much?

Kevin Monaghan:

A tough idea. There’s a lot of reasons why. When you give somebody equity, you are staking a claim and it’s easy. It’s an easy solution for the business owner because if you give them 10% or I’m going to give you 2% a year for five years, you give it to them. It doesn’t cost you anything today. So it’s just easy to transact, “Hey, here’s this.” There might be some gifting or tax consequences, but it’s not too much out of your pocket because you’re giving it to them.

And typically, you haven’t done a valuation too much on it as well, or you’re just in that partnership. You’re starting it up and you give away equity to somebody to come onboard. But the problem with it is you don’t know how much you just gave them 5, 10 years down the road. You can build a $40 million company. You can build a $2 billion company or you can just build a company that chugs along.

The problems with it is what if something happens outside of your control, would that person then leaves? Their spouse gets transferred to Idaho so they have to go and they choose to go with you and now, he owns 10% of it. Now what do you do? You can’t give somebody else new 10%, and this person is not going to have the same … They’re not going to be putting anything else into it and usually, people are smart enough to get equity that’s not dilutative, which means that you can’t get it back or you can’t just dilute them to zero.

Everybody saw that Facebook movie on how they diluted the share so they know [crosstalk 00:04:10] to look for those types of things. So giving away equity creates a lot of problems and especially when you have a situation where if your employee leaves that has that equity, and I’ve seen people leave with minor stakes of equity and their name was on the company, and they go to another firm, how do you get it back? They want liquidity. “Hey, I want my money for this,” and you don’t want to buy them out because it was their decision to leave.

So now you’re stuck and the problem with being stuck is what if in the future, the tax law is changed where instead of paying yourself a higher salary, it makes more sense to do equity distributions. Now that person is getting paid year over year over year for no work and that’s really the worst scenario. So those are the tough parts about equity that we see out there.

Drew McLellan:

Well, the other thing that I see is that when you give someone stock, when someone has to buy in even if they’re buying in at 2% or 5% or whatever it is, when they’re buying in, they have skin in the game. Who’s not going to take free shares? So it’s not a very accurate way to see how invested this person is in the company.

Kevin Monaghan:

Right. So buying in is another way. I run into that a little bit less often because it’s not, now you’re buying in, you’re putting money. And usually that comes with a raise. So, “Hey, you’re making $100,000. I’ll give you $120,000 but this $20,000 is going to go into buying the shares.” So they buy in. The problem is it’s really hard to sell those shares, or it’s really hard to get the value back out of it.

So business owner has used this as a way sometimes to raise money even, but the problem is selling it on the outside. Imagine if you’re going to [crosstalk 00:05:57] and you’re going to bring a new employee in. Is this new employee going to commit to buying a company when they come in to buy it? So I know people out there who are in their late 50s who are now sitting there with 10% of four different companies getting nothing for it and it’s doing nothing for them overall that they just hope that it sells one day and that they benefit from that.

Drew McLellan:

Well, for most agencies, it would be unacceptable to them to have someone owned shares of their business if they weren’t active in the business. So what happens is they give the equity. And then as you say, some event happens and it could be that they just get hired away. It could be that they have a spouse move, whatever it is. But then the owner is in the position where they have to buy back the equity that they give away to begin with.

Kevin Monaghan:

And that’s a fun fight. You want to value the business as low as possible. They want it valued as high as possible. And what if they leave during a time when you weren’t liquid? You just bought another media agency or you just something or invested in something and you’re not liquid. I got to take out a loan? That changes your cash flow.

So yeah, those are the issues.

Drew McLellan:

For the agency owners that are listening that have that junior employee and they’re not ready for whatever reason, we’ll get into selling shares and that, but not ready … The employee isn’t ready to buy in. The owner may not be ready to sell and do the valuation and do it properly to sell the shares. How else, what other golden handcuffs can an agency owner use to keep their young talent that is not involving owning their company?

Kevin Monaghan:

Sure. So let me do this. Let me go to a high profile example and then go back into the media relation. So if we look at the University of Michigan, they hired a coach, Jim Harbaugh in 2013. And what they did was, at that time, they made him the highest paid coach coming into college and they gave him a contract that paid him in two ways. One of them was a compensation strategy that we used that’s called split dollar.

So University of Michigan, it was public. Based on his age, people try to extrapolate numbers but the concept for his compensation package worth something like this. The University of Michigan would pay him $5 million salary and $4 million would go into another vehicle. Now, we listed equity as one of the ways to compensate people. There’s profit sharing. There’s benefits. There’s revenue sharing, other types of things.

What we looked at is using different tools and one of the tools that we used and this is outer left field, stay with me, cash value life insurance. So, the university-

Drew McLellan:

… do that, yeah.

Kevin Monaghan:

So the University of Michigan, you put $4 million into a cash value insurance policy. Fast forward two years later, they paid him $5 million and $5 million in salary, $4 million and $4 million into a cash value insurance policy. Now, the reason that they have the confidence to pay him that type of money was because the $4 million into the insurance policy was loaned or used as collateral.

If Jim Harbaugh left, and he went back to NFL to coach, all of a sudden, the University of Michigan after two years, can pull back $8 million. How many business owners out there especially in marketing agencies would pay their employees more if they knew that if they left, they could recoup some of their salary that they paid them?

Drew McLellan:

So in that scenario, was there a time frame like you’re vested in X number of years and then you get to keep the money?

Kevin Monaghan:

Correct. So of the compensation strategies that we used, you can put a time frame on it. You don’t have to. You can put a time frame in writing. You can make a handshake agreement. You can just put it in the employee’s name and trust him. You can put a legal document in place that says you need to work this long. And there’s a lot of rules around the different ways to structure it.

So we come in to try to help people do that. But let me give you an example as an lieu of equity compensation strategy where I continue with the Jim Harbaugh here for a second and say, “Here he goes with, he’s got this loan now for $4 million for two years.” Let’s say that Jim Harbaugh wins one of the top ball games. They can have an agreement where if you win the top ball game, boom, I forgive the loan. So you got to performance incentive to do that.

Now, in that scenario, if you forgive a loan in a compensation package, Jim Harbaugh now owes the taxes on that so you got two carrots on a stick. One is I can forgive the loan, two is you do really well, I can bonus you the taxes.

Drew McLellan:

Got it.

Kevin Monaghan:

That’s a high level example with millions of dollars and those exist. But they also all the way down the chain to three people coming together to develop a digital marketing agency, who are just starting where they each own a third and they’re two months into it, they’re already worried. “I’m producing more or I’ve sold more a third, a third, a third stake. I’m doing 60% of the work.” They’re already getting into these “oh, my goodness” scenarios, how’s this going to play out?

So the compensation strategy can help all the way down to a new company startup that-

Drew McLellan:

As partners?

Kevin Monaghan:

Two people start a 50-50 company, five years later, it’s usually 80-20 of who’s doing the work. Very rarely does it stay still. Compensation strategies are designed between partners, between employees, to keep them there. But the practical or the tactics where it works for agencies is that you start a digital agency and you are getting clients who are paying you thousands of dollars a month and you’ve got one guy who’s bringing in, let’s say, he’s adding two net clients a month. So he’s bringing in $4,000 new a month.

But now he wants partnership. He wants agency. What we normally hear is an owner will promise them, “If we keep going in this direction, I’ll do this for you. If we keep doing this.” So what’s nice about our compensation strategies is it starts putting money behind the promises. And the business owner, we can structure it so that it’s all on the business owner’s books or it’s all in the employees, or you can work together with a strategy.

But what it starts doing is it starts placing dollars in a vehicle where there’s known numbers behind it and there’s known incentives too to put things away. And the reason that you use cash value insurance is because while it’s boring, you don’t want your compensation to be … You want the business to be the risk and the go-to getting. You want the compensation to be there when you need it. So that’s why we used … It might be boring.

Drew McLellan:

And when you put it in an insurance vehicle, what are the tax implications for that? So do you pay tax on the growth or you pay tax on the initial deposit?

Kevin Monaghan:

So let me take a step back here and say there’s a couple of ways to structure this. Business owners care about two things. The first one is going to be they care about control. The second one is going to be taxes. So in a world where we’re focused on control, the business owner will typically buy a life insurance policy with cash value for their employees.

When they do that, it sits on the books of the company. You don’t get to deduct it. So there’s no deductibility to it. The nice part about it is you have control. So if that employee leaves, it’s all yours. It comes back to you. Maybe it didn’t grow, but it sat in a vehicle that was there for you. If you see that a-

Drew McLellan:

So I’m using after tax dollars to buy this vehicle. So I’m the business owner. I’m paying tax on this money that I’m then putting into an account that I, in essence, share with this employee. There are some rules around when he or she could access the money. Yeah?

Kevin Monaghan:

In an overall? Yes.

Drew McLellan:

Okay.

Kevin Monaghan:

There are some instances no, but that was a good generalization to say yes to. On the control side, really where you see this happening is super, super big premiums like the Jim Harbaugh example or you’ll see it in family on businesses where you’ve got a son coming into a digital agency. You don’t know if he’s going to stay. You don’t know if he’s going to be able to lead that organization, but you want to start positioning it. Plus maybe you have three other children outside the business so you want this policy to equalize it for the other children so they don’t think you’re leaving a million-dollar business to one child, and not to the other. That’s where-

Drew McLellan:

Your favorite kid, right?

Kevin Monaghan:

Right. On the other side, the taxes, this is where you’re actually putting it in that employee’s name. It’s nice because this is the executive bonus. You’re buying it. You’re putting it in, but he has access to the … He owns it. He has access to the cash value any time he wants and you get deducted in taxes but he can just use it to walk away.

So essentially, you’re paying him more.

Drew McLellan:

I must give him a bonus in another format?

Kevin Monaghan:

Correct. Now going back to what you said before, you can put a restricted bonus on it saying, “You have to work for me for 10 years,” and then that cashes work. So if you leave before that, the owner recoups everything.

The downside to that is when you make a future promise like that is that there’s heightened regulation around it, there’s risk requirements that you have to file so there’s a bit more tax and due diligence that you have to do on that end.

Drew McLellan:

If I have an employee that I want to put golden handcuffs on and I create this life insurance policy where I’m putting it in their name but I say, “You have to be with me for five years and then it’s all yours.” Who pay? Who and when is it a taxable event?

Kevin Monaghan:

Sure. In an executive bonus scenario where you’re deducting it and you’re putting it in his name, he owns the taxes on it. So if you are earning $100,000 a year as an employee and you put $50,000 into his name, he has to pay taxes on $150. So what they did was-

Drew McLellan:

Even though it’s going into an insurance product?

Kevin Monaghan:

Yeah. He’s going to pay them. So they came up with double bonus. Double bonus solves that problem. You’re paying the $50,000 plus there’s a formula. Call it circa $20,000 that you have to give him to pay the taxes on it depending on his tax bracket. And so you pay the taxes for him so he knows he’s got an after-tax benefit that comes net to him without any-

Drew McLellan:

Got it. Okay.

Kevin Monaghan:

Then there’s one more form that really kind of puts the golden handcuffs on employees and that’s between the two. You get a little bit of control and you get a little bit of the tax breaks. So where that comes in, let’s say … Maybe let me use an example. Let’s say you’ve got a media company where you’ve got somebody who is … You’re a 50-year-old business owner. You’ve got a 35-year-old in the business who is doing work so that you can spend more time on the lakes or more fun projects doing speeches or traveling or golfing, whatever you do.

You’ve got a guy that you know or you’re worried is going to leave to start his own firm because now he’s saying, “I’m doing all the work, why don’t I get all the reward?” And your media digital, some of these are very easy and low cost to start your own.

Drew McLellan:

Very low barrier of entry, absolutely.

Kevin Monaghan:

Right. Computer and Starbucks is all you need to get going. So what we do is we come in and we say, “Okay, let’s say that this employee is making $150,000 and you really want to keep them. I’m going to use round numbers and every projection needs its own illustration so I’m just speaking hypothetically here.

Let’s say that you said, “I’m going to give this guy another $100,000 a year into an insurance policy.” That’s going to give him huge life insurance benefits, the cash value is going to build inside of that and it’s going to be a real benefit to him as it builds cash value over time. Now, he still has to pay the taxes on it, so whether the leverage bonus or the 162 leverage bonus comes in is you then take $50,000 that he’s going to owe in taxes and you will loan it to him.

So when you loan it to him, you use the cash value as collateral so that if he walks away, you’re recouping your $50,000. So he owes you that money. Fast forward 10 years later, you’ve now put a million dollars into this policy. Let’s say the cash value is about a million dollars. It takes 10 plus years for that cash value really to have growth with.

Again, it’s boring but it’s stable if you use these with guarantees around it. So you know it’s going to be there and you have a vehicle now where about … Humor me … about $500,000 is in collateral and a million dollars is there. So 10 years later, you’ve got a 45 and a 65-year-old with a million dollars between them. Here’s where it gets flexible or so forth.

Now, you’ve got somebody who might want to retire. And you’ve got $500,000, you can take that $500,000, use it and go retire. Or here’s where the leverage buyout comes into play. What can a 45-year-old who’s running your company buy with a million dollars in his name? He could buy the agency.

So buyers who … You’re bringing another buyer to the table who’s already running it, or if you sell your agency and the company has that collateral on that employee, now, the person buying knows that they have a vehicle in place to-

Drew McLellan:

To keep that employee.

Kevin Monaghan:

Yeah. So you’re positioning them. And you’ve got a lot of options to work with this employee. If he does fabulous along the way, you can forgive the loan, pay the taxes, you can do things like that. You could also say, “I’ll forgive the loan if you buy the company,” you have to get lawyers involved in that transaction to find out and CPAs to find out how best to do that.

But you’ve set him up to do that and he knows that if you go back on your word, he knows exactly how much he’s walking away with and if he goes back on his word, you know how much you’re recouping.

Drew McLellan:

Yeah, makes sense.

Kevin Monaghan:

So it gives business owners confidence to move forward with something that’s not a promise, that’s got a known if they walk away and the golden handcuffs come in because inside of an insurance policy, unless you’re using very specific insurance that are designed to have a lot of the cash value there in the first year.

Typically speaking, you know you’ve got them for a few years because if they walk away, the collateral is going to be more than the cash value in the policy. So you can hold it to them where they have to come out of pocket-

Drew McLellan:

To pay that.

Kevin Monaghan:

… to walk away. You’ve got to make it worthwhile for him to agree to something like that but that’s where we come in to help facilitate between the two what’s a good working number.

Drew McLellan:

So let’s say after all of that, I decide, “You know what? I do have someone that I think I want to make a minority partner in my business,” despite everything we just said. So I’m going to sell them or give them or whatever shares of stock and I’m going to bring them in. So I know you guys have some strategies around the best practices for bringing a younger partner into the business and really infusing them in as an owner.

So what are some of the things that you recommend business owners think about when they’re the majority owner and they’re about to bring in a minority partner?

Kevin Monaghan:

Sure. the first thing I say is if you’re bringing them in over time, the best thing to do is to put something like we just talked about in place for two reasons. One, you’re working together and building up cash value so that now he can buy into it with money that he’s earned. You have a sense of how he’s going to perform.

If you’re bringing somebody in and you don’t know who they are or how they’re going to perform and to give them equity is a little dangerous. So you can put the strategy in place for the first couple of years to see how things play out. What you tell them is we’re using this to fund you, to put you in a position to buy into the company and this is a vehicle we might have the option to use.

So it gives you guys a trial run together and if you just gave them equity up front and the guy left, now, how do you get it back if you just had the structure in place? He knows what he’s walking away from and you get some back, so it’s more of a win-win. So we help them develop and say, “Hey, here’s how these things play out.”

We also suggest for minority partners, let’s say you have one of these packages in place. While compensation and strategies working together to give rewards and retention a go, the backend of this is that you’ve just funded the buy-sell agreement. If something happens and this guy goes out and he’s texting and driving and runs off the roa