Pros, Cons, and Challenges of an Internal Perpetuation Plan, Part 2

Video Transcription

Welcome back. I’m George Bucur, managing director and co-head of MarshBerry specialty practice. Picking up on our last recording where we talked through the overall high-level perpetuation challenges that firms experience in the marketplace, today I want to dive a little deeper in regards to what are some of the more granular pros and cons and challenges of an internal perpetuation plan.

Well, to start, if someone wants to sell internally, they have to realize that they are going to be selling at a significant discount to that of what could otherwise be received in the external open markets. The reason being is when somebody sells externally, they get the benefit of synergies with the potential buyer –whether that’s through enhanced carrier contracts, whether that’s through efficiencies in back office and administration support, or just overall guidance in regards to best practices and thought leadership of how an organization may grow. Selling internally, what you’re going to do is you’re not going to have the benefit of those synergies meaning your EBITDA (earnings before interest, taxes, depreciation and amortization) is going to be lower, and in addition the multiple that your internal marketplace would really be willing to offer and probably can offer is going to be lower to compared to that of what we see in the external marketplace. What does this translate to in dollars and cents? Well, if you sell internally, you’re probably taking at least a 50% haircut in regards to, uh, versus that of selling externally.

In addition, there’s other challenges around perpetuating internally. One, the duration of time it takes to perpetuate stock; it is a decade-long proposition, not something that can be handled in a short period of time. Why is that? It’s because the people you’re selling to need to buy in, and that buying in takes an amount of debt leverage, which frankly is predicated upon debt preference and whether your, uh, colleagues, have an aversion or are willing to take on the debt risk, but also the fact that it needs to be bought over a period of time and sold over a period of time that just elongates the overall perpetuation process. Further, as a seller you are –if you perpetuate internally– you’re selling and giving up your control of the entity while still maintaining the risk. Why is that? It’s because when you sell internally, those that are taking on the debt are going to need the cash flows from the operations to service the debt, and then as that debt is paid down it goes to you as the former shareholder. These two instances alone make it very challenging –and sometimes thought to be foolish by sellers– to take on that risk while giving up control versus selling externally, getting a lot of cash up front and, uh, giving up the risk side of things. So, you give up control, but you also give up the risk. There is not an easy path to perpetuation it takes time, planning, and frankly a commitment to make it happen.

If you have questions in regards to how MarshBerry may help your organization set up an internal perpetuation plan, we encourage you to reach out. Until next time, be well.