Mark Pestronk
Q: In past Legal Briefs columns such as "Maximizing profits will maximize an agency's selling price," you have observed that experienced buyers of travel agencies look at cash-flow profits to determine the value of a target and that they offer a price that is a multiple of those profits. However, almost no travel agencies are profitable these days. In other Legal Briefs columns such as "Giving notice when closing your business," you have observed that every agency with a good client base has value. So how would you evaluate an agency right now if you were representing a buyer or seller? Would you use 2019's profits, an annual average or what?
A: I would not evaluate an agency using cash-flow profits. Instead, I would propose that the purchase price be set as a percentage of future revenue beginning next year.
The formulas that I have seen recently are a percentage of revenue for 2021, 2022 and 2023. The percentages that I have seen vary depending on the buyer's projection of how long it will take to recover its investment.
The number of years varies, too, depending on the seller's willingness to wait. Payments are typically made quarterly, although I am also seeing monthly payments.
By "revenue," I mean commissions, fees, markups and overrides. In accounting terms, this would be the same as gross profit, which is defined as sales minus cost of goods sold. "Gross profit" is not the same as "cash-flow profits," as the latter includes all expense deductions except personal and one-time expenses.
The formula could also be stated as a percentage of gross sales, which would make certain calculations easier and may be attractive to a buyer whose commission levels are much higher than the seller's. For a corporate agency acquisition, the simplest formula would be a small percentage of future ARC sales.
Revenue or sales could be applied to every client that uses a brick-and-mortar location that the buyer retains, everyone on the seller's client list as of closing or everyone that the seller's staff handles over the term. It could also be based on some combination of any of those elements.
These revenue or sales-based payment terms are called "earnouts." They were the prevalent acquisition terms after 9/11 and the 2008 financial crisis, and they are prevalent again.
Although I am seeing earnout payments begin in 2021, the postponement would not preclude closing the deal now, if the parties are willing to have the buyer take the business off the seller's hands in return for a first payment six months or so from now. Closing now assumes that there will be no complications arising from the seller's Paycheck Protection Program loan.
To protect the seller, buyers sometimes offer a floor on payments. For example, the sales contract could be written as 10% of revenue for the next three years but not less than $100,000. So if the earnout payments came to less than that amount, there would be a balloon payment at the end for the difference.