Mark Pestronk
Mark Pestronk

Q: I am going to be selling my agency to a much larger competitor. The buyer wants to close down my office and employ me to work at the company's headquarters as a manager for at least two years. The buyer wants to pay most of the purchase price as an earnout, i.e., a percentage of revenue during the two years after the acquisition, which is OK with me because the buyer's commissions on sales are higher than mine. I have two key questions: First, since the buyer will be moving my clients into his office, what should the earnout be based on? Second, if the buyer fired me soon after the acquisition, would I lose my salary or would the buyer be obligated to pay me for the two years?

A: The answer to both questions is: a) it's all negotiable, and b) what you negotiate needs to be clearly written into the contract to avoid misunderstandings and potential litigation.

An acquisition that involves moving the seller's business into the client's office is what I call an "absorption." These kinds of acquisitions are probably the most common today, since many buyers do not like multiple brick-and-mortar locations.

The client sales that the earnout is based on are what I call the "client base." There are three possible ways to define the client base in an absorption.

First, the earnout can apply to just the list of clients that you turn over to the buyer at the closing. This definition will result in the lowest earnout because the client base can only decline in the years following closing; it cannot increase.

Second, the earnout can apply to the list of clients transferred to the buyer plus all clients that are brought in by you while you are an employee of the buyer. If your employment contract provides for a commission incentive for new clients, it is possible for you to be paid in two ways on the new client's sales: first, as an increase in the client base to which the earnout percentage applies and second, as a sales commission for your efforts.

However, it is more likely that the earn-out and the sales commission will be mutually exclusive, i.e., you will be compensated either as an increase in the purchase price or a sales commission, but not both.

If the buyer offers a choice between an X% increase in the purchase price or the same percentage commission split on the sales to new clients, the former will usually be more advantageous taxwise for you, as it is capital-gain income instead of ordinary income.

Third, the earnout can apply to the list of clients transferred, new clients that you bring in and new clients handled by your former employees who work at the buyer's headquarters. Defining the client base to include all three elements will be the most advantageous for you.

Regarding your question about being fired, keep in mind that if you become an employee at will like almost all travel agency employees, the buyer can indeed fire you anytime for any reason or no reason. Therefore, make sure that your employment agreement provides that you be fired only for "cause" and be sure to define "cause" in a way you can accept.

Finally, you note that the buyer's commission percentages are higher than yours and that you are depending on that fact in your exit planning. Ask for specifics in writing.

Even better, try to add those specifics to the agreement as a representation and warranty that you are depending on. Otherwise, a buyer can promise anything.

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