The purpose of this article is to identify guidelines for enhancing the value of your agency, as well as important items to consider in succession planning for your agency. The guidelines are based on the author’s experiences of being involved in more than 100 agency transitions. First, the stage will be set with a look at valuations, along with important structural elements and historical perspective. Then, we will examine some strategic planning points that might increase the consideration payable to you, if and when you decide to pass along your agency.

Valuation

Valuation in the rep agency world is elusive. The assets go home at night and, therefore, are not bankable. That is, most reps know the difficult experience of going to a bank in an attempt to get a loan. Since there are virtually no hard saleable assets such as inventory, real estate or equipment, obtaining a bank loan is difficult at best. Worse yet, many rep contracts are terminable on short notice, so future income streams are always in doubt. Therefore, most agency ownership transitions are financed by the agency itself, and payable out of future commissions to be received by the agency.

That having been said, the consideration payable historically in the 1990s was generally 100 percent to 150 percent of the annual commission revenues of the agency, plus book value, which will be defined below. Unfortunately, the early 2000s introduced tough foreign competition along with the bursting of the dot-com bubble. Consideration payable on average generally declined to the lower end of the range of 80 percent to 100 percent of agency annual commission revenues. Since the Great Recession of 2009, most transitions have gravitated back toward the higher end of that range, frequently as much as 100 percent of annual commission revenue.

Ultimately, consideration payable to the departing owner can only be equal to the total of payments to other reps to cover the owner’s prior responsibilities, and also pay the departing owner. For example, suppose the departing owner was making $125,000 per year. A typical consideration scenario might equal $60,000 to pay a replacement rep, and $65,000 per year for five years to the departing owner, for assistance during the transition period.

Structure

Consequently, the actual stock in the agency changes hands at book value. Book value is the assets of the agency less its liabilities, as reflected on its balance sheet. Most agencies have relatively modest book value, usually something on the order of $10,000-$20,000 more or less.

Consideration Payable

Since the agency’s assets are not bankable, an agency transition lends itself to paying compensation to the departing owner, out of future commissions. The compensation is for management work effort associated in transitioning both the principals/suppliers of the agency, as well as the customers of its suppliers.

Frequently, this compensation takes the form of shared commissions, and is paid at the rate of 20 percent of agency revenues, for five years. Total payments equate to 100 percent of annual agency commission revenue. With such an approach, concerns regarding variability are alleviated, since both the new agency owner and the departing agency owner share in the ups and downs of future agency performance.

Recent agency sales have repeatedly shown that an agent’s true value lies with his or her pre-existing relationships with customers. Of course, reps generally have no contracts with these customers. The reps’ contracts are with the manufacturers the agency represents. While there are no agency contracts securing these customer relationships, the rep’s ability to bring on more and new product opportunities to his or her underlying customers is what makes the efforts of that owner valuable.

Maximizing Value; Long-Range Planning

Here are some thoughts on maximizing the value of your agency, and in turn, maximizing the consideration payable when it is time to sell your agency:

1. Line Diversification

Of course it is easier said than done, but if the agency has at least six to eight complementary but not conflicting suppliers with none of them accounting for more than 20 percent of annual commissions, agency value will tend toward the higher end of the percentages discussed above. Similarly, to the extent your customers are in fairly diverse industries such as food, electronics, capital equipment, plastics, health care, etc., the higher the consideration payable, because of the enhanced stability of the agency revenues.

2. Planning Two Lines Ahead

Thinking not one, but two steps ahead is a best practice plan for both principal and customer relationships. Practically, this requires a two-step action plan should the agency lose any of its largest lines (or biggest customers). The next logical replacement should be in mind with additional prospects to fill the void if the first replacement should not work out. Building relationships with potential future principals and customers in advance by simply connecting a few times a year is another best practice to enhance agency values.

3. Non-compete Agreements

Non-compete agreements restrict your employee-reps and other agency owners from competing with your agency by preventing them from representing your principals should they leave the agency. To the extent such non-compete agreements are in place, a potential agency buyer will feel more secure in acquiring the agency. Principal and customer relationships are the life blood of the agency. They need to be protected with the proper agreements to address the risk of disruption at the agency.

4. Assignment provisions

Many sophisticated manufacturers attempt to prevent the assignment of their contracts with agents. However, most of them think of agency transition before the agency itself. Therefore, to the extent these clauses permit transition to internal owners with the proper notice and consent, the transition is likely to take place more smoothly.

5. Profiling and Identifying Buyers

From experience, more than 50 percent of agency buyers tend to be pre-existing agency employees. Usually, the employee has worked three to five years or longer at the agency, learned the ropes, and gotten comfortable with how the transition would work. The owner candidate also saw the great benefits of being a rep: meeting customers’ needs through independence and flexibility, and appropriate compensation for the efforts of the rep.

The remaining portion of agency buyers consist of friendly competitors or buyers experienced in sales, but new to the world of manufacturers’ rep agencies. Potential buyers should be considered years in advance of any transition. More often than not, the first prospective buyer is not the ultimate buyer of the stock in the agency.

Strategic Planning Considerations

Important structural and strategic planning items are set out below:

1. Tax Structure/Tax Efficiency

Taxes play an important role in transitioning the agency to a new owner. Some of the most challenging agency transitions require the new owners to generate earnings, pay tax on the earnings, pay the departing owner, who then in turn pays tax, which creates a double tax system. A more tax-efficient structure is to simply compensate the departing owners for the transition of the relationships, since most contracts are terminable in a relatively short time frame, with no guarantee of renewal.

2. Seller’s Efforts

The development of guidelines for how much and to what degree the seller will be actively involved in the agency through the transition requires some planning. Typically, the departing owner will be actively involved for several months after the effective date and on a reduced basis for an extended period of time.

The proper script and arrangements need to be made for both principals and customers so that a consistent anticipating message is heard. The departing owner typically has quite a bit of flexibility in their situation. Their continued presence is valuable in providing a lifeline for the buyer in managing important customer and principal relationships, in case of a crisis or need, as the exiting owner can be accessed. This might involve calls and meetings to describe the transition plan, and its benefits, to both customer and principal, and access to the former owner’s thoughts and experiences at critical points in the future.

3. FICA Tax Planning

Succession plans frequently involve deferred compensation to reward the seller’s efforts. With the proper planning and in certain situations, the FICA taxability associated with deferred compensation can be accelerated. Provided the owner is over the FICA maximum wage base (currently $117,000), the acceleration results in no current or future FICA taxes payable. Specifically, the FICA tax of 12.4 percent on future payments can be avoided. When the prior owner is compensated through deferred compensation, there is an opportunity to save quite a bit of funds in the way of FICA taxes with the proper advanced planning.

Generally, the accelerated plan must be in place one year in advance of the transition. It comes at the cost of paying the Medicare tax of 2.9 percent on the deferred compensation currently.

Conclusion

With the proper structure and advance planning, the consideration payable for your agency and your related work effort can be maximized. It is important to get involved early and often with an action plan to increase the chances of a favorable outcome and smooth transition. Owners should not be frustrated if the transition requires going through several candidates, or takes a number of years to develop. The same persistence in sale efforts used by successful agency owners can be applied to increase the consideration payable on the transition of the agency.