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This article provides the highlights of the MANA special report on valuing your rep firm. You are in the best position to understand the factors impacting the value of your rep firm through your day-to-day management and operation of your agency. Where you and your agency stand on a number of valuation drivers will have a major impact on the cash flow and eventual value of your agency should you ever decide to sell it.

Valuation Drivers

Having good relationships with multiple customers can significantly enhance the value of your agency. A simple phone call may provide you with the ability to present a complementary product that might create revenue, save cost, or save production time for a customer. If so, you and your agency stand well-positioned to use your preexisting relationships to grow the sales revenue of your supplier. Also, to the extent this relationship is built on the credibility of good engineering and technical knowledge, your value is further strengthened.

The strength of the agency’s line card is very closely related. In each case the agency may represent the leading manufacturers in a particular industry and may be constantly on the lookout for product developments, both with its current manufacturers or emerging ones, thereby enhancing the value of the agency.

Conversely, agencies with a significant degree of customer or supplier concentration are subject to greater risks. Either the customers or suppliers could undergo a management or ownership change, leaving the agency in a tough spot. Customer or supplier concentration tends to decrease the value of an agency.

Valuation Mechanics

While long-term there has been both upward and downward trends in agency valuations, an industry rule of thumb that has stood the test of time is one times or 100 percent of average annual commissions payable over five years plus book value. If an agency is averaging $400,000 in annual commissions, the agency would be valued at $400,000. If the owner in the same agency is earning $180,000 per year, and it will require $100,000 to replace him or her, the net resulting annual cash flow is $80,000. In this example, the $80,000 might be an appropriate amount of consideration to be paid annually over a five-year period to the retiring rep.

Book value represents the assets on the balance sheet of the agency, less the liabilities on the balance sheet of the agency. Assets typically include depreciated vehicles, computers, and product samples. Liabilities might include accrued payroll, taxes, or retirement plan obligations. Cash is typically removed in an agency transition and book value is a modest amount relative to monthly commission receipts.

Structure

The most typical structure is to sell the stock of the agency. Selling the stock of the agency would minimize the amount of disruption with existing agreements between the agency and principals. In an asset deal, technically, each new principal needs to be involved in signing a new and updated contract.

Regarding financial structure, the most typical scenario is to pay 20 percent of annual commissions per year. Here, both the buyer and seller are aligned in hopes of increasing commission revenue rather than having it decline. Modeling and understanding the cash flow post-transition is very important. There needs to be enough allocated to properly compensate the new owners while fairly paying the retiring rep.

It is worth taking an inventory of the status of the relationship with each of the lines and the extent to which ready replacements are available in the event of a change. It is also a good idea to take an inventory of each of the contracts to note their notice provisions, length of time for payment of post-termination commissions, and whether these contracts have change in control notice requirements. A change in control provision requires that the manufacturer be notified and probably consent to any change in parties under the contract or substantial change in ownership of the agency.

Methods for Transition

Frequently, one or some of the existing key employees of the agency buy out the retiring rep. A common structure is to identify and allocate a great deal of the proceeds to goodwill. Some favorable tax laws a few years back give the rep the right to obtain capital gains for this personal goodwill while the buyer amortizes it over 15 years. In certain situations, this can be an effective method for the transition.

Also, frequently, it is recognized that contracts with principals are terminable on fairly short notice. In such situations, the transition payments are in fact compensation to the departing owner for the maintenance and shifting of those relationships. In this manner, the new agency owners receive a tax deduction and the retiring owner has income at ordinary income tax rates.

Tax Planning

As you might expect, there are a number of tax considerations in terms of the structure. Payments to the selling owner can be properly characterized as wages with the agency able to take certain deductions, such as 401(k) contributions, from these payments. Alternatively, at some point all of the payments can be characterized as deferred compensation. If the proper requirements are met and the plan has been in place for one year, there is a method to save the FICA taxes on these payments for both the departing owner and the agency.

Risk Management Considerations

There are a number of risk management considerations to be addressed. One such obvious risk is the loss of a principal. If so, the shared commission payments are reduced correspondingly by the agreed percentage.

Insurance is always worth examining. It is common for at least term life insurance to be obtained, both on the seller and the buyer of the agency. Health insurance should be addressed as well, at least until the seller is eligible for Medicare.

Conclusion

Long-term, an agency owner looking to maximize the value or payments for the transition of his or her agency can take steps to do so. Developing a diversified portfolio of both customers and principals and building relationships with them will pay dividends in the long run. Much goes into the planning of an effective transition. Keeping an eye on managing risk and tax planning is advisable and will help maximize the value of your agency.

MANA welcomes your comments on this article. Write to us at [email protected].