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As the rep industry begins to age, it is important to have a succession plan for the benefit of the next generation of employees, as well as the agency’s principals and customers. A well thought out and crafted succession plan will provide for continuity of the agency and will benefit all parties in the event of death, disability or retirement of the owners.

Arrangements for buying or selling a rep agency require an evaluation of the business. Both buyers and sellers should require the use of a reasoned evaluation for determining how much the agency is worth and thus, how much the buyer should expect to pay and the seller should expect to receive from the sale or disposition of the agency.

A common starting point when evaluating a rep agency is to look at the previous one-year’s gross commission income. From there it is important to consider a number of business factors that would tend to increase or decrease the value of the agency. Factors such as long-term and stable relationships with principals and customers, selling products with a potential or likely upside in the marketplace and an agency with an increasing commission stream would tend to increase the value and thus the price. On the other hand, downward sales trends, short-term relationships with principals and customers, high employee turnover and a concentration of revenue in a small number of customers and principals are negative factors that tend to lower the price.

Fixed-Purchase Price

The question then arises as to whether an agency should be sold for a fixed purchase price typically based upon historical performance or a variable price based upon a “looking forward” approach.

A fixed-purchase price can be as straightforward as 100 percent of the previous year’s gross commission income or to smooth out some of the rough edges, the parties may use a two- or three-year average or a weighted average of the two or three prior years. A fixed-purchase price can favor the seller unless commission income is expected to grow in the near future. However, as a practical matter, most sellers are not particularly motivated to sell at a time when there is a steady growth in commission income.

A fixed-purchase price can present a significant problem for both buyer and seller when there is the loss of a key line, important customer, valuable sales employee or a significant portion of the territory which could have a substantial negative impact on the value of the agency and its ability to pay the purchase price. This occurs because a rep agency is rarely purchased for cash but is almost always a “boot strap” transaction where the purchase price is paid from the profits of the agency. Thus, the buyer’s ability to pay the purchase price and the seller’s ability to get paid is almost always dependent upon the stream of commissions available from the agency itself.

Making Adjustments

If using a fixed-purchase price, those transactions may also provide for the purchase price to be adjusted downward based upon an agreed formula upon the loss of a key line, territory, customer or salesperson. This protects the buyer and, in all fairness, there should be an upward adjustment if the commission income increases. Otherwise, the seller is being expected to accept the downward risk while receiving no upside benefit.

Whether representing the buyer or seller, we tend to favor a “looking forward” variable purchase price based upon future performance of the agency. Future performance is often more indicative of the value of the agency than a historical perspective. Also, current and future performance can be more accurately used when crafting a payment formula. For example, the purchase price could be 15 percent of gross commission income, payable monthly for a seven-year period following the sale, which equates to 105 percent of gross commission income. In our experience, most rep agencies can afford to pay 15 percent of gross commission income after a sale without adversely threatening cash flow.

Using a formula and a variable purchase price allows the parties to be somewhat flexible. For example, if due to positive business factors the commission of the agency increases, the seller will receive a higher sales price. The increased commission stream will also allow the buyer to pay the seller a higher sales price. Conversely, if commission income declines for one reason or another, the monthly payments would decrease but it would be unlikely that the buyer could pay a higher monthly payment in any event.

Variable-Purchase Price

The variable-purchase price formula is also flexible in that the parties can include an upper limit cap and a lower limit floor on the price. This will ensure that the buyer will never pay “too much” and the seller will never receive “too little.”

When using a valuation formula for succession planning purposes, the objective is to develop a formula that not only results in an appropriate value but one that also can be applied without generating controversy or incurring substantial expense. For these reasons we generally avoid using EBITDA (earnings before interest, taxes, depreciation and amortization) or providing for the value to be determined by a third-party appraiser, which is not only expensive but time-consuming.

We also counsel clients to avoid using a fixed value as of a certain date subject to periodic review and adjustment. In our experience, most rep agencies will neglect to actually review and adjust the formula and purchase price. This can result in a major dispute when a triggering event occurs, and an outdated valuation is reflected on the agency’s books and records.

Keeping these general principles in mind, it remains the case that every rep agency is unique, and therefore every rep agency requires careful attention paid to both the factors identified above and the particular goals of the buyer and seller. Nevertheless, reps considering buying or selling an agency are well advised to keep these valuation approaches in mind and also rely upon the professional advise of their attorneys and CPAs when negotiating and crafting a purchase/sale agreement.

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