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