Don't Gamble on the Sale of Your Business Unless You Have To

Mike Ginsberg

Like some of you, I enjoy gambling every once in a while.  A quick stop in the casino during one of the many trade shows in Vegas every year breaks up the sessions and late night meetings for me.  A Friday night game of poker among friends is a great outlet for me.  The bracket wagers during the NCAA basketball tourney attract my attention.  However, when it comes time to sell a business, betting the entire transaction price on generating future revenues after a sale is a risk most owners are not willing to take…unless they have to.

Since the start of the Great Recession, a number of collection agency transactions involved deal structures that included no cash payment at time of closing.  Instead of being paid some defined amount at closing in cash or a seller’s note, some owners have been paid the entire purchase price based on a percentage of revenues generated over some defined period of time.

The agreed to payment percentage would drop each year and after the defined period, payment would stop unless the seller  generates new business, and the sliding scale starts over again for new revenues generated.  Or, they might be compensated as a salesperson for the client relationships they convey to the buyer, and continue to be compensated in this manner for as long as they bring in new business opportunities. These are simple structures designed to assure client retention for a reasonable transactional period while the buyer proves itself with the clients.  In my opinion, use of this type of deal structure should not be applied equally to all collection agency sellers.

If a collection agency is not generating profits, use of these structures make a lot of sense.  As Michael Lamm pointed out in his blog post last week (“Adjusted EBITDA: Using Add-Backs to Maximize Your Company’s Enterprise Value”),  a common method buyers use to determine value is applying a multiple to adjusted EBITDA.  But what if the seller is losing money?

It would be impossible to assign a multiple to a company without an adjusted EBITDA.  Even if an agency is consistently losing money year after year, the revenue generated from its clients may still have value to other agencies seeking access to those relationships, but the buyer may be reluctant to pay any amount up front to acquire those relationships.  In this scenario, a payout over a period of time based upon revenue generation makes a lot of sense.  Of course, a lot of transaction details would also need to be addressed but at the very least a payment methodology has been established for a company that is losing money.

But what if the agency is profitable?  That’s when size typically becomes a factor.  Many buyers of smaller, profitable collection agencies will try to tie payment to the future performance of the agency.  Their rationale is that a smaller agency is typically heavily reliant on the owner and the buyer needs to be assured the clients will be retained post-sale. In addition, most of the “profits” of a small agency are tied to owner salary, perks and benefits.

When the owner of a small business is critical to retaining clients, or the income generated is tied directly to the owner’s compensation, it is valid to structure the deal using a method such as the ones described above for at least some portion of the purchase price.  However, the argument quickly goes away as the business gets larger and if the seller can demonstrate that the client relationships exist with others in the business and not the owner, or if the business is generating profits above owner compensation.

In scenarios where the agency is profitable beyond reasonable owner compensation, and has infrastructure to support client relationships beyond the owner operator, most buyers will apply a multiple of adjusted EBITDA to determine purchase price, and most buyers will pay a defined amount to the seller at time of closing in cash and/or seller notes.  Over and above this defined amount, a buyer may add structure to their payout based up revenue retention and/or revenue growth.

If you are thinking about buying or selling, or you’re trying to determine how deal structure might apply to your particular deal, give me a call or send me an email.  I am happy to confidentially discuss.

Mike Ginsberg is President and CEO of ARM advisory firm Kaulkin Ginsberg. The firm is celebrating its 20-year anniversary in the ARM market.