Commercial Agency Valuation – don’t ignore the positive factors

by Thom Vaughan of E.A.D. Solicitors L.L.P.
and Adrian Pym of RSM Tenon

The valuation of an agency relies on more than
the commission figures or the accounts of the
agent. In our previous article we discussed the
costs of running an agency and how taking
these into account in the smaller agencies
often led to a very low or negligible value. In
this article we look at some of the positive
factors that impact upon the value of agencies.
These factors are usually external to the
agency but nonetheless are important in
determining what a willing buyer might pay to
acquire the agency.
In Lonsdale the court stated “if the market for the
products in which the agent dealt was rising or
declining, this would have affected what a hypothetical
purchaser would have been willing to give. He would
have paid fewer years’ purchase for a declining agency
than for one in an expanding market.” So an assessment
of the market is critical in assessing value.

AN EXPANDING MARKET

In the recent case of McQuillan -v- McCormick [2010]
EWHC 1112 (QB) the Judge accepted our opinion that,
in assessing the agency’s maintainable earnings, it was
reasonable to reflect the rising market for the product
sold by applying a ‘growth’ multiple of 1.5 to the
commission income prior to deduction of the
attributable overheads and directors’ salary. The agent
sold jewellery products manufactured in Denmark. The
principal was the UK importer and distributor of the
product. The sales were rising exponentially for the
manufacturer and the agent was benefitting from the
rising market for the product. It is perhaps useful to add
a layer of detail and note that the Defendant acted as
UK distributor for Pandora Jewelry, which retails popular
charm bracelets as its core product. Around 5 years ago
the range could only be found in a small number of
designer boutiques but is now a recognised name on
the high street. It has enjoyed a stratospheric rise.
A willing buyer would recognise this positive factor and
be willing to pay more for the agency. By applying a
growth multiple to the commission income the rising
trend was recognised in full rather then by applying a
multiple to the profit of the agency. This was
appropriate because the costs of operating the agency
were not directly proportional to the commission
income.
However, the court also recognised the risk that the
principal’s contract with the product manufacturer
could be terminated within two years. If it was the agent
would be out on his ear. The Judge concluded that “For
my part I doubt if anyone would pay more than 1 years
purchase…” Therefore in assessing value the parties
must look at the stability of the agency – was it
longstanding, durable and likely to continue for a
number of years? The case also considered other
relevant factors, such as exclusivity and its impact on
value; as well as overheads and directors’ salary.

EXPANDING MARKET – BUT FALLING
COMMISSION?
In another unreported case the existence of a rising
market did not result in an enhanced value for the
agency. The factors specific to the case were that the
principal was showing increasing turnover and profit
year on year. Press releases and trade news were all
positive about the future prospects of the business. In
isolation these factors suggested an increasing value for
the agency. However, the agent’s commission was
falling year on year; the direct opposite of the principal’s
rising fortunes.
Detailed investigation highlighted a change in the way
the principal conducted business. It had historically
relied on a number of regional agents to source and
manage customers, and to sell its product, thus giving
national coverage. However, in the last two years it had
secured national deals with two new key customers
independently of its sales agents. The agents were still
required to manage the national accounts but were
only paid a small commission on these “house
accounts”. The impact over time was to dilute the
influence of the agents and their commission income
fell as a greater proportion of sales were made at the
lower commission rates.

HIDDEN POSITIVES IN CYCLICAL
INDUSTRIES
Certain industries have defined cycles of activity which
need to be understood to explain the changes in
fortune of the principal and agent. For example, large
capital intensive projects can last many years.

The water treatment industry operates a five year cycle
of asset management projects (“AMP”). This involves
significant investment in new infrastructure projects to
improve, replace and maintain water treatment
facilities. Sales of water treatment equipment will
therefore follow closely the current AMP, typically
starting low, rising to year 3 and then declining.

This allows for planning, procurement and then
installation of equipment. Advising an agent in this
industry would require detailed knowledge of the
current AMP, which phase it had reached and what level
of capital expenditure was planned for the next AMP.
Reliance on the normal three to five years accounts of
the agent and principal would not necessarily result in
the correct assessment of value in this particular
industry.

Agents in, say, the fashion or furniture industries will be
acutely aware of the often cyclical nature of business
performance and the rapidly fluctuating fortunes of
certain wares. One minute oak furniture is the rage and
the next it cannot be shifted and sits on the shop floor
gathering dust. Rimless sunglasses were cool when a
certain Swede was managing the national football team
and now they’re yesterday’s news.

SUMMARY

Understanding the agent’s business and the wider
industry in which the principal operates is therefore
critical to the valuation of any agency. It may be that
positive factors exist within the market that enhances
the value of an agency beyond that suggested by the
accounts of the agent alone.
If these factors would arise as part of a notional
purchaser’s theoretical “due diligence” then they should
be fed into the valuation process when compensation
comes to be discussed.

Adrian Pym is Director of Forensic Accounting
business valuation experts RSM Tenon.

Head Office: Charterhouse,

Legge Street, Birmingham B4 7EU

Tel: 0121 333 3100
www.rsmtenon.com

Thom Vaughan is a solicitor with E.A.D Solicitors LLP
and specialises in commercial agency matters.

Head Office: Prospect House,
Columbus Quay, Liverpool L3 4DB
Tel: 0151 735 1000
www.eadsolicitors.co.uk

Disclaimer: This column does not contain legal advice and is for general guidance only. Agentbase, E.A.D. Solicitors, RSM Tenon and the writer accept no liability in connection with the general guidance given in this column.

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