This is often one of the hardest conundrums for particularly vendors, and we have certainly seen some interesting approaches. I think the first point to note is that generally the vendor, in our experience, will be quite conservative about what fees they feel will transfer across to the prospective purchaser. Now, I have certainly heard about many disaster cases where the vendor has grossly overstated the fees associated with the proposed transaction which hasn’t been picked up in DD, however our experience is somewhat different.
That said, what I typically recommend to vendors is to try and achieve an educated and informed guestimate, to avoid becoming overly conservative, but also not to be overly optimistic. I appreciate this can be hard to do. To provide an example, if a firm’s fees have consistently been around say $1 Mill annually for the past couple of years, why would the vendor suddenly start to suggest that the fees for sale would be $900K or conversely $1.1 Mill. Yes, there can certainly be reasons for both of these outcomes, such as some client loss or gain, retiring clients etc, and this is when consideration of such reasons is made. However, in lieu of tangible and fairly certain knowledge, there would seem to be little reason to think fees wouldn’t be around $1 Mill for the purchaser.
An important factor to always keep in mind, is up until now, rarely was there an upswing in the contract for sale, which meant that if the vendor was overly conservative, and in the case of the example above, generated $1 Mill from the transaction after the retention period but quoted $900K, there typically isn’t any additional payment for the extra $100K above the originally agreed sums. Thus, the vendor would miss out on their additional price. To put it briefly, in the vendor undersells the fees, they receive nothing further, however if they oversell the amount of fees be sold slightly, the retention or clawback amount is there to cover it and protect the purchaser. Yes, the key word here is ‘slightly’. That said, we have certainly had success in negotiating rise clauses for our vendors where they have elected to be particularly conservative in their determination of fees for sale or where a purchaser has excluded some fees for a particular reason which actually continued on for the retention period.
Another approach that we see at times is the desire of the purchaser to utilise an average of two or three years’ fees to set the revenue benchmarking upon which the price is determined. Whilst I understand this approach from a formal valuation setting, this is not the common approach within the open marketplace. Generally, the determination of fees is based on one year. If the sale is taking place prior to Christmas, we mostly see this set against the prior financial year’s revenue. If the transaction takes place post Christmas, then fees for sale are commonly representative of the expected or estimated fees for the current financial year.
Purchasers also seem set on removing revenue from what is deemed as ‘consulting services’ on the basis that such fees are not maintainable. From our experience, every firm has 10%, 15%, perhaps 20% of its fees generated from consulting or advice. Thus, on this basis, and presuming it remains fairly consistent, this revenue remains as part of maintainable fees. Where there is an extraordinary amount of fees associated with a large, non recurring, event, then yes there would be an adjustment for the sum above the typical level of fees from this source.
Other inclusions and exclusions include sums such as GST. No, fees should be exclusive of GST. The vendor is not paid on GST inclusive revenue. Other sources of revenue that will remain with the vendor, such as interest. Certainly exclude sums from government grants, and the like, such as JobKeeper. Sources of revenue that the purchaser may not wish, or does not have the qualifications to, continue to provide such as audits or financial planning. This is a difficult one, because this revenue makes up part of the fee base that is being sold. From the vendor’s perspective, they are selling their entire firm. However, from a purchaser’s perspective, if some of these services are not offered by them, then they don’t want to pay for these fees, as this revenue will not be retained. Ultimately in this latter consideration, the inclusion or exclusion of such fees may be influenced by the overall suitability of the transaction, the number of potential suitors, and/or the size of the fees in question.
