Mark Pestronk
Q: You have written that most agency acquisitions are at least partly based on "earnouts": i.e., a payment formula under which the purchase price depends on revenue generated during a fixed number of years after the acquisition. For example, I may sell my agency for a price equal to 20% of the agency's revenue (commissions, overrides, fees and markups) for two years after the acquisition. How can I be sure that the buyer is not going to make management decisions that will result in less revenue than I anticipate?
A: You can provide, in your agreement with the buyer, a set of restrictions on the buyer's decisions that might have the unintended effect of reducing the payouts to you. You can also provide a set of rights for you that will help maintain and even increase the business.
To protect the earnout, the most valuable step you can take is to retain the right to stick around as an employee or independent contractor for a mutually agreed period.
If the buyer is new to the industry, you need to educate the buyer over a period of months or a year. If the buyer is a larger agency, you need to make sure that it isn't making decisions that could result in a lower earnout.
Ideally your agreement should provide that the buyer cannot do any of the following during the term of the earnout without your consent:
- Discharge your old employees or independent contractors, except for cause.
- Reassign the employees away from clients who they were handling before the acquisition.
- Intentionally cease doing business with any clients.
- Move clients to another buyer office.
- Cease using the same phone numbers and email addresses that clients were used to using.
- Close your office, if you have one.
If the buyer will not agree to most or even all of these protections, you need to try to accelerate the payments to you, get a price that is fixed or just decline to sell to that buyer. It is just too risky to proceed with a deal enabling the buyer to do whatever it wants.
Here is another lesson that I have learned over the years: A large buyer such as a mega-agency may not follow through on its contractual commitments such as those discussed here because the buyer's negotiators do not communicate with or supervise the decisions of the buyer's operations staff. As a result, the staff makes decisions in the interest of efficiency without knowing about the restrictions in the agreement.
For example, even if the agreement prohibits the buyer from moving accounts from your office to another office of the buyer, the buyer's operations chief may decide to merge one of your former divisions into the buyer's headquarters. The chief may have made this decision unaware of the agreement's restrictions, and it's up to you, if you are still around, to point out that the move would be a breach of contract.