Mark Pestronk
Q: I want to sell my travel agency, and the potential buyer wants to pay me on an "earnout" basis; i.e., the payments would be set as a percentage of revenue received over a period of months or years from the business that I sold. What, typically, does "revenue" consist of? Are overrides included? What about GDS incentives? What about commissions?
A: You have hit on one of the most complicated parts of travel agency mergers and acquisitions: setting the earnout formula. There are multiple possibilities, and they are all negotiable.
Attorneys and advisors from outside the industry often fail to grasp the issues involved in setting the formula, so they draft ambiguous payment terms. The ambiguities lead to disputes that sometimes result in mediation, arbitration or court litigation.
Besides the obvious question of what percentage of revenue the seller is entitled to, there are three questions to address in negotiating an earnout. First, what kinds of revenue are included? Second, what clients are included? Third, does the formula apply to revenue received, or to sales made, during the earnout term?
In this column, we will deal with the first question, which is often the most contentious, especially when the buyer is a large travel agency.
Travel agency revenue consists of commissions from airlines, hotels and resorts, car rentals, cruises, tours and insurance sales; transaction and service fees; airline and other supplier overrides; markups on group and other travel; GDS incentives; and other miscellaneous payments, such as a share of consortium profits. However, it is fairly rare for an earnout to include all these elements.
Many buyers have difficulty including hotel and car rental commissions because they are often unable to match a sale at a seller's former location with a centrally paid commission payment. The administrative burden of tracking the seller's sales and commissions may well cost more than the value of the percentage to which the seller is entitled.
With airline overrides and GDS segment incentives, some buyers take the position that this revenue is really generated after the acquisition because of the buyer's superior airline and GDS agreements, so the seller should not be entitled to a portion or should be entitled only to a lesser percentage. Other buyers simply neglect to include this revenue, probably because the buyer's staff that tracks it is not even aware of the need to pay part of it to the seller.
Too often, former agency owners contact me because the buyer is not including all the elements of revenue or all the transactions that the seller expected to be included. These problems could have been avoided if the purchase agreement had spelled out exactly which elements of revenue are included, how they are calculated and which elements are excluded.
A purchase agreement should also require the buyer to provide, along with the earnout payment, a detailed report of each sale and each item of revenue, and the seller should have the right to audit the transactions listed in the report.