Many agents looking to get out of the business have one main question: “How much is my business worth?” Of course, the answer to that question is usually, “It depends.” Yes, profitability of the business matters, but there are other factors that go into determining what a buyer will pay for your real estate agent business.
Agent business valuation factors
Profit: The better term for profit in the context of valuing an agent business is “discretionary earnings.” It’s called discretionary earnings because the seller has the discretion to do anything with that money that they want, and earnings are the profit of the business after the operating expenses are deducted from the operating revenues.
The profit number is just the starting point for managing deductions or add backs, with the final number — after all of that addition and subtraction — being the discretionary earnings of the seller upon which we will then press forward with the next steps to value the business.
Deductions from profit: The buyer should look in the revenues section of a profit and loss statement (P&L) for any single, non-recurring or non-operational revenues. Here are some examples:
- The first example that comes to mind of non-operational revenues are the Paycheck Protection Program and other federal subsidy payments relating to COVID-19. If the seller included those payments on the business P&L, they should be deducted from the profit, because those monies were not created from actual business operations.
- A non-recurring revenue could be commission funds received from a procuring cause arbitration on a closing that occurred in 2020, but the award from the panel and monies were received in 2021. This is called non-recurring because we don’t expect an agent business to make continuous revenue from association arbitrations.
Why are we doing this? Because we’re trying to find out the actual revenue number that the buyer would’ve realized strictly from business operations, because that’s the only number that can help us value a business from the revenue side.
Add backs. Add backs are expenses that get “added back” into the business because they were payments made by the business for personal expenses of the seller, or often, their family, that the buyer would not have incurred.
These expenses can include health insurance or cellphone expenses for a child, personal meals or automobile repairs. Adding an expense back into the business increases the profit (at least on paper), and therefore increases the value of the business with the purchase.
Add backs can sometimes include expenses that the buyer may realize as a savings, although the buyer may decide not to formally add them into the analysis to avoid paying the seller additional money. For example, if the seller paid $2,500 annually for document storage, and the buyer would have minimal to zero marginal cost on this item as all of their records are kept digitally, this cost could be an add back as the value of the business is now increased by the amount of the cost savings to this specific buyer.
By marginal cost I mean an expense over and above what the buyer is paying now for the same item. If there would be no additional annual cost to the buyer for digital storage for the quantity of documents that the seller generated in the last year, then the marginal cost is zero, and the entire expense is an add back.
Revenue enhancers and cost savings. When the buyer examines the marketing and subscription expenses of the seller (Facebook ads, Zillow leads, etc.), they may find that the seller is not realizing a Return on Investment (ROI) consistent with what the buyer is generating off of the same avenues.
If the buyer believes that they can use their strategies successfully (e.g. changing up titles or keywords on YouTube videos, using different interests on Facebook ads, etc.), they could keep the same type of business and improve the revenue with little to no additional expense (a revenue enhancement).
This specific buyer may place more value on this business than another buyer who was not able to execute on the foregoing strategy. The business essentially has unrealized revenue that this specific buyer may obtain for free.
Balance sheet. Most agents will never keep a balance sheet on their business. Larger teams may keep a balance sheet if they incur debt to finance the growth of the business, or start acquiring equipment to service staff and agents.
I typically recommend that teams doing more than 100 units keep a balance sheet on operations, as they start owning a decent amount of assets at that time.
The balance sheet tracks current values of assets (equipment, accounts receivable, cash, moving van used by clients) and liabilities (loans, accounts payable, leases, security deposits on property management inventory), with the difference between these two numbers being how much equity the seller has in their team.
If the buyer has no experience with a balance sheet, they should consult with their accountant to determine any questions to ask the seller based upon the size of the business be acquired and the numbers presented.
Hank Sorensen is the Pinellas County area manager for RE/MAX Realtec Group in Palm Harbor, Florida.
This content should not be considered accounting or legal advice. You should consult your local tax or legal professional in your state for appropriate strategies.
Part II of this article will review how to determine a proper multiplier, the sale structure, and outline actual numbers of a hypothetical sale.
This column does not necessarily reflect the opinion of RealTrends’ editorial department and its owners.
To contact the author of this story:
Hank Sorensen at [email protected]
To contact the editor responsible for this story:
Tracey Velt at [email protected]