Key Takeaways:
– The Fair Market Value (FMV) is the home price that a willing buyer would pay a seller.
– FMV is not always the final purchase price in mergers and acquisitions (M&A) deals.
– In brokerage M&A, there is almost never an all-cash-at-close deal, with terms usually including a portion of cash at close and the remainder as contingent payments over time.
– Neutral terms, where risk is equally shared, vary depending on market conditions.
– Due to recent market challenges, terms have shifted to favor buyers.
– Terms that are favorable to the seller result in higher cash at close and/or a shorter earn-out period, but may lead to a lower purchase price.
– Terms that are favorable to the buyer result in lower cash at close and/or a longer earn-out period, but may lead to a higher purchase price.
– Deal terms can greatly affect the overall value and purchase price of a transaction.
HousingWire:
When we go through the brokerage valuation process, the product is Fair Market Value (FMV). This is essentially the home price that a willing homebuyer would pay a seller.
Interestingly, though, FMV isn’t always the final purchase price in a lot of the deals out there. In mergers and acquisitions (M&A), nearly everything is negotiable, especially the purchase price.
When we see transactions that are executed at a price that is materially different than FMV, it is usually because the deal terms are imbalanced, favoring either the buyer or the seller.
First and foremost, it is important to understand that in brokerage M&A there is virtually no such thing as an all-cash-at-close deal.
The terms of a transaction almost always include a portion of cash at close, with the remainder in the form of contingent payments over a period of time following the closing, known as an earn-out.
FMV is based on what we consider neutral terms, where the risk is equally shared between the buyer and the seller. Neutral terms are, however, dynamic depending on what’s going on in the market.
Neutral terms a couple years ago, when the M&A market was hot, saw cash at close in the
neighborhood of 40% to 60%, with the rest over a two- to three-year earn-out.
Given the recent housing market travails and ongoing economic uncertainty, neutral terms are currently more in the neighborhood of 25% to 35% cash at close, with the remainder over a three- to five-year earn-out.
Given the prevailing market risk, terms have shifted to favor buyers.
As an example, let’s say a broker had net operating income of $200,000 over the last 12 months. At a 3x multiple, FMV would be $600,000. At this FMV, neutral terms would be somewhere around $180,000 down (30%) and the rest over a four-year earn-out, contingent on the production of the agents who were with the seller as of the closing date.
In very simple terms, if agents produce at the same level over the next four years as they did over the previous 12 months, then the seller would get their full earn-out ($420,000). If they produce less, the seller gets less; if they produce more, the seller gets more (if the earn-out is uncapped), based on a standard earn-out formula.
Using this same example, let’s change the framework to see how terms may affect value, (i.e., the purchase price). Terms that are favorable to the seller provide them with higher cash at close and/or a shorter earn-out than what would be considered neutral.
Let’s say the seller desired 45% at close and only a two-year earn-out. A buyer may agree to these terms, but because the buyer is taking on more relative risk, they would only do so at a lower multiple, say 2.5x. In this case, the purchase price would be $500,000, with cash at close of $225,000 and a total potential earn-out of $275,000.
Terms favorable to the buyer would be lower cash at close and/or a longer earn-out than what would be considered neutral. Let’s say the buyer desired to pay 15% at close and the rest over a five-year earn-out. A seller may agree to these terms, but because the seller is taking on more risk, the seller would only do so at a higher multiple, say 3.5x.
In this case the purchase price would be $700,000, with cash at close of $105,000 and a total potential earn-out of $595,000.
There could, of course, be several other options that may be agreeable to the parties of a transaction, but this is an example of how deal terms can affect value.
Scott Wright is a partner with RTC Consulting in Colorado.
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Property Chomp’s Take:
So, have you ever wondered what exactly is the Fair Market Value (FMV) when it comes to brokerage valuation? Well, let’s dive into it and find out!
When we talk about the brokerage valuation process, the end result is the FMV, which is essentially the price that a willing homebuyer would pay to a seller. However, interestingly enough, FMV doesn’t always end up being the final purchase price in many deals. In mergers and acquisitions (M&A), almost everything is negotiable, including the purchase price.
When we come across transactions that are executed at a price significantly different from FMV, it’s usually because the deal terms are imbalanced, favoring either the buyer or the seller. It’s important to note that in brokerage M&A, there’s virtually no such thing as an all-cash-at-close deal. The terms of a transaction usually include a portion of cash at close, with the remaining amount structured as contingent payments over a period of time following the closing, known as an earn-out.
FMV is based on what we consider neutral terms, where the risk is equally shared between the buyer and the seller. However, these neutral terms are dynamic and can vary depending on the market conditions. For example, a couple of years ago when the M&A market was hot, neutral terms saw cash at close ranging from 40% to 60%, with the rest paid over a two- to three-year earn-out.
But given the recent housing market challenges and ongoing economic uncertainty, neutral terms have shifted. Currently, they are more in the range of 25% to 35% cash at close, with the remainder paid over a three- to five-year earn-out. This shift in terms reflects the prevailing market risk and favors buyers.
To illustrate this, let’s consider an example. Suppose a broker had a net operating income of $200,000 over the last 12 months. At a 3x multiple, the FMV would be $600,000. Under neutral terms, the buyer would pay around $180,000 (30%) at close, with the rest paid over a four-year earn-out, contingent on the production of the agents who were with the seller at the closing date.
Now, let’s see how terms can affect the value or purchase price. Terms that are favorable to the seller would provide them with higher cash at close and/or a shorter earn-out than what is considered neutral. For instance, if the seller desired 45% at close and only a two-year earn-out, the buyer may agree to these terms but at a lower multiple, let’s say 2.5x. In this case, the purchase price would be $500,000, with cash at close of $225,000 and a total potential earn-out of $275,000.
On the other hand, terms favorable to the buyer would involve lower cash at close and/or a longer earn-out than what is considered neutral. Let’s say the buyer desired to pay 15% at close and the rest over a five-year earn-out. The seller may agree to these terms, but because the seller is taking on more risk, they would only do so at a higher multiple, say 3.5x. In this scenario, the purchase price would be $700,000, with cash at close of $105,000 and a total potential earn-out of $595,000.
Of course, there could be other options that may be agreeable to the parties involved in a transaction, but this example demonstrates how deal terms can affect the overall value.
In conclusion, when it comes to brokerage valuation, the Fair Market Value may not always be the final purchase price. The negotiation of deal terms plays a crucial role in determining the value, with factors such as cash at close and the length of the earn-out period influencing the final price. As the market conditions change, so do the terms, leading to an imbalance that can favor either the buyer or the seller.
About the author: Scott Wright is a partner with RTC Consulting in Colorado.
