In business, as in life, many of the most spectacular successes and failures owe much to timing. Who could have foreseen an end to the 1980s house price boom, and who could have predicted the phenomenal success that e-commerce is now becoming?
The travel industry is witnessing an unprecedented level of merger and acquisition activity, as big tour operators seek to secure the distribution of their products and protect profit margins.
“When is the right time to sell?” is one of the most common questions that we are asked by independent travel agents.
The answer is that there will usually be conflicting influences present. The time may be right in terms of price but not in terms of personal objectives. Judging this balance can be difficult, and it’s unlikely that both will coincide.
When there is a conflict, arising maybe from a fortuitous call from one of the travel industry’s major tour operators, one approach is to sell under an “earn-out” arrangement.
These generally involve an upfront payment for the business with further payments made following the achievement of agreed performance targets, usually profits.
This is often a good approach for buyers and sellers in cases where volumes and profits are growing quickly and the owner’s perception of value – based on historic profits alone – often looks unrealistic to the purchaser. If vendors are confident in their projections of future performance, the “value gap” created can be bridged if they accept an earn-out.
The purchaser reduces business risk by paying a high price only if the business delivers on its forecasts; the vendor gains an immediate payment whilst also participating in future business growth.
An excellent example of this type of arrangement is the sale of the Travel House to Thomson Travel Group, where Peter Hemington from my corporate finance team advised the Travel House.
The upfront consideration was £22.5m but additional consideration will be payable, which could bring the final price up to £40m, if the business hits tough earnings targets.
Such arrangements can have pitfalls. It can be difficult to agree the definition of profits to base the arrangement on. This is the case in a vertically integrated business such as tour operating, where it can be difficult to pinpoint whether the parent company or the subsidiary created the profit growth.
But if you get your timing right, earn-outs are one of a number of techniques that can be used to generate real value for both buyer and seller in travel industry deals.