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How do you value agent compensation?
This article originally appeared in Women's Wear Buyer
How do you value compensation to be paid to your agent on termination of the agency agreement? For some time, the position has been clear – compensation is the price that a notional third-party purchaser would pay for the agency if the agency had continued and was made available for sale on the open market.
Usually, the amount in question is determined on the basis of expert evidence put forward by agent and principal.
Indeed, this was the position in the latest reported court case concerning compensation. The experts in this case had agreed the direct costs of the agency. But there was a dispute as to the indirect costs to be deducted from the profits of the agency in order to ascertain the net income stream. The agent held a number of agencies with different principals. The agencies generated an aggregate annual commission of around £1m. Accordingly, the £60,000 annual commission that was achieved under the terminated agency agreement represented only a small proportion of the agent’s total commissions received each year. The agent’s expert claimed that the majority of the agent’s overheads should be regarded as fixed costs because they would continue to be required to support the agent’s other agencies, whether or not the agent still had the agency with the former principal.
Unsurprisingly, the former principal’s expert disagreed. Instead, he proposed “absorption costing”, by which all overheads (including fixed costs) were to be apportioned to costs centres and income streams using pre-determined rates. The court preferred the evidence of the agent’s expert on fixed costs. However, what of the multiplier to be applied to the annual net income stream? The former principal argued that a multiplier of 2 times should be applied. In contrast the agent argued that a multiplier of 7 times should be applied. The judge, in a Solomonesque decision, determined that a multiplier of 4.5 times would be applied to the net income stream. While this was less than the amount the agent had sought, it is the case that it was still 250 per cent more than the principal had offered to pay and, with a certain degree of planning, the principal could possibly have avoided having to make a payment of this amount.
To avoid paying compensation, the principal must provide in the agency agreement that on termination the agent will be entitled under the regulations to an indemnity and not compensation.
If the payment of compensation or indemnity is to be avoided, then the principal must point to a material breach of the agency by the agent which justifies immediate termination.