By Lloyd Manning
If you are buying into the real estate brokerage that employs you and in effect forming a partnership of some sort, many questions must be answered. Consider the ramifications of acquiring a partial interest only, which could be either a majority or minority ownership position.
A majority interest is the holding of 50 per cent plus one of all issued shares of an incorporated company. A minority is less than this. At law, there is no such thing as an equal interest. If exactly 50 per cent of the issued shares are owned by any party, this is a minority position.
In smaller companies such as most real estate brokerages, control is usually obtained by owning more shares that anyone else or all other shareholders combined. A minority interest holder may have a small voice, a growth investment and perhaps a job with slightly more security than otherwise; but legally, little else. The person who holds the majority interest, special covenants excepted, controls the brokerage. With certain exceptions, that individual can make all of the decisions and run the firm as he sees fit. Although there are some legal protections in the day-to-day operation, minority shareholders are at the mercy of the majority shareholder.
Although you may have been involved in the brokerage for some time, it is always wise to have the financial statements reviewed by an accountant who is not connected with the brokerage. A common problem is that insiders allow sentimental attachment to hinder their good business judgement. An impartial look-see will be well worth the expense. This same professional may be in a position to give you a rundown on the value of the brokerage, from which the value of a partial interest can be calculated. If there is a professional practice appraiser in your neighbourhood, this is the way to go. However, the supply of professional practice appraisers is limited.
An important factor is the market into which the brokerage trades, its growth potential and the competition. Another consideration is the sales force, their ages, experience, abilities and longer-term probability of their remaining with the firm.
When selling partial interest, it must be to an employee of the brokerage or, if to an outsider, only after obtaining the consent of all shareholders. These sales are usually the sale made at “fair value”. However, often there is a misunderstanding as to what the term “fair value” means in practice. A buyer would equate this as “fair market value”, which suggests the value of a minority position should be discounted. A seller would argue that a majority interest is entitled to a premium. Although several factors could combine to make the value of a minority interest less than its proportionate share of the total value of the brokerage, a majority interest is seldom entitled to a bonus.
In this situation a “notional market” must be inferred. This implies an open market condition when in fact no such market, as usually defined, actually exists. Valuation is always made on a going concern basis, which assumes continuance of the business, not a liquidation.
Subsequent to applying other discounts, additional factors must be taken into account, particularly lack of liquidity or marketability for the partial interest. In practice, a broker who wishes to sell a partial interest in his real estate business will have difficulty without reducing the pro-rata sales price.
When valuing, much depends on what comes with the package. If, for example, you buy the interest of the broker and assume his position; or alternately, purchase the interest of someone’s spouse who is part owner in name only, all else being equal, it would seem that the broker’s shares would have more value. Yet, legally, the per share value of both party’s interest is the same.
A normal discount would range from a low of 20 to a high of 50 per cent. The selection is more of a “shoot from the hip” than one based on market criteria. A general rule of thumb, and it is very general, is discount a 50-per-cent interest by one-third, a 25-per-cent interest by one-half and all others around or between these ranges. There are no strict rules or infallible guidelines. Often a discount, if any, is arrived at by mutual agreement between the parties. Sometimes for a minority position a discount of 50 per cent may be insufficient and in another 20 per cent may be too high. It all comes down to what you anticipate gaining and what the seller will settle for.
Consideration should be given to:
The percentage of the brokerage being acquired. The value of a minute percentage is always greatly reduced, particularly if it is of the employee stock ownership, non-voting class.
The division between the in situ value of the capital assets and goodwill.
The financial condition and earning capacity of the brokerage.
The history and reputation of the brokerage.
Its dividend paying capacity. If you only get the same remuneration you got without ownership, why buy?
Limitations created by the articles of incorporation.
The capabilities and contribution of those who hold the remaining interests, particularly the majority shareholder.
The highest premium would be for 51 per cent of the brokerage, as control would be obtained for a lower investment, the premium declining as ownership increases to 100 per cent. However, these are being steadily reduced as the rights and benefits accorded to minority holders are becoming better protected by law and better understood by their owners. The criterion in establishing the bonus is measured by the benefit to be derived by the acquiring party. It must be on account of added value with strong subjective motives. It is not a fact of the market.
With a buy-in, the usual procedure is that the seller’s interest is acquired over an extended time frame, usually not less than two years and seldom more than five. The purchase price is agreed to when the buy-sell contract is entered into. The major difference between this and traditional seller financing is that the seller remains active as a transitioning partner until the full debt owing is retired. However, there is no typical template to fit all situations and as such a buy-in should be negotiated carefully.
The last word is that before buying a partial interest in a real estate brokerage you need to consider all of your options and select the one that works best.
Lloyd Manning, AACI, FRI, CCRA, PApp is a semi-retired commercial real estate and business appraiser and broker who now spends his time writing for professional journals and trade magazines. He resides in Lloydminster, Alta. Email [email protected].
