Today's acquisitive marketplace has put the option of a mergeror sale in front of many agency owners, but if you're making a goodsalary and annual growth has been in the double digits, you mightthink that selling now would be killing the cash cow.

Not necessarily. When you perform a detailed financial analysis,you might find that the cash cow is producing skim milk. Indeed, toassess the true value of a potential sale, you must compareprojected growth and tax ramifications against an investmentportfolio created from sale proceeds after taxes.

Factors that could tip the scale toward selling include:

o The tax differential on capital gains versus ordinaryincome.

o The present value of invested funds.

o The uncertainty of future market conditions.

Also consider the possibility that your agency's rate of growthcould flatten. Essentially, you would then be working harder whileearning less.

Many agency owners closely track their growth rate and resolveto sell at the time that rate is cresting. Ask anyone on WallStreet how risky a game it is to attempt such timing in themarkets.

When you delay the decision to explore consolidation ordisposition of the business, you are betting the future onuncontrollable factors.

Perhaps the biggest factor in the sell-vs.-continue equation isin taxes.

In 2003, the federal government presented agency ownersconsidering a sale with a 25 percent reduction in tax liability--bysignificantly reducing the capital gains tax rate. The tax rate of15 percent on long-term capital gains can have a significant impactwhen compared to the effective ordinary tax rate for a high-earningindividual, which could be 39 percent.

Many times, too, the acquiring company will desire--orinsist--that the selling principals continue working for thebusiness. Far from being a drawback, this offers great benefits.You can continue to earn income and stipends, and the sale hassubstantially reduced your personal financial risk.

If agency owners have most of their personal worth tied to theirbusinesses, the timing of a sale may be even more crucial.

In today's competitive landscape, consolidation may be the onlyway to remain viable--especially in the middle and larger markets,where competition is fierce.

Also, alignment with a larger organization provides professionalopportunities for a leadership role within a larger organization.The greatest benefit is minimization or removal of personal risk tothe owner by obtaining liquidity for ownership in the agency.

Right now, the low cost of capital is making acquisitions quiteattractive, but that equation will change. As banks and second-tierbrokers build their networks, the acquisition pace will inevitablylevel off as supply will be greater than demand.

When it does, market stabilization of product rates will resultin very modest, incremental revenue growth--or even declines. Ratedeclines (market softening) will result in elevated direct expensesand earnings deterioration.

Because the valuation of a business is based upon revenue andearnings trends, such leveling or a decline will certainly meanlower valuations for agencies on the market. This would be furtherexacerbated by the shrinkage in demand for agency acquisitionsamong the leading acquirers.

Finally, there is no guarantee that today's low capital gainsrate will continue into the future. In fact, there already isspeculation that the tax cut would be quickly abolished if aDemocrat should be elected to succeed President George W. Bush inthe next presidential election.

To fully weigh the options, agency owners must understand theconcept of monetizing their agency versus a "steady state" course.The playing field must be equalized to be able to compare the twoscenarios.

The net difference can be seen by looking at long-termcumulative results, and by comparing these results on atax-effected, discounted, present value basis.

To be, or not to be on the market?--that is the question.Whether it is wiser to seek a sale can be objectively compared bycreating a numerical pro forma of continuing operations at apresumed growth rate. Assumptions can be made about manypredictable elements of the equation.

Comparisons must include these key input variables:

o Current agency market value.

o Current owner compensation.

o Length of employment time for the owner after acquisition.

o Any debt or leverage carried by the agency.

o Presence and stability of any minority shareholders.

o Reinvestment requirements.

Using these variables, the firm's expected growth rate and amarket-based approach to agency valuation, projections can becreated to compare selling versus remaining as-is.

The following scenario outlines an evaluation using a formuladeveloped to assess sale versus continued operations:

o Begin with the projected net tax-effected cash flow undernormal operations for future periods.

o Add the market value of the agency at the end of those futureperiods (tax-effected and discounted to present value).

o Subtract from this number the current market value ofdisposition (factoring in any earn-out or deferred purchase),yields earned on invested sale proceeds and post-transactioncompensation earned by the principal (all tax-effected anddiscounted to present value).

o The resulting number will show the value of immediate sale ordisposition versus continued operations.

If the result is a negative number, there is deterioration inshareholder value and a merger should be considered.

On the other hand, a positive number supports a premise that thebusiness shareholders would be better served by continuingoperations.

To effectively evaluate the assumptions, several scenariosshould be modeled.

For instance, assume earnings growth rates (usingEBITDA--earnings before interest, taxes, depreciation andamortization) of 5-, 10- and 15 percent. Although some firms showdouble-digit growth rates going back a number of years, it is notwise to assume those healthy rates will continue forever.

Also, it is best to model several possible sale dispositions,such as the agency selling for 7.5, eight or 9.5 multiples ofpresent annual earnings. These variables will balance the overallimpact of a severe, moderate or favorable environment, and thusprovide parity in the overall comparison.

Take, for example, an agency with current cash flow of $6.6million. Assume growth rates and market multiples as mentionedabove.

In a baseline scenario (see the accompanying table), we wouldassume an expected growth rate of 10 percent and a current marketmultiple of eight-times earnings.

Other factors are reinvestment in growth at 20 percent ofearnings and a discount of 18 percent to arrive at present valuesfor cash flows and for the agency.

The bottom line result is a present value of $44.6 million, ifthe business remains as-is.

For an acquisition model, we would assume a total purchase priceof $52.8 million (current cash flow of $6.6 million with a marketmultiple of eight), paid out by the buyers over three years.

We assumed two more key elements:

o That the principal stays with the business for five yearsafter the sale (at an initial compensation of $400,000, that growsby 15 percent annually).

o That the investment rate for the proceeds from the agency'ssale is 8 percent (pre-tax).

The result of this model shows present value to theprincipal--through the investment portfolio and netcompensation--to be $60.4 million.

Thus, in this case, the net benefit of selling versus continuingis $15.8 million. In fact, in this case it would take a sustained25 percent annual growth rate for the numbers to tip in favor ofcontinuing operations rather than selling.

While this analysis (the numbers are from an actual recent case)showed the wisdom of selling the agency, the next case might showthe opposite.

Indeed, every case analysis provides different results. Manytimes, the shareholders are better served by continuing operations.Before embarking on either pathway, it is prudent to obtain thistype of analysis.

Any evaluation must include realistic assumptions and must takeinto account both tax rates and the value of an investmentportfolio.

Once a financial analysis is in hand, intangible factors such assuccession planning, risk reduction and uncertainties in theacquisitions market may be considered.

Only then can a sound decision be reached--whether to milk thatcash cow, or put it out to pasture.