Joint IRTA/NATE Advisory Memo for Buyers of a Trade Exchange
Published: May 5, 2018
Background
IRTA and NATE have joined forces to provide an important industry-wide advisory memo for buyers of trade exchanges. The memo is intended to educate potential trade exchange buyers to the key factors in determining the valuation of a trade exchange.
This memo can also be helpful to owners who are considering selling their exchange, as it outlines the key elements that a buyer considers in their evaluation of a potential acquisition.
First Steps
Before any serious discussion take place, a non-disclosure agreement (NDA) should be signed by all the concerned parties.
Preferably, the seller should provide a written narrative historical overview of their company. The review should include market focus, marketing strategies, related ventures, cash & trade revenue results, personnel issues and positive/negative factors that have affected the overall business.
After receipt of the written overview, the buyer should obtain the following initial information from the seller:
- Number of clients/members, and the breakdown of active vs. non-active, vs. collections, etc.
- Percentage of accounts positive balances vs. percentage with negative balances.
- Identify all bad debt accounts.
- Identify all accounts that can be closed.
- Identify accounts in collections and litigation
- Identify the number quality accounts, (ie., hotels, airlines, computers, cruises, printers, car dealers, manufacturers and other desirable products or services).
- Location of operations – any satellite offices? Are they desirable locations? Is it a travel destination location?
- Annual gross cash & trade revenues – review last three years of tax returns.
- Check for credit card debt that may be the liability of the company, it may be in the company’s name or the name of the owner.
- Identify all other cash and trade debts
- Identify all cash and trade fee structures.
- Identify a realistic accounts receivable number.
- Who is providing the software – what are the terms of the software agreement?
- Identify all direct reciprocal accounts and their balances.
- Identify UC and/or BANC balances Joint IRTA/NATE Advisory MeMo
- Verify the selling company is current with all state corporate registrations.
- Personnel matters, what is the quality of the staff? Any employment contracts? Amount of turnover? Who is interested in staying-on if the company is sold?
- Inventory position – does the seller have a showroom and company-owned inventory? How is the inventory accounted for on the seller’s software system?
- Is there a bad debt reserve fund? Has it been used correctly?
- Obtain a complete record of all prior bad debt write-offs.
- Identify all owner, owner family accounts and staff accounts.
- Are there any outstanding IRS issues? Any unpaid 941 payroll taxes? Any 1099B Non-Matching TIN civil penalty issues?
Exchange Deficits vs. System Deficits
The amount of the exchange and barter system deficits is a critical factor in determining the value of a trade exchange. High deficits can reduce the velocity of trading and cause the system to ultimately freeze-up.
Exchange deficits result from the managing exchange making trade purchases that exceed the amount of trade dollars they’ve earned. The barter exchange is effectively borrowing from the membership of the exchange collectively to fund its exchange deficit. System deficits result from writing-off negative trade balances, due to a member’s insolvency, bankruptcy or disappearance. A properly funded bad debt trade reserve account will help minimize the system deficits.
For a detailed review of exchange and system deficits, see the attached Exhibit “A” – IRTA’s October 24, 2016 Advisory Memo titled, “Guidelines & Recommendations For Barter Exchange Deficits.”
Key deficit factors to analyze are:
- Size of the exchange and system deficits – does the total deficit number fall within IRTA’s recommended guideline of 2.5 to 3.0 times the annual averaged monthly trade volume?
- Has the seller had a good faith policy to reduce the deficits? Have they followed through on the deficit reduction plan?
Distinction Between the Assets and Liabilities of the Managing Exchange vs. Assets and Liabilities of the Members’ Exchange System
It is critical for buyers to have a complete understanding of the difference between the assets and liabilities of the managing exchange vs. the assets and liabilities of the trade exchange system itself. Exchange owners sometimes commingle the two, which can result in an inaccurate valuation of both the seller’s exchange, as well as the buyer’s exchange.
In short, the managing exchange and the members’ exchange system have two separate balance sheets. Because the actual legal liability for the redemption of goods and services in a barter system lies collectively between the members of the exchange themselves, the exchange members’ negative trade balances are categorized as assets, (since they are an account receivable to the member exchange system), and positive trade balances are considered liabilities, (since they are an account payable to the member exchange system). For a more detailed review of these issues, see the attached Exhibit “B,” IRTA’s February 7th, 2017 Advisory Memo on Assets and Liabilities.
The managing exchange’s assets are limited to the cash and trade revenue it receives from transaction fees and/or monthly fees, plus exchange-owned inventory, furniture and equipment. IT IS IMPROPER FOR THE MANAGING EXCHANGE TO TRANSFER ASSETS OF THE MEMBERS’S EXCHANGE SYSTEM TO THEIR BALANCE SHEET – TO DO SO MISREPRESENTS THE TRUE VALUE OF THE MANAGING EXCHANGE.
The buyer should ask the potential seller the following questions to determine if the seller is adhering to acceptable barter accounting principles:
- Where and how does the seller record the positive and negative balances of the exchange members? The members’ negative balances should be recorded as assets and the members positive balances should be listed as liabilities on the MEMBER EXCHANGE’S balance sheet.
- How does the seller exchange record the seizure of a positive trade balance? The positive trade balance should be deposited into the system’s bad debt reserve account.
- What are the parameters for the seller exchange when they decide to seize a member’s positive balances? The selling exchange should have a fair policy that respects the member’s rights to use their positive balance, in accordance with the reasonable terms and conditions of the barter agreement the member signed. The selling exchange should not use unreasonable and harsh fee increases as a leveraging tool to seize the positive balances of members of their exchange. NOTE: The treatment of members’ positive trade balances is critical issue as it can substantially affect the valuation of a barter exchange. IRTA & NATE have received complaints about trade exchanges seizing members’ positive balances simply because the member refuses to pay the exchange’s monthly fees and/or transactions fees – members must be given a fair chance to reconcile their past-due cash fees, before account seizures are implemented.
- Has the selling exchange made a good faith effort to pay-down their reciprocal accounts? If the answer is no, it’s a red flag as to the lack of quantity and quality of goods and services that the seller has to offer in their exchange.
Additional Buyers Due Diligence Checklist
Sellers of trade exchanges should also cover the following additional areas:
- Contact IRTA and NATE to inquire about the most current ratio formulas for determining the value of a trade exchange. Contact your CPA or attorney and ask their opinion about appropriate evaluation formulae.
- Is the seller a member of IRTA/UC and/or NATE/BANC? If so, contact IRTA or NATE to verify the buyer is a member in good standing.
- Have any Ethics Complaints been filed in either organization against the seller?
- What software is the seller using? Contact the software provider to verify their account is in good standing.
- On Google search, type-in the seller’s name and company name and type the word “fraud” and “scam.”
- Check internet fraud sites for any derogatory reports about the seller.
- Call established mature barter exchanges, who have been in the barter industry for over 10+ years, and ask them what their experiences have been with the seller.
Additional information and Documents the Seller Should Provide for Review
- Members’ Exchange Information:
- Member trading history
- Fee structures and past due fees.
- Membership agreement
- Rules of trading Joint IRTA/NATE Advisory MeMo
- Managing Exchange Information:
- Financial statements and tax returns
- Leases
- Franchise agreements
Asset Purchase vs. Buying the Managing Exchange
Typically there are two types of sales contracts in the barter industry; 1) an asset purchase, whereby only the trade exchange members’ accounts are being sold, or, 2) a sale of the managing exchange whereby the liabilities of the managing exchange are being sold as well, along with the trade exchange members’ accounts.
When an asset sale occurs, the managing exchange entity continues-on after the asset sale is completed. The owner’s of the selling managing exchange remain responsible for the managing exchange’s liabilities, the reverse is true with a sale of the managing exchange itself – all liabilities are passed to the new acquiring company when the managing exchange is sold.
Regardless of which type of contract that is used, it is important that ALL barter accounts in the system be transferred to the buyer – the buyer cannot agree to only buy selected accounts, (aka “cherry-picking”).
When to Announce the Purchase
It’s important to not announce the purchase of the trade exchange until the transaction has legally closed and all funds have successfully been transferred.
The signing of a letter of intent, (LOI), does not guarantee that the transaction will be finalized. There are a myriad of hurdles that need to be cleared after the LOI is executed.
Post-Closing Matters
- Re-Alignment of Fee Structures
- The transaction fees and monthly fees of the buyer’s and seller’s trade exchanges are rarely identical. Therefore, the buying exchange must develop a practical and equitable approach to bringing all the acquired exchange’s fee structures in-line with their own fee structures.
- Zeroing-Out Accounts – Bad Debt Accounts & Other Transfers
- Invariably the buying exchange will want to close-out some of the acquired accounts that are in a deficit position, to clean-up bad debt accounts. It is important that the buying exchange zero-out the member account’s deficit by debiting another account, preferably the bad debt account.
- The selling Exchange should zero out all member accounts and make the appropriate debit/ credit to a new account called “Buying Exchange transfer account” so that it should be the only account and it should be at zero when the transfer is complete.
- The buying exchange should then create a new account called “selling exchange transfer account” and do the reverse of above to recreate all member balances in the buying exchange.
Conclusion
Buying a trade exchange requires careful due diligence. By following the guidelines set forth in this memo exchange owners will be better prepared to make an informed decision about buying a trade exchange. As a result, well-informed buyers will be assured that they’ll pay a fair price for the exchange, and not be surprised by undisclosed nightmares after closing on the purchase.
