See for general discussion.
In BVX, consulting and/or employment agreements are a purchase price allocation, and hence are part of the Purchase Price, not in addition to it. If consulting and/or employment agreements are in addition to the purchase price they should be treated as an on-going expense by reducing the EBITDA margin entered in the Income Statement.
A portion of the purchase price is often allocated to consulting and/or employment agreements for tax-motivated reasons rather than for material services. Such allocation reduces the amount allocated to goodwill. Goodwill is amortized over a period of 15 years whereas the consulting and/or employment agreements are for a shorter duration. Thus by allocating a portion of the purchase price to consulting and/or employment agreement, the buyer is able to write-off this portion of the purchase price over a shorter period than 15 years. Such faster write-off improves buyer's cash flow in the early years, which in turn helps him afford a higher purchase price. Seller on the other hand has to evaluate the potential increased tax burden resulting from foregoing capital gains treatment of the goodwill to ordinary income treatment of consulting and/or employment agreement.
Sell-side advisors often insist that payments for seller's consulting and/or employment agreement are in addition to the purchase price. In this situation the buyer should calculate the purchase price by reducing the future profits by the amount of the consulting and/or employment payments. Otherwise, he will be over paying. In small businesses, seller's presence is essential to transition the business to the new buyer due to lack of management depth. In this situation, buyer should not have to pay for the transition support in addition to the purchase price. In large transactions consulting and/or employment salaries to owners (or management) are often paid in addition to the purchase price because such expenses are small relative to the over all profit. One should not apply such practices of larger transactions to smaller transactions without understanding the economics and rationale.
Enter $ amount of Total Consulting payments, and the number of Years over which the Total Consulting payments will be amortized (which equals the duration of the consulting agreement). BVX does not allow interest to be paid on Consulting payments.
Some or all of the Consulting payments can be paid at the time of closing (see ). BVX pays down the Remaining Consulting payments, which is the difference between Total Consulting payments and Prepaid Consulting payments, in uniform equal annual payments over the duration of the Consulting agreement. Example: If Total Consulting = 1000, Prepaid Consulting = 400 and the length of the consulting agreement = 5 years. Then, Remaining Consulting is 600 and BVX will pay it down at the rate of 120 per year. BVX will amortize the Prepaid Consulting of 400 at the rate of 80 per year. (Note: Prepaid Consulting is amortized over the number of years specified in this section)
BVX records the face value of Total Consulting payments on the Balance Sheet. However, the consulting component of the Purchase Price is based on the present value (PV) of the consulting payments, not on the face value. PV of consulting payments is calculated by discounting the consulting payments at the default rate of 8% (to change this rate see ).