With the amount of debt accumulated by both the consumers and businesses in recent years, professional debt collection is a growing business.
Key industry stats
Classified under SIC code 7322, there are close to 7,780 collection agencies operating in the US alone. They generate over $11.99B in annual revenues.
According to the US Bureau of Labor Statistics, over 121,000 debt collectors were employed in 2008 and the industry employment growth is likely to continue until at least 2014.
The industry is highly fragmented with the average collection agency making $1,700,000 in annual gross revenues and employing 16 collectors plus support staff.
Main business value drivers for collection agencies
Successful professional debt collection services get their business from a variety of clients that refer past due accounts for recovery. Effective firms focus on specific industries and achieve collection rates in excess of 10%.
While there are a number of factors that make for a successful business in this industry, some do stand out as the key business value drivers:
- Client concentration. A diverse client base is essential for smooth business cash flow. This, in turn, contributes to higher business value.
- Employee turnover. Work in a collection agency is stressfull and requires considerable skill. Training and retaining effective employees is an important factor that contributes to higher business valuations.
- Business practices that comply with legal requirements. Both the Federal Trade Commission and state governments regulate debt collection practices. Strict compliance is important to avoid severe penalties. Actual or pending legal actions can reduce the value of a collection agency considerably.
- State of the art communication systems. Efficient debt collection requires specialized phone systems and data processing equipment. This may be capital intensive and exert downward pressure on the business cash flow.
Valuation multiples for collection agencies.
Companies in this industry are driven by cash flow. Hence, you can value an agency using the cash flow based valuation multiples:
- Business selling price to seller’s discretionary cash flow.
- Business selling price to EBITDA.
- Price to gross revenues.
Other business valuation methods for collection companies
If you are valuing a smaller agency, consider doing it directly on its cash flow using the Multiple of Discretionary Earnings business valuation method. Importantly, the method also lets you assess such important value drivers as client and market concentration, quality of staff and management, and stability of earnings.
Established collection agencies with long-term client relationships can build significant business goodwill as part of the overall company value. In this situation, you can take advantage of the Capitalized Excess Earnings method – an excellent way to determine the value of business goodwill.
This may be an essential step toward allocating the business purchase price in a tax-advantaged manner, setting up an earnout agreement with the outgoing ownership or a departing partner.