Often, sellers of small, subscription-based magazines who discover too late that their company is worth less than they anticipated simply have unrealistic price expectations. But the more insidious demon may well be the whole issue of Deferred Subscription Income (DSI)—those revenues the publisher has already collected (and likely spent) but not yet fulfilled to the subscriber. Who assumes that liability in a sale? And how?
Enlightened buyers such as Clay Hall, CEO of Aspire Media, recognize that DSI represents “the right to renew” and, accordingly, is seen as a benefit. That’s why strategic buyers are now paying top dollar for quality, subscription-based properties—titles that are not wholly dependent upon the whims of advertising sales—and why they are willing to assume what amounts to a “phantom” tax liability by assuming DSI. In the case of large magazine deals, the issue of DSI rarely comes up, although certainly the actual production costs of physically fulfilling the liability will be taken into account in determining the final price.
But the seller of a small, subscription-based magazine—especially a title that is marginally profitable—may be told that the buyer intends to subtract every penny of the DSI liability from the proposed purchase price. The rationale here is that the seller has already collected the revenue and incurs no forward-going expenses to satisfy fulfillment. DSI, therefore, is like any other pre-paid income item—the buyer wants the money handed over at closing. The counter argument is that the seller has incurred expenses to develop and maintain the subscription revenue in the first place, and that in turn drives ad sales. At best, the seller may negotiate a reduction in the DSI liability because actual fulfillment costs are less than the income.
Everything Is Negotiable
Barbara Israel, with the New York accounting firm Weiser LLP, points out that in deals large and small, the issue of DSI is subject to “arm wrestling” and nothing is cast in stone. One side will typically want to peg DSI at “historical value” while the other party will argue for a cost-to-fulfill approach. And indeed, the smaller seller will likely have to negotiate even more aggressively to minimize the impact of DSI considerations on the final purchase agreement. Moreover, the tax consequences of how a deal is structured vis-à-vis DSI can greatly affect both buyer and seller. Who assumes the DSI liability and the value at which it is assumed impacts how the associated income is taxed at ordinary or capital gains rates. Her point: everything is negotiable. And these negotiations, especially as they relate to income tax treatment, can have a bearing on selling price. This column does not purport to address the many complexities of tax law affecting buyer and seller in transactions involving deferred income. Make sure you have a tax accountant well schooled in the intricacies of publishing to help navigate these waters when you sell.
Here’s another twist on the DSI conundrum. Since completing a magazine acquisition can take months from first discussions to closing, the intended seller will face a dilemma: why spend money developing (and renewing) subscriptions for someone else, especially if you may actually be penalized for the deferred liability? Savvy buyers, says Israel, may insist that sellers follow a routine schedule of subscription promotion and development throughout the negotiation process—or risk a price reduction at closing. Savvy sellers, on the other hand, can legitimately negotiate to share or be reimbursed for promotional expenses that will ultimately benefit only the buyer, especially after the LOI has been signed.
For publishers planning to sell a small, subscription-based magazine, there is no way around the DSI issue. But there are preparatory measures you can take to strengthen your position.
Before you decide to sell, conduct a reality check on the actual value of your title (it may be worthwhile to have a professional appraisal done). Approach prospective buyers with a clear understanding, up front, as to which party will assume the DSI liability. Be prepared to negotiate hard and fast for a deal that offers you the greatest benefits—and least penalties—especially in the gray area of DSI. This is your nest egg. You don’t want it served scrambled at the negotiation table.
Michael D. Kreiter is director at W.B. Grimes & Co., a Gaithersburg, Maryland-based investment firm for the media industry. He can be reached at email@example.com