Dealing With the Deferred Subscription Issues
Director- Magazine M&A
Grimes, McGovern & Associates
The proprietors of Mom & Pop Publishing have toiled for years to build subscription and advertising revenues for their small, niche special interest title. They struggled at first, survived the lean years, put the kids through school, and now theyre making a decent living. Next step: sell to a well-healed strategic buyer and enter the Golden Years with a nice, fat nest egg.
Imagine the shock, the chagrin, when they discover their beloved magazine is worth far less than their rosy expectations. They may even conclude: we can’t afford to sell!
The sellers may 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.
Unfortunately for Mom & Pop, this sophisticated view may do them no good simply because they own a … small property. And, as has been pointed out in this column ad nauseam, the same rules that apply to big deals dont apply to small deals, because small deals are riskier and are more difficult for the prospective buyer to project ROI.
So 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.
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 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.
Heres 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 Barbara 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. Remember: everything is negotiable.
Even the smallest publishers usually report DSI on the Balance Sheet unless they maintain their accounting on a cash basis. But that doesn’t mean the deferred income is available in ready cash. Most likely, that income has already been used for operating expenses, including costs to develop new and renewal subscriptions. In a worst-case scenario, the publisher realizes he can no longer afford to publish a losing title, and no longer has the cash to refund subscriptions. What now? Bankruptcy may be one option, although there is some question as to how Uncle Sam would treat the DSI tax obligations. A better solution is to find another publisher, often a competitor, to assume the subscription liability and fulfill it with his own publication. There are also individuals who specialize in finding publishers to assume the subscription liability or outright buy the list for subscription-based magazines that are facing the last round-up.
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. Well 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.
Grimes, McGovern & Associates provides expert advice during all phases of a transaction. Contact us today for a confidential consultation: John McGovern, CEO, email@example.com, (212) 255-9700.
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