BUSINESS BUILDING IDEAS
Most Industry buyers will utilize a form of an EBITDA-Multiple valuation. In the case of small to midsize-cap agencies, they can expect a 3X to 4X Multiple for a baseline valuation. That is, unless there is a valuable point of differentiation. These days, the point of differentiation will likely be a more sophisticated version of digital media or search software or technology. In this case the basis of value moves from EBITDA to Gross Income, and in some cases, top line Revenue.
But, in a usual transaction, there are some guiding principles that determine how much near-term cash a seller will receive. The first of these is the more near-term cash received, the lower the overall value offered by the buyer. This is so because the more near-term cash paid out to the seller, the greater risk the buyer carries.
The schedule below illustrates this point. In this example, the initial valuation calculated the value of the business at around $8 million. But, the seller wanted a $10 million valuation. He insisted. So, the buyer stretched the purchase over 36 months and made the $10 million value contingent on the business achieving certain increasingly higher milestones, which when achieved, would support the higher valuation.
The buyer agreed to a 5X Multiple up from 4X, but kept the cash downpayment at 2X EBITDA. This clearly shifted more risk to the seller. In my mind, this offer would lead to further negotiation with the goal of taking the ceiling off of what the seller could ultimately make from the transaction. Instead, the seller rejected the offer and walked away.
C’est la vie. It is difficult to find fault in either of the parties. People are different. So, one will accept a deal that another would reject out of hand.
The schedule below summarizes the payments over a 3 to 4 year period. It was prepared on the basis of a forecast that set the milestones required to be met.
The takeaway is that as a seller, you can negotiate a price up to where you believe it should be, if you are willing to make concessions. It is critical that a seller understand the structure of the terms of his or her transaction. The price of a business sale can always be increased, if the seller will accept a change in the conditions.
Take a look at the chart below for a sample of Purchase Price Overview.
SMALL TO MID-CAP AGENCY VALUATION CHART
Stay tuned for my next AdBlog on Small Cap Marketing Agencies.
Henry Corona, Financesur
www.financesur.com • 305-748-0888
Last time we alluded to other viable options. What’s viable to one agency owner may not be so for another. Consider an agency network, for example. There are various types.
- The simplest are the networks which build on one foundation agency and extend into an integrated multi-office holding company operation. These are the core of the Advertising Industry. These are not an option for small cap agencies, unless one has a unique value proposition that differentiates them from the rest or has specific value to the Holding Company that acquires them.
- There are networks that focus on small to mid-cap agencies. The math with these vary, but generally they choose agencies they can acquire at a value driven by 3X to 4X EBITDA and offer cash at Closing at 2X EBITDA or less. The value proposition that the organizers offer is that they will make 10 to 15 such acquisitions and create a larger agency that will command 6X to 9X Multiple at the end of 4 to 5 years of operation. The result is that Sellers are encouraged to accept stock instead of cash because the stock they receive will double or triple in value by the end of the period. Some pay out cash along the way, but generally not before 2 years, and only if the individual agency has achieved all of the milestones (growth) they agreed to meet when they sold.
- The formulas that dictate the conversion of individual agency stock into corporate stock vary. Early sellers have to be careful that the stock they trade for will not be diluted as additional agencies are acquired. The later arrivals have to be aware that if the network grows, the value of their individual agency stock will return them progressively less corporate equity. This scheme isn’t inherently bad. The thing is that the big promise may not come true due to a number of variables out of the control of the selling agency owners. In the end, they may not be able to cash out, because their stock has little or no liquidity. This is especially true if the organizers use debt to finance acquisitions.
- There’s another network strategy that offers to acquire majority interest in a small cap agency, and then provides back office and sophisticated technology services at cost to their agency subsidiaries. They do not acquire to integrate. They maintain the individual cultures in the agencies they acquire. The key requirement is that the Seller be profitable.
You should contact me if you’re interested. In any event, look for the next installment on how to negotiate a higher sales price.
Stay tuned for my next AdBlog on Small Cap Marketing Agencies.
Henry Corona, Financesur
www.financesur.com • 305-748-0888
Sample One: A NYC Media agency hired me to assist with the acquisition proposal she received from a diversified marketing and production company. It turned out to be a good fit from the business culture POV. She knew the principals and the key management execs going in.
The overall valuation was low in the range, with the currency a combination of cash and equity. And the latter was what my client was interested in. That, and it addressed a major concern.
She felt that she was increasingly becoming a “one-woman” show in her own agency. Being completely responsible for everything, or just feeling that way, was wearing on her. On top of that, her perception is that mid-size and larger company clients are interested in finding one supplier that can provide all, or at least most of the marketing and advertising services they require.
So, she was happy to have senior colleagues to work with and share weight of many of the important decisions. In addition, she retained enough of an equity interest in the transaction to give her a sense of ownership in the business.
This agency’s circumstances are similar to many of the thousands of marketing and, or tech shops, and design firms; and not far from Outdoor and experiential marketing service companies. All of them have to determine the best way to position themselves for the future.
Sample Two: Deciding to sell now or preparing to sell aren’t the only options to choose from. Another agency client was approached to sell by a group seeking to assemble an agency network. We reviewed the offer and determined it wasn’t strong enough.
That episode led my client to decide to concentrate on generating organic growth for another year, and to make its own acquisitions in preparation for a sale in 2 or 3 years.
Sample Three: These agencies share the belief that they must get more services and skillsets under their roof in order to have the value that will attract qualified buyers. There’s one more agency that decided that their creative product and their strategic thinking are strong enough to attract larger clients. They focus now on consumer challenger brands and plan to grow that segment.
They are not thinking about a near term sale. But they believe they must grow to win larger brands. We are seeking a strong tech group that will complement their current strengths.
These are a number of viable options available. But there’s always more to consider.
Stay tuned for my next Blog on Small Cap Marketing Agencies.
Henry Corona, Financesur
Agency Value in a Digital World – Purchase Price Structures
Over the last 10 years, we have seen the value of agencies with digital business models receive extravagant valuations. And, while strong technology expertise remains a key element of value, digital expertise has become more of a familiar tactic than a point of differentiation. I heard the comment at an AMI conference that basic online digital services are part of the “table stakes” that every agency must put up in order to be seriously considered by a prospective new client, or by a current client for some types of projects. That is consistent with my experience; and with the caveat that an agency may contract the necessary expertise.
Agency values continue to be simply defined as a combination of profitability, size, the client list and the services the agency provides them. All of these may be outweighed by the strategic value the seller represents to the buyer. And, “strategic value” is generally defined differently according to the buyer’s objectives.
So, what about the seller’s objectives? Those are more important to you, as a seller. Suffice it say that the one general rule is that the sale prices has to be enough to enable the seller to achieve his or, her objectives.
For the purpose of this commentary, let’s consider one element, the structure of the transaction. How, how much, and when are you going to get paid? Oftentimes, the amount of the sales price doesn’t matter as much as when are you going to get receive it.
First of all, how much cash are you going to receive at Closing? What can you expect? And, how negotiable is it?
Well, that depends. Let’s assume that your business is profitable, with a respectable margin. Say that the Net Margin is 15%. Experienced buyers will expect that the seller’s business is going to fall off 20% to 25% in the first year following the acquisition. Every buyer I have ever worked with will consider the cash on cash return of their initial investment. Most do not wish to wait 3 years to get their money back.
Whether you think that your circumstances are different, or not. The reality is that with a 15% Net Margin, you are likely to have an EBITDA Margin over 20%. And, this is the minimum many buyers stipulate. In most cases, but not all, your Operating Margin is a good proxy for your EBITDA Margin.
The EBITDA Margin will be the principal factor in the calculation of the cash down payment at Closing. In general, the down payment will fall within 1.5X to 3X EBITDA for the trailing 12 months of the seller’s business.
In general, the higher the EBITDA Margin, the higher multiple applied to how much cash to pay at Closing. This isn’t the total cash a seller could expect to receive at, or before Closing. There will be a cash balance or balances on your Balance Sheet. You will be entitled to take part, or all of it.
Now, part of this balance is attributable to your working capital, which you may (should) have accrued for client work for which you have received payment but have not completed. Under normal circumstances, you will have a surplus of cash above the working capital requirements. You may or, may not be able to keep the entire surplus. The buyer may want to have all or, part of the surplus left in the agency for a period (normally) for 2 to 3 months.
There will be a document referred to as, “Reps and Warranties” which you will sign to account for any liabilities, which have not been provided for in the calculation of final obligations that were not accounted for in the Closing financial statements. Cash accounts are typically escrowed for 2 to 3 months to pay unexpected agency-related charges.
That isn’t the end of the world, if your Closing accounting statements are accurate. The funds are yours to collect. Later.
However, if the seller did not accrue unearned retainers, or has spent some of the cash, there will be a reckoning, and the seller will pay. I cannot recall any transaction in my experience where there has not been a discussion about cash balances as Closing approached; some more heated than others.
In general, without special circumstances, the total value of the selling agency will be calculated at 4X to 5X EBITDA. Or, buyers such as WPP have used Profit Before Taxes (PBT) as the basis instead of EBITDA. Either way, if total value was valued at 4X, and the cash down payment was calculated at 2X, there is another 2X EBITDA to be negotiated.
This balance will be paid as an earn out. The buyer and seller negotiate and, agree upon performance milestones that the seller has to achieve in order to be paid the “Earn out” over time. The Earn Out period has fallen to generally, 3 years from the 5 years that used to be the norm.
As the seller’s representative, I have normally asked for funds to be escrowed. This is more important if the buyer is another independent agency or a new network, rather than a publicly traded Agency Holding Company. It gives the seller more security when dealing with private buyers.
Another variable worth mentioning is the structure that includes equity in the buyer as part of the purchase price. In principle, this is intended to be an added incentive for the seller to receive a higher ultimate value as he and his new owner build the newly combined entity.
There are many elements to evaluate when considering the sale of a business. In the coming weeks, I will address other elements, such as:
- Crosstown Mergers
- How to plan the sale of a Marketing Agency
- The Integration of the two marketing agencies
- The Challenges for owners who sell their businesses
- Financial reporting and the calculation of Seller Earn Out Payments
- How to sell an unprofitable agency
- How to integrate a technology company into a Marketing Agency
- Purchase Price Structure
Advertising agency “culture” is always a lively topic. After all, it’s an intangible element that is difficult to pin down. So, almost anyone’s opinion is valid. It’s an opinion.
Nevertheless, the issue comes up whenever two agencies contemplate a business combination. Addressing the integration of operations always includes the consideration of the two cultures.
Or, if owners simply wish to make changes to increase profits, they will be concerned about affecting the working environment of the business. Or, in other words, they don’t wish to adversely affect the “culture”.
In both scenarios, the “culture” must be addressed. But, how is it defined?
One explanation of an agency’s culture is that it is a function of the owner’s profile. This school of thought is that the owner’s values and beliefs tend to lead employees to act and perform in concert with them. When they determine what the owner believes in and emphasizes, employees do it. So, processes evolve from the owners’ profiles.
This is more apparently true in privately-held agencies. But, the principle holds true in large, publicly traded corporations. In the latter, there is a corporate culture that individual gatekeepers at every level of an organization may manipulate and change in their own image. And so, minor fiefdoms emerge throughout the business operations that new employees have to understand in order to succeed.
These factors often affect the failure or success of a business combination. They are crucial elements that must be addressed in order to assure successful integration. However, they are also important to an agency operation when they find that they cannot manage to increase efficiency and profitability.
Processes and procedures guide the activities and shape the behavior of the people who work in the business. When you want to improve the profitability of a business, one of the first places to look is how to improve processes and procedures. In order to do this, you must change the behavior in the workplace.
About 15 years ago, the owner of the agency where I worked directed me to look at their processes, and find ways to improve efficiency. The agency made great ceremony about its’ “10 Steps to Success” mantra. However, the owner informed me that the “10 Steps” required about 125 touch points in their process.
The first person I spoke with was the production manager. He informed me that there weren’t 125 touch points. There were 146.
We managed to whittle the touch points down, but never really made much progress because the owners wanted systems in place to double check a number of elements in the agency’s work product. Not the least of these was compliance with the brand books from several large national clients.
This agency had grown from $3 MM to $15 MM in AGI. But, the owners insisted on maintaining many of the practices they had employed when they were a smaller agency. To my knowledge, they held on to the practices from their storied past right up until the agency closed its doors about 5 years ago.
New technologies have increased the velocity of the world we live in, and the businesses we operate. Technology affects, and in fact shapes most of the workplace. It is important to remember that humans adapt; hardware and software can be adapted. Humans are still in control, and the culture of the workplace is still important in the health of a business.
So, the question is, “What can you do to improve the efficiency and profitability of your business?” If given the opportunity, where would you begin?