Overcome a Typical Agency Balance Sheet: Get a High EBITDAx for Your Business
By: Christian H. Gomez
The first question I am inevitably asked by any marketing agency owner when discussing valuations of recent transactions is
“What is my company worth”? As Leo Burnett was reputed to have said when commenting on the value of his agency, “The assets of this agency go down the elevator every night.” Indeed, if one looks at the balance sheet of the typical marketing/advertising agency, there is very little there in the way of hard assets, and intellectual property has always been notoriously difficult to value on the balance sheet.
For years the “Rule of 30” has been the benchmark of a well-run agency and a starting point for determining the value of the
business. The Rule of 30 means any combination of operating profit and revenue growth percentages totaling 30%. An agency producing a profit of say 20% will be doing well if it also has a growth rate of 10%. Conversely, the same can be said for an agency that might only have an operating profit of 10% if its growth rate is 20%. The logic here is that as more investment is made to spur short and or longer term growth such as sales and marketing or technology, operating profit will suffer but growth will increase and visa-versa. Furthermore the Rule of 30 axiom says that it is unrealistic to expect an agency to sustain both a rapid growth rate and profitability simultaneously over time.
Enter the Inc. 5000 where over 10% of the companies on the list (click on the Resources Tab on the Home Page tool bar to
view the list) are marketing and advertising agencies with the vast majority boasting revenue growth rates well over 20% and a ratio of staff to revenue that would indicate high profitability. What gives here? Are the agencies fibbing in reporting their financial results or have these businesses found a solution to consistently exceeding the Rule of 30? While there might be a certain number of companies that overstate their financial results there is no question that this is not the case with over 500 agencies on the list. What are they doing right? Let’s start with the typical areas buyers focus on in determining value:
1) What is the future income stream?
2) How desirable are the clients and what is the likelihood of these clients staying?
3) Are there special capabilities or characteristics of the agency such as industry focus, “productization” (to be discussed later), processes, technology, a recognizable brand, etc.?
4) What is the strength of leadership to remain with the business and core talent?
5) Geographic considerations.
Assuming that the answers to the due diligence above yield a comfort level with the chances of maintaining the Rule of 30, how can agencies break through the Rule of 30 to accelerate both growth and profitability simultaneously and realize a valuation north of 7x EBITDA (see our 2013 M&A Outlook)?
First and foremost for agency owners, there needs to be a tight linkage between the Income Statement and Balance Sheet and the Company’s business plan. The bottom line here is that the agency’s value can be enjoyed now or later, but make no mistake that financial largesse in the short term will affect future value.
In an excellent article titled “What the Marketing Agency of the Future Will Do Differently” in the Harvard Business Review, Mitch Joel asserts that the dogma of the industry is being rewritten and lays out five new attributes that marketing agencies will need to survive.
Attribute 1. Models of Leanness. Metrics and outcomes for projects will have to be established from the beginning and
programs will have to bend, move and iterate as we learn from what the market is telling us (marketing optimization anyone?). The days of quarterly planning or seasonal initiatives (aka marketers know best) are over. The transition must be made to a true real-time way of operating (aka consumers know best).
Attribute 2. Utility over Content. This is key. Joel writes that while the last ten years have been about developing content in the social channels (in order to provide value, humanize the brand, be present in the search engines, etc.); the next five years will be about the brands that can actually create a level of utility for the consumer. Furthermore, the utility is something that consumers will use of their own accord because it adds value to their daily lives, regardless of attribution to a brand. The benefit comes to the brand by creating something consumers can’t live without and the appreciation and attachment that come from it.
Attribute 3. Content as Media. Joel indicates that content has been used as chum for brands but that enormous overload and clutter is making it more difficult to resonate with consumers. Content must morph into media as agencies help brands to create more relevant and original pieces of content that don’t look, smell or act like a press release or advertorial. There are many examples such as websites offering educational articles on virtually any subject like www.ezinearticles.com. While these sites promise traffic back to your website they are very strict in not allowing self-promotion in the body of the articles rendering the articles as nothing more than advertisements and a turn-off to visitors.
Attribute 4. R&D. Joel indicates that in the past agencies used to selling services have not been very good at selling products. He says this will have to change. Our Mtech Roundtable Guru Kenyon Blunt saw this first-hand as the CEO of a marketing agency and has authored an article on “21 Ways to Productize Your Services”. Blunt offers three benefits in Productization, namely, consultants who package make 87% more than those that charge by billable hour, you differentiate your company from the competition, and it’s easier for customers to understand and buy and makes the sales and business development process much easier. He breaks down the 21 steps into a four part process; Research, Product Development, Branding, and Go-To-Market Strategy (click on the Resources Tab to view the article in its entirely).
Attribute 5. Many Big Ideas. Joel talks about the traditional “Big Idea” and how agencies traditionally worked with it across all media. Consumers are not now the same when they are watching television as when they are on a smart phone or reading reviews or when they are in a retail location. What are needed now are many big ideas that enable a brand to simultaneously directly or loosely connect with the consumer across channels in a highly personalized manner. Agencies can no longer focus on the Promotion part of the “4 Ps”. It really is about Product, Price, Place AND Promotion. Back to the future?
In summary, here are the steps to follow to exceed the Rule of 30, prepare your agency for the future and exceed the 7x EDITDA benchmark of a well-run agency:
1) Remember that you must align your current personal financial requirements with your long term valuation expectations of the business. Specifically, a well-developed, successful, long term business plan requires sufficient investment and the
discipline to assure that investment.
2) Put yourself in the shoes of a buyer annually in focusing on the areas a buyer does to evaluate your business. When going through this exercise assess your strengths, weaknesses, opportunities and threats (SWOT).
3) Evaluate Mitch Joel’s attributes of the marketing agency of the future and how they can be applied to developing your business plan and running your business.
4) Consistently evaluate the skill sets and performance of your staff and upgrade as often as possible keeping in mind the necessity of maintaining productive team chemistry. It will be your team’s abilities, not yours, when a buyer does his or her
valuation analysis and considers the prospects for a future income stream.
Last but most importantly, according to Mike Carlton of Carlton Associates, “And surprisingly while agencies are highly skilled at marketing their clients’ products many don’t do so well in marketing their own brand. Their business programs can be tightly focused on tactical selling with very little strategic marketing. As one very successful agency leader said, “With a
strong tactical selling new business program you make the phone calls. With a strong strategic new business program you just answer the phone”. This suggests that a continued investment in strategic marketing can have an important long-term impact on the agency’s market value. And, in fact, aggressive marketing, as differentiated from aggressive selling, is probably one of the best kept secrets of hot agencies.”
I couldn’t agree more.
By: Christian H. Gomez
The first question I am inevitably asked by any marketing agency owner when discussing valuations of recent transactions is
“What is my company worth”? As Leo Burnett was reputed to have said when commenting on the value of his agency, “The assets of this agency go down the elevator every night.” Indeed, if one looks at the balance sheet of the typical marketing/advertising agency, there is very little there in the way of hard assets, and intellectual property has always been notoriously difficult to value on the balance sheet.
For years the “Rule of 30” has been the benchmark of a well-run agency and a starting point for determining the value of the
business. The Rule of 30 means any combination of operating profit and revenue growth percentages totaling 30%. An agency producing a profit of say 20% will be doing well if it also has a growth rate of 10%. Conversely, the same can be said for an agency that might only have an operating profit of 10% if its growth rate is 20%. The logic here is that as more investment is made to spur short and or longer term growth such as sales and marketing or technology, operating profit will suffer but growth will increase and visa-versa. Furthermore the Rule of 30 axiom says that it is unrealistic to expect an agency to sustain both a rapid growth rate and profitability simultaneously over time.
Enter the Inc. 5000 where over 10% of the companies on the list (click on the Resources Tab on the Home Page tool bar to
view the list) are marketing and advertising agencies with the vast majority boasting revenue growth rates well over 20% and a ratio of staff to revenue that would indicate high profitability. What gives here? Are the agencies fibbing in reporting their financial results or have these businesses found a solution to consistently exceeding the Rule of 30? While there might be a certain number of companies that overstate their financial results there is no question that this is not the case with over 500 agencies on the list. What are they doing right? Let’s start with the typical areas buyers focus on in determining value:
1) What is the future income stream?
2) How desirable are the clients and what is the likelihood of these clients staying?
3) Are there special capabilities or characteristics of the agency such as industry focus, “productization” (to be discussed later), processes, technology, a recognizable brand, etc.?
4) What is the strength of leadership to remain with the business and core talent?
5) Geographic considerations.
Assuming that the answers to the due diligence above yield a comfort level with the chances of maintaining the Rule of 30, how can agencies break through the Rule of 30 to accelerate both growth and profitability simultaneously and realize a valuation north of 7x EBITDA (see our 2013 M&A Outlook)?
First and foremost for agency owners, there needs to be a tight linkage between the Income Statement and Balance Sheet and the Company’s business plan. The bottom line here is that the agency’s value can be enjoyed now or later, but make no mistake that financial largesse in the short term will affect future value.
In an excellent article titled “What the Marketing Agency of the Future Will Do Differently” in the Harvard Business Review, Mitch Joel asserts that the dogma of the industry is being rewritten and lays out five new attributes that marketing agencies will need to survive.
Attribute 1. Models of Leanness. Metrics and outcomes for projects will have to be established from the beginning and
programs will have to bend, move and iterate as we learn from what the market is telling us (marketing optimization anyone?). The days of quarterly planning or seasonal initiatives (aka marketers know best) are over. The transition must be made to a true real-time way of operating (aka consumers know best).
Attribute 2. Utility over Content. This is key. Joel writes that while the last ten years have been about developing content in the social channels (in order to provide value, humanize the brand, be present in the search engines, etc.); the next five years will be about the brands that can actually create a level of utility for the consumer. Furthermore, the utility is something that consumers will use of their own accord because it adds value to their daily lives, regardless of attribution to a brand. The benefit comes to the brand by creating something consumers can’t live without and the appreciation and attachment that come from it.
Attribute 3. Content as Media. Joel indicates that content has been used as chum for brands but that enormous overload and clutter is making it more difficult to resonate with consumers. Content must morph into media as agencies help brands to create more relevant and original pieces of content that don’t look, smell or act like a press release or advertorial. There are many examples such as websites offering educational articles on virtually any subject like www.ezinearticles.com. While these sites promise traffic back to your website they are very strict in not allowing self-promotion in the body of the articles rendering the articles as nothing more than advertisements and a turn-off to visitors.
Attribute 4. R&D. Joel indicates that in the past agencies used to selling services have not been very good at selling products. He says this will have to change. Our Mtech Roundtable Guru Kenyon Blunt saw this first-hand as the CEO of a marketing agency and has authored an article on “21 Ways to Productize Your Services”. Blunt offers three benefits in Productization, namely, consultants who package make 87% more than those that charge by billable hour, you differentiate your company from the competition, and it’s easier for customers to understand and buy and makes the sales and business development process much easier. He breaks down the 21 steps into a four part process; Research, Product Development, Branding, and Go-To-Market Strategy (click on the Resources Tab to view the article in its entirely).
Attribute 5. Many Big Ideas. Joel talks about the traditional “Big Idea” and how agencies traditionally worked with it across all media. Consumers are not now the same when they are watching television as when they are on a smart phone or reading reviews or when they are in a retail location. What are needed now are many big ideas that enable a brand to simultaneously directly or loosely connect with the consumer across channels in a highly personalized manner. Agencies can no longer focus on the Promotion part of the “4 Ps”. It really is about Product, Price, Place AND Promotion. Back to the future?
In summary, here are the steps to follow to exceed the Rule of 30, prepare your agency for the future and exceed the 7x EDITDA benchmark of a well-run agency:
1) Remember that you must align your current personal financial requirements with your long term valuation expectations of the business. Specifically, a well-developed, successful, long term business plan requires sufficient investment and the
discipline to assure that investment.
2) Put yourself in the shoes of a buyer annually in focusing on the areas a buyer does to evaluate your business. When going through this exercise assess your strengths, weaknesses, opportunities and threats (SWOT).
3) Evaluate Mitch Joel’s attributes of the marketing agency of the future and how they can be applied to developing your business plan and running your business.
4) Consistently evaluate the skill sets and performance of your staff and upgrade as often as possible keeping in mind the necessity of maintaining productive team chemistry. It will be your team’s abilities, not yours, when a buyer does his or her
valuation analysis and considers the prospects for a future income stream.
Last but most importantly, according to Mike Carlton of Carlton Associates, “And surprisingly while agencies are highly skilled at marketing their clients’ products many don’t do so well in marketing their own brand. Their business programs can be tightly focused on tactical selling with very little strategic marketing. As one very successful agency leader said, “With a
strong tactical selling new business program you make the phone calls. With a strong strategic new business program you just answer the phone”. This suggests that a continued investment in strategic marketing can have an important long-term impact on the agency’s market value. And, in fact, aggressive marketing, as differentiated from aggressive selling, is probably one of the best kept secrets of hot agencies.”
I couldn’t agree more.
Build Your Company to Sell (Even if YouDon't Want to)
By: Kenyon Blunt - CEO A Player Group - [email protected]
I watched a great video this week from Brent Hodgins from Mirren (www.Mirren.org). Mirren works with advertising agencies and marketing firms to improve business development. His point-of-view is that you should build your agency (company) like it is going to be placed on the market for sale. Too many firms, especially smaller ones, are so reliant on the founder that it’s impossible to attract prospective suitors.
Having been through this process several times, I thought it would be good to elaborate. One of the best business books over the last decade has been Michael Gerber’s The E-Myth. His premise is that you should build a small business like a franchise with operating systems and procedures so that it runs as smoothly as possible and not be so dependent on the founder. You know, the old “work on the business, not in the business” mantra. Brent and Michael’s philosophies both underscore the need for the business owner/founder/CEO to create a company that runs independently of herself.
From my experience, this is much easier said than done. Here’s what a prospective acquirer looks for in a target company; revenue growth potential, risk of loss of key team members (including the founder) and competitive superiority. Let’s take the talent issues first. Acquirers want to know the business can survive without the founder. He or she may agree to stay on for a period of time but it’s usually in a transitory role and not something to bank on for future results. In many smaller firms that I’ve been associated with, the founder is instrumental in generating new business. This can be a big problem if he or she wants to exit. One of the first priorities must be to develop a new business engine that is independent from the owner.
The second priority is to develop a leadership team that in highly attractive to an acquirer. Everyone says they have a terrific team; the challenge is to prove it. If you have a talent management system like Topgrading (www.Topgrading.com), it makes it easier to document and sell would-be acquirers on the fact that you have A-player talent.
Finally, acquirers are looking for financial results. Yes, everyone says they are on the verge of “breaking-out” but the key, again, is to prove it. Acquirers also want good margins, scaleability and predictability of revenues. While all of these are financial metrics, they can be “proved” with talent. Can your leaders duplicate current results and improve them in the future? And, of course, that means without the help of the current owner.
Our goal, whether we want to sell or not, is to create a company that’s independent of the founder and that can grow with the skills of the leadership team. As I said earlier,“easier said than done.”
By: Kenyon Blunt - CEO A Player Group - [email protected]
I watched a great video this week from Brent Hodgins from Mirren (www.Mirren.org). Mirren works with advertising agencies and marketing firms to improve business development. His point-of-view is that you should build your agency (company) like it is going to be placed on the market for sale. Too many firms, especially smaller ones, are so reliant on the founder that it’s impossible to attract prospective suitors.
Having been through this process several times, I thought it would be good to elaborate. One of the best business books over the last decade has been Michael Gerber’s The E-Myth. His premise is that you should build a small business like a franchise with operating systems and procedures so that it runs as smoothly as possible and not be so dependent on the founder. You know, the old “work on the business, not in the business” mantra. Brent and Michael’s philosophies both underscore the need for the business owner/founder/CEO to create a company that runs independently of herself.
From my experience, this is much easier said than done. Here’s what a prospective acquirer looks for in a target company; revenue growth potential, risk of loss of key team members (including the founder) and competitive superiority. Let’s take the talent issues first. Acquirers want to know the business can survive without the founder. He or she may agree to stay on for a period of time but it’s usually in a transitory role and not something to bank on for future results. In many smaller firms that I’ve been associated with, the founder is instrumental in generating new business. This can be a big problem if he or she wants to exit. One of the first priorities must be to develop a new business engine that is independent from the owner.
The second priority is to develop a leadership team that in highly attractive to an acquirer. Everyone says they have a terrific team; the challenge is to prove it. If you have a talent management system like Topgrading (www.Topgrading.com), it makes it easier to document and sell would-be acquirers on the fact that you have A-player talent.
Finally, acquirers are looking for financial results. Yes, everyone says they are on the verge of “breaking-out” but the key, again, is to prove it. Acquirers also want good margins, scaleability and predictability of revenues. While all of these are financial metrics, they can be “proved” with talent. Can your leaders duplicate current results and improve them in the future? And, of course, that means without the help of the current owner.
Our goal, whether we want to sell or not, is to create a company that’s independent of the founder and that can grow with the skills of the leadership team. As I said earlier,“easier said than done.”
2021 Window to Sell Will be Closing Soon
The perfect storm of dry powder (capital to invest), low interest rates, and pent up post-Covid demand has created the hottest Sellers' market since the 2009 recession. In addition to price Sellers are in a position to negotiate transaction structure and concessions only possible in the current enviornment. For instance, we are seeing many more all-cash deals and fewer earn-outs (especially in purchases by corporate strategic buyers). In private equity acquisitions, earn-outs are being replaced in many deal structures by "equity rolls" where sellers are reinvesting a portion of cash received at close for an equity interest in the follow-on business. Whereas Buyers previously negotiated a separate class of equity junior to their investment for the Seller equity roll, the current environment is providing Sellers with the opportunity to reinvest along side private equity in the same class of stock.
If business owners are considering a sale in 2021 it is important to begin the process ASAP. The sheer transaction volume and post-Covid transaction processing environment requiring virtual methodologies is extending the normal time required to complete and close deals. Axial, an online Buyer/Seller exchange recently posted an interesting article advising Buyers how to compete for deals in a Sellers' market. We believe this information is very valuable in informing Sellers on items of real value that can be negotiated in addtion to price. The link is provided below.
Our Marketing Valuation Multiples Table (link at the top of the Home Page) for marketing technology businesses with annual revenues to $50 million remains viable albeit at the high end of the EBITDA multiple ranges.
The perfect storm of dry powder (capital to invest), low interest rates, and pent up post-Covid demand has created the hottest Sellers' market since the 2009 recession. In addition to price Sellers are in a position to negotiate transaction structure and concessions only possible in the current enviornment. For instance, we are seeing many more all-cash deals and fewer earn-outs (especially in purchases by corporate strategic buyers). In private equity acquisitions, earn-outs are being replaced in many deal structures by "equity rolls" where sellers are reinvesting a portion of cash received at close for an equity interest in the follow-on business. Whereas Buyers previously negotiated a separate class of equity junior to their investment for the Seller equity roll, the current environment is providing Sellers with the opportunity to reinvest along side private equity in the same class of stock.
If business owners are considering a sale in 2021 it is important to begin the process ASAP. The sheer transaction volume and post-Covid transaction processing environment requiring virtual methodologies is extending the normal time required to complete and close deals. Axial, an online Buyer/Seller exchange recently posted an interesting article advising Buyers how to compete for deals in a Sellers' market. We believe this information is very valuable in informing Sellers on items of real value that can be negotiated in addtion to price. The link is provided below.
Our Marketing Valuation Multiples Table (link at the top of the Home Page) for marketing technology businesses with annual revenues to $50 million remains viable albeit at the high end of the EBITDA multiple ranges.
