Selling your agency, a how-to guide, Part 2: Why do agencies get acquired?

A few months ago, I created a list of every search engine marketing agency with at least 10 employees in the US. You can view it here; there are over 100 agencies on the list.

You’ll notice that more than 80 percent of the agencies listed are independent. To be clear, many agencies have no intention of ever being acquired, so being independent doesn’t mean you aren’t acquirable. Still, many of these firms would be open to acquisition, so the question emerges: Why do some get bought and others passed over?

The four reasons agencies get acquired

As I noted in the last column (Part 1 of this guide), there are four primary reasons agencies get bought.

1. Revenue. It’s no secret that a lot of large agencies grow revenue through “inorganic growth” or acquisitions. That said, all revenue is not created equal. More specifically, the more revenue your agency has, the more acquirable you are. As a general rule, it’s challenging to be acquired if your agency has less than $10 million in revenue (and by revenue, I mean actual revenue, not media pass-through).

Here are some other financial factors that will influence the value of your revenue:

2. Geography. Having relationships and staff in a specific city or country can be very attractive to an acquirer trying to break into that market. This is particularly true where foreign languages or customs create a barrier to entry for outsiders.
   
3. Unique services or technology. There’s always a new channel or trend in marketing that big agencies feel they need to quickly offer. Ten years ago, that meant SEM agencies. Today, the trend is toward mobile and analytics agencies. Creating traction in an emerging niche is a great way to be attractive to acquirers.

Creating great marketing technology can be very valuable to acquirers, but it can also lead agencies down an expensive and distracting path. I say this because I have seen several agencies that have built proprietary technology but have gotten no value for this technology when they are acquired.

In other words, the acquirer is unwilling to give the agency a “technology multiple” and instead only offers a “services multiple” on their revenue. So if you’ve spent $5 million building technology that does not increase your valuation, you’d better hope that that technology truly drove $5 million worth of efficiency or growth for your company, or you’ve wasted a lot of money.

4. Client base. Lastly, an agency with a few choice clients may get acquired because a bigger agency wants access to those clients. Usually, this means that the agency has a long-standing and very solid relationship with one or more important clients, either solidified by an iron-clad contract or through evidence of a relationship that will last beyond an acquisition.

What is enterprise value, and why does it matter?

Simply put, enterprise value is value that exists in the agency and not in its people or clients. If the top executives and clients of the agency left the day after an acquisition, would the agency still exist? If not, there’s no enterprise value.

In smaller agencies, the big question is whether the agency is more than just the founders. For example, if the founders do all the selling and manage a large percentage of client revenue, the enterprise value walks out the door the day the founders leave.

To some degree, this can also be true for clients. If 25 percent or more of the agency’s revenue concentration is in a few clients, this can also raise enterprise value concerns (although, as noted above, this concern can be rebutted).

The bottom line is that your agency is most acquirable if you can provide evidence that the agency will flourish in the future, even if a key executive or client leaves.

What matters more: revenue or profit?

Reaching the $10 million revenue tipping point is only relevant if you can also demonstrate that you have healthy profits. Profits are an indicator of sound management and a healthy business, and of course, they are also something that you can distribute to shareholders.

But which is better: a $10 million revenue company with $1.5 million in profits, or a $5 million business with $2.5 million in profits? There isn’t one obvious answer.

I have heard anecdotally that the “average agency” generally does 15 percent profit (often referred to as EBITDA — earnings before interest, tax, deductions and amortization). Because bigger agencies generally like to acquire companies that will improve both their revenue and EBITDA, striving for profit in a range that is at or above industry standards is beneficial when attempting to sell your business.

Of course, the other benefit of profit is that you have money to invest in growth or to have on hand for months when the business isn’t performing. Put another way, with good profit, you don’t have to feel pressure to sell — you can just keep running your business.

To answer my hypothetical about 15 percent EBITDA at $10M versus 50 percent EBITDA at $5M: The most important thing to do is to have a good explanation for why your business is operating one way or another. Fifteen percent EBITDA might be great, but not if you are spending 30 percent of your budget on luxury vacations for the executive team.

Would you buy you?

There are numerous factors that make an agency a good acquisition candidate: strong financial performance, great clients, geography, technology and enterprise value all factor into the equation. The mix of each of these varies for each acquisition; there isn’t a precise formula.

If you aren’t sure if your agency is really sellable, ask yourself this: Knowing everything you know about your agency, would you buy it? If you can’t give yourself a resounding yes, there’s work to be done before you put your firm up for sale.

Coming next: What’s it like to be acquired?

In the next column, I’ll discuss the mechanics of being acquired, from responding to unsolicited offers to working with high-priced lawyers and investment bankers.

Some opinions expressed in this article may be those of a guest author and not necessarily Marketing Land. Staff authors are listed here.

About The Author

David Rodnitzky

David Rodnitzky is CEO and co-founder of 3Q Digital, a Harte Hanks company, a marketing firm with offices in the San Francisco Bay Area and downtown Chicago. David is the founder of the LinkedIn Online Lead Generation Group, an advisor for Marin Software, and a regular contributor to the 3Q Digital blog. He can be found at numerous speaking engagements across the SEM community.