Do You Want to Sell Your Digital Agency in 3-5 Years?

Is it time to sell your digital agency? Considering a merger or acquisition in the near future? John Burns worked in mergers and acquisitions for 15 years when he realized a gap in the market, specifically for agency owners. So 7 years ago, he started Clare Advisors, a company that provides mergers, acquisitions, and financial advisory services to privately-held digital agencies and companies in the marketing, media, and business services industries. In this interview, John discusses what owners should consider preparing to sell their agencies, the common misconceptions of when to sell, and why now is a good time if you're considering selling in the next three to five years.

1. What you need to start preparing. There's a number of factors a buyer would potentially look at in evaluating whether or not they should buy your agency. One of them is profit margin, whether you're consistently making profit and whether your profit is expanding. Also, revenue growth and scalability, since obviously buyers want to buy agencies that are growing and have a lot of momentum. John says the important thing is considering whether you have the infrastructure in place and the right team to grow, over any earn-out or follow-up period.
2. A common misconception. One of the most common questions John gets is around the target revenue for selling. Whether an agency should be at $10 or $5 million and then sell. “This is a common misconception from owners,” he says because people think the right time to sell is when you’ve topped out at a particular number. Many commonly look to sell a business when their lease is up, and John agrees it could be a factor, so have in mind it may come up. But actually, the right time to sell is when you have the most momentum behind the business and the most wind behind your back. If you’re not in this situation and still want to sell, remember that Jason always advises the right time to sell is when you need the money or you hate the business.
3. Thinking about selling soon? We have a very active market right now with a lot of owners who are thinking of potentially selling. There are really low-interest rates, so cash is easy to come by, and a lot of companies have excess working capital on their balance sheets because of either PPP loans or some of the fiscal stimulus. Also, capital gains tax rates are potentially going to increase at some point in the near future. It is a very dynamic climate and John advises taking some of those factors into consideration. Don't necessarily sell sooner than you want, but it is a good time if it's been something you're considering the next 3-5 years.

Common Misconceptions About Selling & Tips to Selling Your Agency in The Current Active Market

{These transcripts have been auto-generated. While largely accurate, they may contain some errors.}

Jason: [00:00:00] What's up, agency owners? Today I have an amazing guest. We're going to talk about valuations and preparing your agency for selling and why you would sell or why you would not sell. So let's go ahead and jump into the show.

Hey, John. Welcome to the show.

John: [00:00:21] Hey, Jason. Great to be here.

Jason: [00:00:22] So tell us who you are and what do you do?

John: [00:00:25] Uh, I am the founder and managing director of Claire Advisors. Claire Advisers is a boutique mergers and acquisition and financial advisory firm that specializes exclusively in working with agencies and marketing services companies.

Jason: [00:00:38] Cool. And so why did you get into this business?

John: [00:00:41] I've been doing mergers and acquisitions for about the last 15 years. Uh, started initially working in New York for a couple of different investment banks. And about seven years ago found there was a real gap in the market in terms of, uh, resources for agency owners specifically related to mergers and acquisitions.

So I decided to found Clare Advisors in order to specifically work with boutique agency owners ann the mergers and acquisitions field.

Jason: [00:01:12] I wish you just said that, uh, I got into it to pick up women. Because I keep thinking of there's a movie going, like, what do you do? I've been mergers and acquisitions.

I've always wanted to say that. And now I'm kind of am and that's the kind of…

John: [00:01:25] I was going to say. I think you technically can.

Jason: [00:01:28] Well, but I'm married. So I can't. Let's talk about what are some of the things, if someone's listening and they go one day I want to sell. Jason, I want to sell, like you did in your agency or, or like someone else, what do they need to start preparing?

John: [00:01:49] So there's a number of factors that a buyer would potentially look at in evaluating whether or not they should buy your firm. They should be looking at profit margin specifically. So whether you're kind of making, whether you're consistently making profit and whether your profit is expanding. Revenue growth, obviously buyers want to buy agencies that are growing as opposed to shrinking and scalability, realistically.

It's very common for any deal that happens to specifically have kind of an upfront piece and an earn-out or roll-over equity piece or some piece that's based on value later in the future. And so the important thing to prepare for is that your agency is in a position where you've got a lot of momentum and where you can grow, uh, over the, over the period of the earn-out, um, in order to maximize your valuation.

So you need to really have the structure and the infrastructure in place where you're in a good position to grow.

Jason: [00:02:44] And how big does someone have to be in order to really kind of start thinking about, hey, I want to possibly sell my business?

John: [00:02:54] So there's no predetermined limit in terms of, like I said, in terms of overall value. Firms sell that are two and $3 million of revenue. Firms, obviously sell that or 20, 50, a hundred million dollars of revenue.

So deals happen at all kinds of places in the spectrum of size. The main thing I would consider if I was thinking about selling is specifically, do you have the infrastructure in place? Do you have the right team in place to be able to grow over any earn-out or follow up period? Because there will inevitably be a link between the ultimate value that you get and the ability you have to grow the agency under someone else's ownership.

Jason: [00:03:33] What are some of the criteria that go into valuation outside of profit?

John: [00:03:39] Uh, so the rate of growth, if you're, you know, if you're doubling in size every year, you're certainly going to get a higher valuation than somebody who's growing at, you know, five or 10% or who's flat. I would say the quality of the management team to a certain degree, um, whether you've got that infrastructure and that team in place, and it looks like a team that can really, really scale and really, really grow the business.

The quality of your clients is another one. Uh, buyers obviously prefer retainer-based clients. The world is looking less and less like retainers these days and more like project-based work. But then the quality of the clients becomes really, really important. Is this a client that keeps coming back to you for more and more services? Is there consistency in your clients or are you effectively, you know, recreating your pipeline every three to four months?

Jason: [00:04:26] Gotcha. And a lot of people think there's a threshold on top-line revenue for when to sell like, oh, I'll get to the million mark or is it based on profit? What, what are you seeing?

John: [00:04:39] So the most common question that I get that is a misconception is owner say exactly what you just said, which is I'm going to get to $10 million and then I'm going to sell, I'm going to get to $5 million and then I'm going to sell.

The right time to sell is when you have the most momentum behind the business. So specifically, it's not necessarily that you're at $10 million. Um, it's important to be at $10 million dollars if you think that over the next couple of years, you can grow to 11, 12, 13, and 15, because the thing that will hurt you the most is if you decline after you sell during your earn-out period, that'll financially hurt you.

And so the ideal time to sell isn't when you've kind of just topped out at a particular number. The best time to sell is when you've got the most momentum behind you and the most wind at your back, going into your earn-out period.

Jason: [00:05:31] I've been telling people the best time is when you need the money or you hate the business.

John: [00:05:37] Those are alternatives as well. Yes, I agree.

Jason: [00:05:40] Alright. But the funny thing, I remember reading a stat many years ago, they said one of the most common reasons why to sell a business is when their lease is up. And I read that… because and then I thought about it and I was like, you know, they got something there because the lease is the longest term commitment that you have.

John: [00:06:03] It's certainly a factor that's brought up, especially nowadays of the question of do you have a lease and, just because everybody's working remotely or at least partially remotely, the question of, do you have a lease? How much space is it for? Where is it? And when is it up? That certainly comes up most buyers I know wouldn't make or break their decision based on that one factor, but it is a factor.

Jason: [00:06:23] And which deals do you see most? And let's say we value the agencies under 10 million. Agencies under 10 million is it more an asset purchase or are they buying everything?

John: [00:06:36] So I would say, generally speaking, most buyers want to do asset purchases as opposed to equity purchases, but that's going to vary between buyer and buyer and specific structure.

So I don't think there's, I don't think you can put too much into that as a generalization. It's really going to depend on the individual buyer.

Jason: [00:06:58] Let's get real for a minute. Do you want help scaling your agency so you can scale it faster? Now you might've been following my content for a while and you really wanting to accelerate your agency's growth. And maybe you're just too close to your agency and not sure which areas you really need the most help.

You know, I hear this all the time from a lot of agency owners, and that's why I brought in a new team member to help you figure out your next step. Now we spent the past couple of months working side-by-side, a little too close, and now we're setting up a free strategy session so you can grow and scale your agency faster.

And so I want you to meet Darby.

Darby: [00:07:34] Hey guys, I'm Darby.

Jason: [00:07:35] If you want to walk through a framework for scaling your agency faster, Darby's the guy. He can assess what's going on in your agency and really help you figure out our next step. He'll be candid, he'll be Frank and he'll be brutally honest. Just schedule a time to chat with Darby.

Darby: [00:07:51] That's me.

Jason: [00:07:52] No strings attached. He's ready to meet with you. So book a call at jasonswenk.com/darby. That's jasonswenk.com/darby. Darby will spend a little time getting to know you, your agency, your goals together. You'll figure out your next steps for scaling your agency faster checkout and wait for Darby.

Darby: [00:08:17] Uh, am I allowed to talk now?

Jason: [00:08:19] You can book a call with Darby. Just go to jasonswenk.com/darby and…

Darby: [00:08:25] Have a Swenk day.

Jason: [00:08:19] And I know when our agency is buying agencies we set a certain kind of requirement. You have to be close to or well, over the million in EBITDA because that's when the multiples really kinda start going up. I, I've always seen kind of anything under that the multiples are really fairly low. Are you seeing the same thing?

John: [00:08:56] It varies a little bit, depending on the specifics of the deal and the structure. I wouldn't generally say the multiples are… Generally larger firms get larger multiples, that's a fair generalization to make, but it really depends on the structure. If you are a smaller firm, you can partner with somebody and they can subsequently give you a tremendous amount of business because you do a capability that they don't do.

Talk about a social media or a digital agency kind of partnering with a PR firm as an example, if one can open up their client lists to all those services, maybe technically they're selling for a lower multiple than a much larger firm would get. But if they're able to really expand their revenue and expand their profitability in a way that they couldn't do on their own, regardless of kind of where the multiples fall, that's probably a deal that maximizes consideration for the seller.

So generally it's true, but it's, it really depends on the structure more specifically.

Jason: [00:09:53] And let's talk about what's the most common structure for something like that.

John: [00:09:57] Sure. So the typical one that you see in the market is like a three or five-year outs where you get a portion of cash consideration at close. Then there's either some kind of rollover equity or some kind of earn out over a three to five-year period.

You actually, as a seller, want a longer earn-out period, if you can do it, if you're, if the timeframe works for you, because it gives you more opportunities to grow, uh. If you have a very short earn-out period, you know, let's say 12 months and let's say COVID happens, or let's say there's a dramatic downturn in the economy, or you lose a client. It's really hard to make up that lost revenue in that lost profitability.

Having an earn-out for at least a couple of years or a few years, at least gives you a couple of opportunities in the event anything goes wrong to subsequently build back up and still try to maximize your valuation.

Jason: [00:10:47] Yeah. And I always tell everybody, you know, like the cool thing we do at Republics is where there's no timeframe on there now. It’s just when you hit it, you hit it.

And we want you to hit it. Where, when I went through, I did well, but I could have done, I lost millions in the earn-out because someone didn't tell me to think about a longer-term earn-out. And so when we were sold for the second time, that was nine months later, that sped up and it was just, it was over.

I was like, oh, wow, you douchebags sold a day after I went out of the window. That wasn't designed, was it? Um, but, uh, yeah, it was.

John: [00:11:27] Your model that you're talking about with no timeframe that looks a little bit more like what you would see from… It, it's a little bit on the unique side. I would say there's normally a defined timeframe just because there's, you know, kind of investment criteria that has to be made depending on who the buyer is.

So your model's a little bit different. It feels a little bit more like, it looks a little bit more like it's a partnership a little bit more like kind of they're rolling footy. So it's not something I've never heard of, but it's certainly more unique in the market.

Jason: [00:11:55] Yeah. Well, I mean, we look at it as we want it to be a win-win, you know, it's not, we don't want to… And, and the thing too is like, when we put the requirements on who we buy, a lot of people think oh, the market turned because of COVID, which it didn't, it actually went up. But there were thinking in the very beginning, oh, I'm going to take advantage of all these people that are losing and going down.

And I'm like, we don't want to buy agencies that are going on the down projectory. We want them to be going up so that they can speed up our, you know, success. And then we can go do the things that we really want.

John: [00:12:30] And if you buy somebody that's in a negative position or that's in a really, really desperate position, you're really not getting, you're truly not getting partnership from that owner. Realistically, that owner is looking to cash out, looking to leave. It’s not… Yeah. And it's just not a good situation for them either. So it's hard to make those situations work.

Jason: [00:12:52] Yeah. I mean, they're just, they're an anchor dragging the whole boat down and, uh, I’d just cut the line and be like, you can sync.

For the agency side. Now, if you're sinking, you can come to us and we can help you out on the consulting and you can be around amazing agency owners. But, um, let me ask you this. What is the biggest multiple you've seen for an agency?

John: [00:13:18] That's hard to say…

Jason: [00:13:20] Just on evaluation and, and I'll preface this because like you talk about different deal structures. Most people that are listening, if you think the valuation is the amount of cash you're getting, you should think again, that's just the valuation.

You'll get maybe some cash. Like, you know, a lot of times what we'll do at Republics, we'll do 50% cash sometimes a little bit more. But it depends on situations, but there's a lot of situations I've seen where people are like no cash upfront. We'll give you the valuation, whatever you want. But that doesn't mean anything.

John: [00:13:54] So the way that buyers generally approach valuation is ultimately it's gotta be a win-win for the buyer as well. Buyers are not in the business of giving away money just for the sake of giving away money. So there has to be some type of alignment between the buyer and the seller.

If you take a look at some of the publicly traded holding companies, as an example, when they buy firms, they typically would want those deals to be a creative to them. Meaning that when that profitability comes over to their publicly traded stock, they get more value for it than they paid for. What that generally means is that they should be buying companies at some type of discount of multiple to what they're trading at in the market.

So if you've got a publicly-traded marketing holding company and is trading at 14 times earnings or 15 times earnings, or, you know, something of that nature, most likely they're not going to be buying firms for, or be willing to buy firms for that multiple, because it's basically, you know, they're taking $2 over here and then moving $2 over there. It doesn't really add any value for them.

So they'll probably buy at a significant discount to that. So, If you've got a buyer, who's, who's a publicly-traded company and they're trading at 15 times, you probably, you should probably should expect your valuation potentially depending on the specifics of your company to be somewhat of a discount from that, either a high single-digit or low double-digit, depending on the buyer and depending on the circumstances.

Jason: [00:15:22] Well, this has all been amazing, John, is there anything I didn't ask you that you think would benefit agencies listening?

John: [00:15:29] I think that the, the only other thing that I would say that is relatively unique about this particular time period, that we're having this conversation in right now, post-COVID and just kind of the economic factors that they are.

It's a very active market right now. Uh, there's a lot of companies that are for demographic reasons you have a lot of owners who are thinking of potentially selling now. You have really, really low-interest rates. So cash is really, really easy to come by. A lot of companies have excess working capital on their balance sheets because of because you know, of either PPP loans or because of, you know, some of the financial stimulus that's been in the market and they've actually done pretty well through that period.

You potentially have capital gains tax rates going to increase in some point in the relatively near future. And so it's a fairly active market right now. Um, and if someone's thinking about potentially selling, I would recommend to them that they give it very serious consideration because there's a lot of people looking for companies right now. There's a lot of… the landscape is changing and people are looking for different capabilities than they were a few years ago as you mentioned earlier, is that some companies did really well during COVID.

And, um, so it's just a very dynamic market right now, so if anybody's thinking of selling in the next couple of years, I would say that they should probably take some of those factors into consideration. And effectively, uh, not necessarily sell sooner than they want to, but, um, it's, it's definitely a time to be thinking about that if you're, if you're planning on selling in the next three to five years.

Jason: [00:16:59] Awesome. What's a website people can go and check you out?

John: [00:17:02] Uh, our website is Claire, claireadvisors.com. So we're at Clair Advisors and you can, uh, you can find us there any time.

Jason: [00:17:10] Awesome. Well, thanks so much, John, for coming on the show.

And if you guys are interested in selling your agency and maybe, you know, you want to get my advice, or maybe you want us to even buy you, I want you to go to jasonswenk.com/sellagency and just a quick little form. And then if we think, uh, we can help you out or position you to a certain buyer, uh we'll we'll help you with that.

So go to jasonswenk.com/sellagency. And until next time have a Swenk day.