Manifesto on Selling Your Agency
So, you want to sell your business?
You have invested a lot of energy into growing your business and now want to reap the fruits of your labor. You've made up your mind to cash in your proverbial chips. You are finally ready to separate your personal identity from your agency’s brand. You, my friend, are now in the right mental state to sell your business. Congratulations on reaching this first step. This is going to be an exciting endeavor for both you and your business. It is now time to embark on the next step of your journey: figuring out how much your business is worth.
Agency Valuation
Placing value on your agency would be a simpler process if it were a publicly traded company. We would simply take your stock price and multiply it by the number of shares outstanding to give us what is known as your market capitalization. Here's an example: if Agency BCD trades at $20 per share and has 50,000 shares outstanding, then its market cap would be $1 million. Unfortunately, the publicly traded market is not assessing your stock price every day; so, we must instead dig a bit deeper to determine how your business generates value.
Your agency generates value in a few different ways:
Clients benefit from the value of your expertise
Employees have a home base to level up their skills while being fairly compensated for their work
You have an asset thriving under your leadership that supports your life outside of work
While all of these activities generate value, they do not get us closer to determining the book value of your business. The term “book value” describes the value of your business according to your financial books or financial statements. Book value is calculated by subtracting the difference between total assets and total liabilities on your balance sheet.
Book value = Total assets - Total liabilities
For instance, let’s suppose that Agency BCD has total assets of $1M and total liabilities of $800K. The book value of Agency BCD would be $200K. In other words, if the agency sold its assets and paid off all of its liabilities, then its net worth would be $200K.
The Two Types of Agency Buyers
There are two types of buyers for your agency business: Strategic Buyers and Financial Buyers.
Strategic Buyer.
The strategic buyer looks at your agency because it's a good fit with their current business. Ultimately, they are hoping to leverage your business to help expand their current offerings. Holding companies are considered strategic buyers. When Omnicom and some of the other large holding companies invest in an agency, they are leveraging the new agency to expand their service offerings to clients. Because of this strategy-oriented fit, strategic buyers are willing to pay a premium over the book value of your business.
Financial Buyer
In contrast, the financial buyer views your business as an asset that will provide a future cash flow stream. They are paying particular attention to recurring revenue streams like long-term contracts and retainers. Financial buyers are concerned with purchasing future cash flow, and generally won't factor anything into the purchase price that does not affect the price.
Determining Your Sales Price
Working out your sales price is a lengthy process. Prior to selling your business, you want to determine the potential sales price of your business about 3-5 years in advance. This timeline gives you enough runway to improve your agency to reach the price you have in your head. When many agency leaders first go through the valuation process, they are surprised to learn that there is a sizable gap between the number they had in their head and the true estimated value of their business. It is important to know that valuation consultants are using financial models to determine the price a prudent buyer will pay for your firm.
Let's look at four of the most common ways to determine your sales price.
1. Asset Valuation
Look at your assets (cash, accounts receivable, contracts, reputation, client list, etc.) and make estimates about what those assets are worth. Next, subtract liabilities (accounts payable, taxes payable, lines of credit, etc.) from the asset valuation to determine your equity. Note that you wouldn't sell for this price—you could earn this money simply by closing your shop, selling off your assets, and paying off your liabilities. When you perform an asset valuation, you are trying to sell the buyer on including goodwill to increase the price over and above your asset valuation. Goodwill is the value of your agency brand and reputation.
2. EBITDA Valuation
Your EBITDA is earnings before interest, taxes, depreciation, and amortization. With this method, you take an appropriate multiple to determine your valuation. Let’s say that your EBITDA is $500K, and the market determines that an appropriate multiple for your agency is 3; your EBITDA valuation would be $1.5M. Investment firm Berkery Noyes has published data on median EBITDA multiples based on recent transactions. Be aware that sometimes, your EBITDA is inflated because you are not paying yourself a fair marketplace salary. The other major item you must factor in is client concentration. Buyers get nervous if your revenue follows the 80/20 rule—i.e., 80% of your earnings are coming from 20% of your clients. Buyers will not pay a premium for agencies with a high client concentration, which is defined as any one client contributing more than 25% of your agency gross income.
3. Agency Gross Income Valuation
Your agency's value can be expressed as a multiple of its Agency Gross Income, or AGI. So that we're all speaking the same language, your Agency Gross Income is the difference between sales and cost of goods sold. For example, say that a buyer examines the last 2-3 years of your AGI and sees that your average AGI is $1M. If similar agencies are selling at a multiple of 2, then the value of your agency can reasonably be set at $2M.
4. Discounted Cash Flow Valuation
Buyers use this method to estimate the value of your business based on expected future cash flows. The present-day value of your agency is determined by estimating how much cash you can reasonably expect to earn in the future (usually over a period of five years). There are many factors that will impact future cash, including the economy, agency management, and competition. Your estimated future cash flow is then discounted using current interest rates to arrive at the present-day value for that cash.
Final Thoughts
From these different valuation models, you can see that there are a variety of ways to determine your agency value. No matter your method of choice, you want to make sure you are correctly assessing your value before you start speaking with potential buyers. I'll go into the weeds with the different valuation methods in future articles; in fact, I'll release the articles as a series for those of you interested in understanding how to value your agency. These articles will include sample financial statements so you can see how the calculations are done.
If you are interested in a valuation of your firm or want assistance determining the value of a potential acquisition, please reach out about our Agency Valuation Services.