Here's Why You Should Consider Phantom Equity When Selling Your Agency
The Very Real Promise of Phantom Equity
The terminology may frighten some away. But phantom equity, especially when it comes to selling your agency, has the potential to breathe new life into your agency. The upsides are well worth taking the time to ensure that phantom equity is anything but elusive to you. Make phantom equity work to your advantage by using it as the adhesive that binds essential human capital to your agency long-term, especially post-sale, promising profit shares in return.
What Is Phantom Equity and Why Does It Matter When Selling Your Agency?
Phantom equity is both equity and not equity. It offers the benefits of company stock without actually issuing any. Known also as “phantom stock” or “virtual shares”, they offer deferred compensation in line with company performance much like actual stock would. And much like actual stock, this equity will vest over time and according to an agreed schedule. However, unlike actual stock, phantom equity never offers the opportunity to exercise a voting right; they are financial-only. This means holders of phantom equity don’t sit on the cap table, carry no liability and, as such, pose practically no added legal requirements or costs to get set up as phantom stockholders.
Should I Take Advantage of Phantom Equity When Selling My Agency?
If you are considering selling your agency and you’re an owner who is looking to stay on long-term, phantom equity makes perfect sense. Phantom equity ensures that a founder – or any other essential team member for that matter – stays on, stays committed and stays a part of the continued growth story even after a sale and post-sale transition period have been completed. Offering phantom stock in the business post-transaction offers an objective guarantee, aligning buyer and seller incentives for continued success.
After all, human capital is the key component to the business that was just acquired. Keeping the engine room of an agency firing on all cylinders means binding that human capital to the agency’s continuing journey down the growth path. Especially when the agency is a smaller business – approximately 15 people or fewer – the value of each team member tends to be magnified. Binding essential team members to the long-run success can be a sure-fire win-win.
When Does it Make Sense to Avoid Phantom Equity?
If you are looking at selling your agency but do not plan to stick around for the long haul once your agency has been sold, then phantom equity may not be for you. Even a full year of commitment post-sale is not in alignment with the purpose and likely vesting schedule of phantom equity. Generally speaking, it takes a minimum of a three-year commitment for phantom equity to really begin to pay off.
In addition, if a buyer only wants to incentivize team members that stick around for an agreed minimum period that extends beyond the start of the vesting schedule, they may want to consider a cash bonus plan instead. The reason here is that these are generally forfeited altogether when an employee leaves whereas the vested phantom equity could mean having to pay out somebody who left sooner than a buyer might have liked.
The Bottom Line
The initial post-sale transition period of, on average, 90 days is tied into every deal. What happens beyond that is down to the interests and alignment of seller and buyer. If the interest is there for a seller to stay on board long-term and keep reaping the benefits of an agency’s ongoing growth story, the direct path to participating in the profits to come, is phantom equity.
Flexibility Is The Key To Sell Your Digital Agency
Selling Your Digital Agency? Why an Owner’s Flexibility is Key to Sealing a Deal
When you are looking to sell your digital agency, negotiating the sale will take time. That time will require more than just patiently waiting on the sidelines. It will require a back and forth that will see most owners giving way at some point, be it with regards to the selling price, payout terms, or the time it takes to complete a deal. Staying focused on the goal of completing the deal – rather than staying focused on a timeline or a price tag – will help ensure a successful transaction.
Your Transaction Doesn’t Live in a Silo
As promising as the performance metrics on the books may look, the growth trajectory of your agency is taking place in a complex environment comprised of many players. There will always be a market reality outside of your agency. And a buyer scanning the market will be well aware of this reality. It’s important to show you understand this in practical terms by adjusting deal terms and pricing in line with what the market suggests is feasible.
Your Agency Has More Than One Type of Buyer
While you may have your mindset on a specific type of buyer, market shifts mean that not only are price and deal terms a dynamic part of the equation, but the buyer type continues to evolve as well. Larger agencies looking to acquire your client portfolio may have been a classic buyer type in the past, but they are far from the only one nowadays.
Solo-preneurs, in particular, have reshuffled the deck. These high-net-worth experts are sitting at a corporate job or a large agency and are looking to apply their know-how and their network to scaling something they don’t have to build from the ground up. Keep an open mind as to who will be steering the ship following your departure and you will be sure to up your shot at getting the deal done.
Take It One Step at a Time To Sell Your Digital Agency
Flexibility won’t go far if you don’t have a healthy dose of patience when you go to sell your digital agency. Keep a leveled head as negotiations inch forward and continue to be calm post-transaction as well. Staying flexible with respect to how long you will be needed after the date of a transaction will help ensure smooth sailings beyond the moment of signing. Putting in the bare minimum of just 30 days to cash out fast is never recommended. A 90-day minimum that is ideally extended into the range of 6-12 months is optimal to make sure all parties’ best interests have been served.
One Step at a Time
An agency sale is not complete on the occasion of signing the deal. It’s important to understand what happens in the run-up and the post-sale and what sort of attitude can help all involved feel like they’ve hit a home run. Just like a solid workout demands a warm-up and a cool-down, no transaction is complete without buyer scoping, due diligence and transition period in the stages before and after a sale. And just like that workout, your sale will fall into place one step at a time. Staying flexible along the way means that you will be prepared for what the process will inevitably throw at you – and ensure sure that you’ll be there to answer the door when opportunity knocks. Ready To Sell?
M&A Transaction Tips: How To Ace An Intro Call With A Buyer
You’ve done your research, prepped your financial materials, honed your elevator pitch, and now it’s time to connect with a potential buyer! Meeting prospective buyers is an exciting part of an M&A transaction, but it requires thoughtful preparation in order to ensure a productive conversation for both parties. Use these tips below as a checklist before preparing for your next call.
M&A Transaction Checklist: Buyer Intro Call
- Minimize Distractions: It seems obvious, but find a quiet place with a good internet connection. If you work from home, buyers understand some limitations, but eliminating distractions and noise will help you make the most of your time! Ensure that your background and surrounding environment look professional.
- Leave a Lasting Impression: Enter the conversation with an infectious, positive attitude, and let your personality shine through! Buyers want to connect with you as a person and potential professional collaborator, not just a business entity. So, lead with charisma during the call to leave a lasting impression that resonates.
- Dive into the Details: A little research can go a long way. By demonstrating your knowledge and enthusiasm, you'll captivate the buyer and create a compelling case for collaboration. Make sure you know who will be on the call and what their role is specifically within the organization.
- Harness the Power of Preparedness: Arm yourself with essential documents that hold the key to success. From crucial financial metrics to client data and team information, ensure you have everything at your fingertips. Your M&A advisor can lend a hand in ensuring you're well-prepared to answer the buyer's inquiries and follow up after the call to close the loop on anything that you were unable to answer.
- Curiosity Fuels Success: Similar to a job interview, the buyer will likely set aside 10-15 minutes at the end of the call for your questions. So, before the call, brainstorm the information you'll need to make an informed and assured decision for your business. Your thoughtful queries will demonstrate your dedication to facilitating a successful M&A transaction.
- Active Listening: During the call, actively listen to the buyer's needs and concerns. Show genuine interest and empathy, and ask open-ended questions to encourage them to share more information. Remember, this is more than an M&A transaction you're trying to close, it's a relationship you're fostering. By staying engaged, you'll be able to customize your pitch and recommendations to precisely match their unique requirements.
- Overcome Objections: Equip yourself to gracefully handle objections or points of concern. Rather than brushing them off, embrace objections as stepping stones to provide thoughtful responses that ease concerns. Utilize persuasive techniques, such as presenting compelling evidence or sharing glowing client testimonials. These approaches will instill confidence in a buyer's decision to proceed in an M&A transaction with you.
- Reflection: Take time after the call to summarize your thoughts while they are fresh in your mind! Be sure to note the aspects of the conversation that you enjoyed and anything that gave you pause or concern. Share these takeaways with other key players, such as your M&A advisor, and be sure to get their feedback on the conversation as well.
Most importantly, remember to keep an open mind during any conversation with a potential buyer! Sometimes the conversation can take a turn that surprises you and lead to an incredible future partnership.
5 Terms To Know Throughout The M&A Process
The M&A process can be a transformative opportunity to increase market share, drive operational efficiencies, and unlock growth opportunities. However, embarking on this journey requires more than just ambition. Having a clear understanding of the process and key terms used in the space allows for informed decision-making to drive a successful transaction.
Key Terms To Know Throughout the M&A Process
EBITDA: The abbreviation for Earnings before Interest, Taxes, Depreciation, and Amortization; a calculation used to express cash profit. Essentially, this is your net profit plus additional expense adjustments that a prospective Buyer would not incur. When valuing an agency, Barney utilizes a multiple of EBITDA to determine your agency's total enterprise value.
Letter of Intent: A non-binding letter that outlines an introductory commitment to do business with another entity. The LOI serves as the blueprint for the transaction between two parties and defines the purchase price, structure, and deal terms. The Barney acquisition team will help guide you through these offer letters and negotiate the most ideal terms on your behalf.
Deal Structure: The financial terms, conditions, and obligations of both the buyer and seller to guide a smooth transition of business ownership. The funding mechanisms outlined in a deal structure are the buyer's tool to “bridge a valuation” gap between the total enterprise value and the available cash they have on hand. Most deal structures will include some combination of the following components - cash at close, seller’s financing, earnout, rolled equity, and phantom equity. Barney’s role is to advocate for your preferred deal structure which usually includes the highest amount of “guaranteed funds” - cash at close and seller’s financing.
Working Capital: The difference between an entity’s current assets and current liabilities; overall the amount of money needed to run the day-to-day operations of a business. Buyers will typically ask for 2-3 months of operating income post-transaction so that the ownership transition does not hinder business operations. Barney will help guide you through all of these house-cleaning steps at the end of the due diligence process.
Earnout: This is the potential portion of the purchase price where payment is contingent upon the company achieving predefined milestones within a set period of time following the transaction. Typically, performance metrics tied to top-line revenue are more advantageous for a seller than those tied to EBITDA. The Barney acquisition team will ensure you are well-informed regarding the obligations of any proposed earnout period and advocate for terms that align with your financial projections and transition timeline.
The M&A process doesn’t have to be daunting! With guidance, advocacy and support from a qualified advisor, it can be an exciting opportunity to launch an agency and its founder into a new chapter of opportunity.
Optimizing Agency Accounting With Fractional CFO Services
Running an agency requires you to be intimately involved in the day-to-day operations and pulled in many directions. A fractional CFO is able to provide assistance on both the intimate details of financial reporting and accounting, as well as advisory and guidance on the overall strategy and direction of the business. This dual perspective is invaluable during the acquisition process to a) set you up for success in regards to having all of the necessary financial documents ticked and tied and b) to consider the big picture implications as you prepare to sell your business.
Four Ways Agency Accounting Benefits From Fractional CFO Services
Cost
The cost of hiring a fractional CFO is significantly cheaper than the salary of a full-time CFO. Your agency accounting efforts will benefit from the financial expertise of an experienced CFO without the commitment and strain of a full-time employee. Buyers want to see clean books and records, so investing in this prior to starting the acquisition process inevitably saves time and headaches during the due diligence process.
Specialized Experience
Problem solving is an invaluable skill in the management of a small-business. A fractional CFO not only provides financial acumen and streamlined agency accounting, but extensive experience identifying issues and implementing processes to solve them. It’s important to identify an individual who has experience with agencies of comparable size to yours, as well as industry experience.
Flexibility
The advantage of a fractional CFO is that their involvement can be tailored to the level of attention your agency accounting efforts require. In the case of preparing for a sale, this person can be utilized to ensure all of the necessary financials, including balance sheets and P&L’s, are prepared with the appropriate amount of detail. Having the ability to quickly pull various financial documents as potential buyers request them, helps to streamline the process and keep momentum.
Perspective
If your agency accounting efforts need enhancing, a fractional CFO can provide experienced counsel and a fresh perspective which can help optimize processes to make them more efficient and cost effective. Having clear systems in place is very valuable to prospective buyers and signals that the agency can run independently of any individual. While the process of selling your business may be confidential, it’s helpful to have another executive who is aware of the sale and can provide support and financial information as needed.
Take Action
Maintaining clean, cohesive, and organized financial statements are crucial to a successful sale of your business. Hiring a fractional CFO to guide your agency before and during the process is an effective use of time and resources to ensure a smooth exit.
How to Grow The Value Of Your Marketing Agency Without Raising Revenue
Top-line growth is only one end of the P&L statement. Agency owners that are not just sales-minded but understand operations just as well, know that their margins can be improved elsewhere too. Although an early-stage agency will need revenue to demonstrate traction and proof of concept, a company with enough track record – and one that is looking to sell – needs to do better than that. EBITDA will take center stage for a buyer looking under your financial hood – and there is plenty of ways to raise the roof on your EBITDA without having to drive sales. Especially in the current market environment that is still demonstrably shaken up by the ongoing pandemic, structural readjustments and remote work are redefining operations. If you are looking to drive up your bottom line as you line up a sale, we recommend you take a closer look at our five hacks to grow the value of your marketing agency without the need to raise revenue.
Five Hacks To Grow The Value of Your Marketing Agency
The Roof Overhead is an Overhead
Office leases, in particular, are dead weight in the current market environment. Long leases are not integral to the business of most marketing agencies – something that is especially obvious since 2020 and the proof of remote work as a key component of agencies in the digital age. As tools to work remotely become smarter and employees become more accustomed to them, it is worth reconsidering if that office lease or that prestigious address on the business card are worth their costs. No less, co-working spaces, insofar as they are open for business, offer a smart and flexible alternative. Why not survey your team to see how many days a week they would be happy working remotely and scale down accordingly?
Automate Where You Can
Automation and streamlining are essential ingredients to your margin improvement. Revisit your processes, workflows and operational architecture to check on where there is still room for automation improvements. Tasks that should raise the automation flag include tasks that involve compliance and audit trails, that require multiple people to execute or that are especially time-sensitive.
From invoice generation to time tracking and from automated workflows to streamlined communication through project management tools with automated notifications, the world of process automation is yours for the taking. Things to keep in mind are that no tool is a cure-all and any tool is only as good as its implementation. Set goals, assign accountability and measure your results over time. Your reduced likelihood of error and improved productivity will work its way into your margins in the medium to long term.
Improve Your Brand & Increase Prices
When was the last time your brand got a shake-up? Are your website and your logo still a little too close to when you first launched? It shouldn’t take a Fortune 500 company in the public eye to make rebranding relevant. Give your look and feel a lift that will strengthen your positioning as you gear up a sale – and that can help you justify giving your prices a lift along the way.
Invest In Your Team
Most importantly, take a good look at your team. They will be the ones carrying your agency not only over – but past – the finish line as you execute on a potential exit. Who are the top-tier candidates that will shoulder your agency and drive the marketing agency at this critical juncture? Invest in these individuals and shed any excess weight as you close in on the valuation home stretch and grow the value of your marketing agency.
Future-Proofing In Times of Crisis
It may be a cliché, but that doesn’t mean it’s not worth taking note: there is opportunity in crisis. Even if you are not looking to make a sale just yet, these are things you can do to improve your operational resilience. Take advantage of the current reshuffle. Let it serve as an eye-opener as to how to cut costs and restructure your agency to help bring the value of your marketing agency to where it needs to be so you can turn it into a listing no buyer would overlook.
M&A Timelines: How Long Does It Take To Sell My Marketing Agency?
When you finally say to yourself, I want to sell my marketing agency, you may think that things will move quickly. But the reality is that the waiting can be long and is often the hardest part. Normally – the Barney M&A timeline in its entirety is 4-6 months.
However, knowing exactly what happens before, during, and after a sale should provide the transparency you need to help you manage the process. Below, we help you understand the necessary steps – and the expected timeline attached to each of them – so that you can get a clear understanding of how long it takes to sell your marketing agency.
Sanity Check
First things first. Before you jump into the deep end and run the risk of amping up the expectations, you may want to ensure that you are ready to sell in the first place. Has your agency been showing sustainable growth year-over-year? Are your margins raising eyebrows or just red flags? Are you delivering an EBITDA of $500k and up?
The M&A Timeline to Triumph
While there is some flexibility around the exact duration of each element required to make the sale of your agency a success, the process that will take you there is very defined. The Barney M&A process in its entirety is 4-6 months. Here is the step-by-step:
- Initially, there is a valuation period before any agency owner enters the circle of sellers. This period requires the vetting of financials to get an accurate picture of what’s on offer. Once a price is agreed upon, the listing agreement is prepped and signed before a listing goes live. Expect this readying stage to take up to 1 week.
- Once your listing is live, it’s showtime! We do our homework to identify your perfect buyer profile before we scour our network to identify potential prospects. We give this stage a solid month to generate enough leads in order to begin issuing a first term sheet.
- Once there is a genuine offer in place, expect a further two weeks to transform those initial leads into a detailed LOI.
- Finally, turning a serious buyer’s intention into a closed deal will take…well, it will take the time it takes, really. The due diligence timeline is correlated with a buyer’s thoroughness and a seller’s previous processes. As a benchmark, we attach an expected duration of 45-90 days – but that can move in either direction. Expect to be able to improve on this timeline with more sophisticated buyers that have gone through this before. In addition, the required paperwork to close a deal will be produced during this 45-day window, which takes into account a small buffer for the required back and forth.
M&A Timelines Vary
Depending on the buyer’s experience and buyer type, the pace of the process can move in either direction as well. Strategic buyers with an eye for an operational fit will typically move faster while entrepreneurial types will take more time as they are likely entertaining more options. Financial buyers will put their targets through a Quality of Earnings report (think of this like a mini-audit), which can add another 3-5 weeks to the process.
Beyond getting the alignment right, which is something out of a seller’s hands, a seller can help shorten the M&A timeline as well. If a buyer and seller remain in agreement with the initial closing docs, and if a seller is well-organized and on top of his operations and financials during the due diligence process, this will help drive up confidence and drive down duration.
Understanding The M&A Timeline For Digital Agenices
Six Ways An M&A Advisor Can Help You Sell Your Agency
Are you preparing to sell your digital marketing, PR, or Ad agency and considering hiring an M&A advisor? If you have never put a business on the market before, your head will likely be ringing with questions like the following:
- How does the sales process work?
- How do I value my agency?
- How do I identify my ideal buyer?
- How do I get the word out about the sale?
- What will it cost me to sell my business?
Once these questions start falling in your mind like rain, you’ll hear a great crack of thunder as a final question strikes you like a bolt of lightning:
“Do I even need an M&A advisor? Why not just take this to market myself?”
Before you decide to put your agency up “For Sale by Owner,” you should be clear on the expertise – and dare we say value – an advisor brings to the table. After all the work you’ve done to build a business that’s worth selling, you owe it to yourself to make an informed decision.
That’s what this article will do: provide the information you need to decide for yourself. So let’s go for broke (pun gleefully intended) and dive into just what it is that M&A advisors do.
Valuation
If there’s one thing you should know about valuation, it’s never to take it at face value. There are many paths to determine the market value of your agency before you put it up for sale. But not all of them are worth their salt.
Let’s say you’re a service-based business, such as an agency. In that case, a valuation based on the value of your physical assets makes zero sense. Other methods that rely on fuzzy factors such as goodwill can also steer you down the garden path.
The truth is, an agency’s value may differ depending on context and the needs and preferences of buyer and seller.
So how do you climb out of the subjectivity hole and get a meaningful valuation? For starters, you can have a chat with an expert on business valuation – your friendly neighborhood M&A advisor.
He or she will likely combine a variety of valuation methods, each of which is weighted and prioritized according to your market, industry, business model, and financials. At Barney, for example, we consider 14 different factors, starting with your year-over-year earnings.
Sound like higher mathematics? It’s really more a cocktail of experience and good sense. However your advisor shakes the tumbler, the result will be far more accurate than a valuation based on a single method only.
Do not underestimate the power of accuracy. A listing price that reflects the true value of your business drastically increases your chance of getting a desirable offer from a buyer.
Confidentiality
Do you know the saying “discretion is the better part of valor?”
Actually, the saying is “valor is the better part of discretion.” But let’s leave our Shakespeare at the door and just point out what every M&A advisor knows: discretion is the key to a sweet deal.
If you are selling your business independently, maintaining confidentiality can be challenging. You will face many temptations, from spilling the beans to an employee whose career prospects are dear to you, to being loose-lipped with a vendor, who may leak word of the sale to a competitor.
Pitfalls and pratfalls like this can destroy a deal before it’s sealed.
An M&A advisor knows the value of discretion and the meaning of the word “mum.” He or she will keep your sale strictly confidential and ensure that information is released on a schedule rather than a lark.
Marketing
Selling your business on your own has its attraction. You can take all the credit if the sale goes well, and you get to keep all the money.
However, you might not have factored in the marketing costs and resources that a successful business sale requires.
From email campaigns to direct mailing, online advertising, social media marketing and word of mouth, the marketing muscle you will need to flex to receive your desired asking price can be massive. If you’re not careful, you’ll find yourself feeling the burn.
This is where a advisor can be a lifesaver. A seasoned M&A advisor has access to networks of buyers and databases beyond your wildest dreams.
Tapping into a advisor’s marketing capabilities can save you time, energy, and money. It can also help you reach your ideal buyer. That means a better deal and a better night’s sleep.
Negotiation
Is negotiating with lawyers your idea of fun? Then by all means, go it alone when selling your business.
However, if you prefer to outsource legal wrangling to those who know the rules and regulations and can handle smooth-talking attorneys, an M&A advisor is the way to go.
That’s right – we said attorneys. Often you’ll be dealing with more than one. An experienced advisor knows the ropes and won’t get rattled when the buyer’s and seller’s attorneys go head to head.
Another legal area in which an M&A advisor can make your life easier is lease negotiation. If a buyer needs a new lease for your business location and you botch the discussion with the landlord, the deal could fall apart.
In such cases, having an advisor handle the negotiation can give you a new lease on life (yes, we own that pun, too).
Financing
Speaking of puns, you can bank on an M&A advisor to have solid banking contacts. If your buyer needs financing to purchase your business, using the wrong lender can cost you months and imperil the sale.
Advisors are well versed in which lending sources to tap for which transaction and spend their careers building reliable contacts in the world of finance.
You may be great at financing a business. But this knowledge won’t always apply to your buyer’s situation. An advisor will know exactly who to call – and how to make, not break, the deal at hand.
Emotional Support
Last but not least, taking a business to market is an emotional roller coaster ride. There’s more at stake here than when you’re selling your tamagotchi collection (and that’s saying something).
When emotions get high – be it during legal haggling or at the closing table, an experienced M&A advisor can provide perspective, empathy, and support. Whatever issue you encounter, your advisors has been there before and can guide you through the haze.
That can’t just get you to a sale. It can keep you out of the looney bin.
That’s a Wrap!
Now that you know what an M&A advisor does, you should have a good grasp of the advantages of working with one. We’re happy to offer more reasons – or to help you sell your business. So don’t be a stranger, hear? Connect with us 🙂
Shifting Your Mindset For A Success Agency Acquisition
You’re not the judgmental type. You’re out to get the most value from an agency acquisition and you’ll give the highest bidder the benefit of the doubt. But this type of buyer prospect rubs you the wrong way.
What Is The Valuation Of Your Digital Agency?
Whether you’re buying a digital agency or selling your own, it’s vital to understand the “science” behind the valuation process! We’ve outlined the basics so you have a good understanding of how to digital agency valuations are determined.
Unsurprising news flash: the size of your digital agency will have a big impact on how much your digital agency is worth to buyers.
If your digital agency is doing $1M a year in net profit, you can expect to sell your agency for 2-4x EBITDA.
If your digital agency is doing over $5M a year in net profit, you can expect to sell your agency for 8-10x EBITDA.
Bigger agencies sell for a higher multiple of EBITA because they are less risky for buyers. The main differences being that if you are a bigger agency, you probably have less likelihood that a few bad employees or clients could hurt the acquisition, and the business is probably more scalable in general. Seems obvious right?
Okay, so the question is, how do you determine where you fall within the multiple range? The difference between a 8X EBITDA multiple and a 10X EBITA multiple for a digital agency doing $5M in net profit could be a difference of millions of dollars in the sellers pocket at the closing table. Needless to say, this is important.
In today’s market, everything from the management structure to the make-up of the revenue stream is considered when determining the valuation of a digital agency. Bring in the 14 metrics that go into determining how much a digital digital agency is worth. Buckle up, this is exciting stuff.
The 14 Factors That Determine How Much Your Digital Agency Is Worth:
When determining digital agency valuations, there are 14 factors we consider, with the most important being how much the company is making year over year.
Outside of going through these factors to determine a valuation and list price, there is another major benefit to having a detailed valuation system. Having a solid understanding of these factors allows our team to easily justify the asking price to potential buyers during the sales process.
For buyers trying to determine the value of a company, these factors are the must-ask questions before submitting an LOI.
1 – Earnings History:
For digital agency valuations, the most important factor is if it’s making money and how much money it’s making. If you’re familiar with EBITDA, you’re probably already familiar with SDE (Seller’s Discretionary Earnings), too, even if you’ve never heard the term. As a reminder, EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization—essentially, it’s the pure net profit of a business.
Like EBITDA, business owners calculate SDE to determine the true value of their business for a new owner, so your SDE will include expenses like the income you report to the IRS, non-cash expenses—whatever revenue your business actually generates. Unlike EBITDA, though, you’ll also add back in the owner’s salary and owner’s benefits into your SDE calculation. Large agencies generally use EBITDA calculations to value their businesses, and small agencies typically use SDE, since small business owners often expense personal benefits and the buyers are generally solo-preneurs.
It’s crucial that prospective buyers understand SDE, too. Most likely, the agency owner will provide you with that number, so it’s important to understand how the agency owner reached that value, and what these values reflect about the actual agency.
To calculate your agency’s SDE: Start with your pre-tax, pre-interest earnings. Then, you’ll add back in any purchases that aren’t essential to operations, like vehicles or travel, that you report as business expenses. Employee outings, charitable donations, one-time purchases, and your own salary can all be included in your SDE. (Buyers might ask about your discretionary cash flow when you offer them your valuation, so be prepared to include and value each major expense or purchase.)
Simply put: when determining your digital agency’s valuation, the most important factor is how much money the company is making.
2 – Time In Business:
Let’s keep this simple – this doesn’t matter A TON in determining how much your agency is worth, but for some buyers, this can be a notch in the right direction. The takeaway – once you hit the 3 year mark in business with steady or growing financials, you’re in the clear and this no longer becomes a crucial component into adding value or detracting from the value of your digital marketing agency. Five years plus – amazing! If you’ve been around for 20 years and have declining growth – your time in business can be a detriment.
3 – Revenue Streams:
The way that your agency makes money and the structure of those contracts is an important piece of the valuation puzzle. For some buyers, this is the golden ticket in determining how much your digital marketing agency is worth. We’ll want to have a thorough understand of how your agency makes money and we’ll also dive into questions like these:
- Do you have long-standing, recurring contracts or is your agency project based?
- How long are your contracts? Are they enforceable?
- What is your client retention rate?
- Do you have one really large client that makes up a significant part of your revenue or is your revenue dispersed among a lot of smaller to mid-size clients?
These questions will help our team determine the value of your digital agency and if revenue streams for your agency should add to the value or detract from it.
4 – Management Structure:
For businesses doing less than $10M a year in revenue, the owner’s role within the company as well as the structure of the management and leadership team is vital. In most cases in businesses of this size, the owner has a role in the day-to-day operation of the company, so buyers want to garner a thorough understanding of how the business will operate once you step-away. When determining how much your digital marketing agency is worth, we’ll dive into questions like:
- What are the roles of each member of your management team?
- How long have they been with the company?
- What is their commitment to stay on board after the sale process is complete?
- Who are other key employees that are vital to business operations?
- How will the company culture be impacted if you were to leave?
5 – Seasonality
If your agency has significant peaks and valleys in it’s revenue due to seasonality, this factors into the digital agency’s overall valuation. This generally isn’t a huge issue for marketing agencies, but we have seen some cases where sales teams are more productive during spring and fall months, resulting in an influx of new customers during those time periods.
6 – Diversified Risk
Buyers will want to fully understand your risk portfolio and how that factored into the valuation of your digital agency. When determining how much your marketing agency is worth, we’ll want to understand:
- Do you have significant monthly overhead?
- What happens when you’re not there?
- What is the churn-rate of your current clients?
- What is the client concentration make-up? Does any one client make up more than 20% of your total revenue?
- How is new business brought into the agency? How strong is the future-facing pipeline?
- How long have your employees been at the agency? What are their long-term plans?
- Do you have any loans, liens or lengthy contracts that pose a risk to the new buyer?
7 – Competitive Advantages
This one is pretty simple. The more niche you are, the easier you are to sell.
- Are you hyper-focus in one industry?
- Do you offer one service really well or are you a full-service agency that offers everything to everyone?
- What do you offer that your competition doesn’t?
- Does that help or hurt your business value?
8 – Growth Potential
The growth potential of your marketing agency is vital to understand when determining how much your marketing agency is worth. If you’re vertical based and the industry in which you operate is expected to skyrocket over the next 5-10 years, this has a positive impact on the valuation of your digital agency. The opposite is true if you operate in an industry that is shrinking. In that case, the industry will have a negative impact on the valuation. During Covid-19, eCommerce agencies were selling for a massive premium, while agencies that focused in the hospitality and physical retail sector really struggled.
9 – Reputation
If you have a stellar reputation in your desired market, that has a positive impact on your business valuation. The same is true if you have a not-so-good reputation. When determining how much your digital marketing agency is worth, we’ll want to dive into things like:
- What happens when a buyer Googles your name?
- How are the online reviews for your agency?
- Do you have letters of recommendation and testimonials from key clients?
- What do your employees think about the company?
10 – Industry
For vertical driven or hyper-niche agencies, the industry in which you operate and the projected economic forecast for that industry will have an impact on how much your digital agency is worth. This can also impact the buyers interested in your firm. For example, if your agency offers paid media for the healthcare industry, a SEO agency that works for law-firms probably isn’t a good strategic buyer.
11 – Location
If you have a location-based digital agency, buyers want to see that the location has growth potential and that it is centered in a favorable business environment. While location is a factor in your digital agency valuation, it’s importance is rapidly diminishing.
Keep in mind that most entrepreneurs are not locked into businesses within the zip code in which they live. In today’s digital centric business environment, seasoned business owners are able to purchase businesses (even those with a location focus) and run them digitally.
In the post-Covid world, buyers are looking for agencies that are successfully working remotely. If you have an office location, many buyers will look at how long you have left on your lease and use that as a key factor in their valuations. For buyers that are looking to make acquisitions of agencies with physical locations, mid-major markets are HOT right now! Strategic buyers already have offices in NYC and LA, so being located in Salt Lake City or Denver is a more desirable location for them.
12 – Comps
Similar to selling your home, it’s important to understand what other agencies have for in the last 6 months. Given that there are so many factors that go into understanding a digital agency valuation, this isn’t as cut and dry as it is in real estate, but it certainly is a factor that plays into determining how much your digital agency is worth. After removing the outliers and odd-balls, we’ll carefully examine those transactions to determine what factors went into agreeing upon a final sales price. You can also take a look at our current digital agencies for sale to get an idea of where the market is today.
13 – Transition Structure
Based on the buyer’s needs, a solid commitment to a transition plan can really bolster the valuation of the company. If there are time pressing health concerns and you need to exit the agency right away, this could have a negative impact on your agency’s value and what someone is willing to pay. On the other hand, if you’re willing to stay on board for 12 months (or even a few years) to ensure the new owner’s success, this could have a positive impact on how much your marketing agency is worth for a certain type of buyer.
14 – Other Assets:
If your digital agency has significant technology, intellectual property, lead producing materials, or other assets that are of value to a buyer, we factor that into your valuation as a positive. Generally speaking, a SaaS platform that is only used to operate the agency does not warrant SaaS multiples.
How Much Is Your Digital Marketing Agency Worth?
If you’re looking for a free valuation of your digital agency, you can do that here. Our experienced team will give you a range as to what you can sell your digital marketing agency for today. Keep in mind that during the sales process, your team of advocates will be forced to defend exactly how the valuation was determined. Using an intricate formula will lead to a faster, more profitable exit as you sell an agency.