Agency Valuation Models Need to Include New Factors if They’re to Measure the True Worth of An Agency and Minimise the Risk of a Failed Acquisition

The factors traditionally used in valuing an agency prior to its sale are beginning to appear as ‘necessary but not sufficient’.

Other factors, previously considered as ‘hygiene’ factors are gaining in importance when it comes to making a sale or purchase decision; but their lack of accountability is continuing to create an unnecessarily high level of risk for both parties.

The agency M&A broking industry can, and probably now should, work harder to attach new measurement criteria to these ‘soft’ factors if it’s to help both sides of a deal avoid experiencing buyers’ - or sellers’ - remorse.

Because unfortunately, despite the costs of the professional fees associated with agency M&A going up exponentially, there's still a fair chance that the deal could end in tears, with both parties ruing the day they met.

In fact, despite the due diligence process becoming increasingly burdensome for both parties, many parties still don’t appear to have the ‘right’ information they need to make a good quality decision, ie, one that considers all the factors and minimises the risk of failure.

I was reminded of this conundrum when I recently attended a webinar, entitled ‘Key Factors That Drive the Valuation of Your Agency’. It was hosted by agency platform provider Productive and featured as guest speaker Mark Sainthill, Managing Partner M&A at Cactus.

Mark’s otherwise excellent presentation covered all the bases in terms of listing the factors used to measure the attractiveness of an agency, but it’s what he left out that interested me.

Here are eight factors that the industry might want to consider attaching more importance to.

That they haven’t to date is probably because they were either considered as being ether less important or unquantifiable and in an M&A broking business that’s dominated by accountants, if it’s difficult to attach a monetary value to it then it probably won’t be included.

But for businesses comprised entirely of intangible assets, like people, that could be a dangerous thing to do.?

1.????Culture

All other things being equal, agency culture will be used as the deciding factor in most deals as in, “Will our agency culture match theirs?”.

And in those situations where the relationship does break down after the sale, the word culture inevitably crops up again. “Turns out we didn’t share the same cultural values after all”, the disappointed parties will lament.

Agency culture, then, matters a great deal in these situations. But what constitutes a ‘strong culture’? And how can we measure it? How can we ensure that there will be a close cultural fit between buyer and seller? (Presupposing that we know what each one comprises).

As the information contained in the Information Memorandum (I.M.) and on both parties’ websites will be entirely vacuous (“The agency prides itself on its strong culture’) then the only way, currently, to find this information out is to have several ‘chemistry meetings’.

In my experience, these are similar to first dates. Both sides are desperate to present their best sides and will tell a few porkies along the way (“Me too! I love Ariane Grande as well!” sounds similar to “Wow. Our staff are committed and diligent too”).

Of course the industry is a long way off agreeing a standard methodology for measuring agency culture (Business Schools please note), but agency owners looking to get top dollar for their agencies would do well if they were to express theirs in more precise terms or better still, to define it and then measure it. Regularly.

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2.????Leadership

Mark Sainthill, rightly, made reference to an agency’s leadership team being an important factor when valuing an agency, particularly its ‘strength and breadth’.

But surprisingly, even though leadership is easier to measure (unlike culture) few agency buyers do. But why not? Given that the success of the deal, to some degree, hangs on both parties’ leadership qualities, why wouldn’t each side want to know more about what those comprise?

The I.M. may state that “the agency has been ably led by its founder since its inception”. But is that true? Just how ‘able’ is his or her leadership?

It would be relatively easy to ask an agency owner or leadership team to take part in a short online leadership survey as part of the due diligence process. The results may not confirm how strong the leaders are but it may well reveal their leadership style. That could be worth knowing, especially if theirs is empathetic and the acquiring agency’s is dictatorial (As if!).

Agency owners looking to sell shouldn’t breathe a sigh of relief that they weren’t asked this question during due diligence but should instead take the initiative here. Undergo regular leadership training for themselves and their executive team using professional third parties; regularly benchmark their leadership skills and look to improve wherever possible.

(As with all these factors, its one thing to tell the other side, it’s another thing to provide evidence of it. And the difference could mean moving the valuation up from 4x-6x EBIT to 8x-10x, so well worth investing in the time and resources needed).

3.????Talent Management

The I.M. will confirm that the agency has a ‘capable and committed’ workforce; but is it an appropriate one?, ie, is it fit for purpose? Does the agency have the right calibre of staff and more importantly, will they stick around after the sale?

The would-be buyer will be hard pressed to unearth this information during the discovery process and that carries a risk to them.

Traditional measures, such as having low levels of staff churn or high levels of retention may not be much help here. ?In fact they may give off entirely the wrong signals.

Most outside commentators would consider Premier League football clubs to be appalling employers, constantly replacing employees with new ones and occasionally having too many to do the job. But if their strategy is to win cups and competitions then continuously replacing good players with even better ones may not be such a daft idea after all.

There’s a balance here to be struck between aping Manchester City’s Darwinian employment strategy and having the agency equivalent of bed blockers preventing the agency from attracting more appropriate staff, but having a documented talent management plan has to add value to the agency, even if the potential acquirer hasn’t asked for one.

4.????Skills

I’m always amazed that, owing to the way current due diligence questionnaires are structured, agencies will provide more information about their IT systems and insurance policies than they will about their staff.

Yes, they’ll disclose employment contracts and details on benefit packages but will only provide the bare minimum on the staff themselves.

Like Prisoners of War agreeing only to provide their captors with their name, rank and serial number, agencies need only disclose details on each member of their staff such as title, age (?!), salary and length of service.

That’s all very well but are they any good? Critically, how highly skilled are they at these jobs? What level of motivation do they have? How much latent potential exists in the workforce that could be unleashed given the right work environment? And how diverse is it? (not just in traditional ways but in thinking too).

Surely agency brokers would now consider an agency’s skills as being of such importance that it needs measuring?

And surely an agency buyer would pay a premium for an agency that could ‘prove’ that it had a highly skilled workforce; that it regularly identified skills gaps and plugged those with training and development programmes? And that it regularly polled its clients to ensure that the skills it offered continued to be what they wanted?

Luckily, this information isn’t difficult to obtain these days. There’s umpteen systems and platforms available that can measure this.

(At Selbey Anderson we ran a pilot with one called Skills-Base that’s free for less than 25 people).

5.????Knowledge

As you’re reading this, an agency somewhere in the world will be receiving the welcome news that they’ve won a pitch. The new client will likely tell the excited agency, “It’s because you were able to demonstrate a really in-depth knowledge and understanding of our company/product/brand/problem”.

Clients then, value knowledge highly - and so should agency buyers. But how can they tell if the agency is truly knowledgeable (in an institutional way) or whether most of it sits in the heads of the most senior staff?

(Much of which, by the way, will leave when the owner walks after three years).

Other professional advisers, such as management consultants know the answer. It’s called a Knowledge Management System (KMS). McKinsey’s is perhaps best known, which they now define as ‘the process of transforming information and intellectual assets into long-term value for an organization's clients and employees’.

These KMS’s needn’t be elaborate, or expensive. Simply preventing staff from saving their work onto their C drives will immediately make all the agency’s information visible and accessible to all.

(Knowledge comes in many forms, including past presentations which, if only held on the creative director’s hard drive, prevents others from accessing it!).

?Intellectual Property (IP)

Knowledge is a key component of IP but it’s not the only one. And due diligence questionnaires do include sections on this area but few would-be buyers expect them to be completed.

Imagine how much more they’d pay if the agency could show that it had patented its methodology or was enforcing trademarks that had been applied to some piece of work they had created in the agency?

For instance, Ogilvy has registered a trade mark for its 360 DEGREE BRAND STEWARDSHIP. They describe it as ‘a proprietary philosophy to uncover the brand’s core essence’.

Other agency groups may sniff but the fact remains that it’s theirs and it now has a value of its own thereby further enhancing the value of the group as a whole.

It costs ￡170 to register a single trade mark in one class. (Source: HM Government website). Compared to the uplift in value that could happen as a result, I’d say that was peanuts.

6.????Reputation

An agency’s reputation in the market is seen as important to would-be buyers but, again, the lack of measurability causes problems when it comes to putting a financial value on it.

What if your good is only my mediocre? What goes into making that reputation? Is it just amongst clients, or employees, or both? Has the agency’s reputation grown over the years or declined?

I think this is an area where the industry is being lazy. There are plenty of metrics that could be used here and plenty of systems that will help agencies to collect them. My advice is for agencies putting themselves up for sale would be to invest in one that’s suitable for them.

7.????Brand

It’s tempting to lump brand with reputation but they are different things. An agency can have a great brand but a lousy reputation and vice versa.

And this is an area where the accountants are happy to ascribe a financial value. OK, it may not reach the $355bn that’s been put on the value of Apple’s brand but heh, you have to start somewhere!

And that somewhere could be defining what your agency’s ’brand’ comprises. Whatever it is, it needs to be measured regularly and the results of any shifts or changes detected then acted on.

There may not be a question on it in the DD questionnaire but attaching the results of these brand tracking studies as an appendices will help push up the price that the other side will consider offering for the agency.

Conclusion

It would be be foolish to admit that just because these factors are not currently measured, they’re not considered important. Or they’re not priced into the deal. They are. But they’ll be subject to a high degree of subjectivity or worse, included as part of the inevitable horse trading that will take place during the negotiation stage.

Many of the eight factors here fall into the general category marked goodwill. ?A tough buyer will find it easier to beat an agency down on price if it can’t offer up any evidence to back up its claim that it deserves to be paid top dollar.

And they needn’t be measured precisely, only considered. Agency culture and leadership are the two factors that take precedence over all the others. Fail to account for those properly and the divorce papers will come out sooner than you think!