M&A DEMYSTIFIED - Chapter One: The Napkin Valuation Method

A mini-series demystifying the M&A process.?

To kick things off let's jump straight to the money. The big question everyone wants to know when they consider buying or selling a creative business. What's it worth?!?... Let me help you figure it out.

Introducing the Napkin Valuation Method

I often meet with founders who have little to no understanding of the relatively simple process of valuing their agency. Whilst it is true that God is in the detail, the basics really are just that - basic!

This exercise can literally be done on the back of a cocktail napkin, preferably with something cold and refreshing in the other hand. Perfect Bank Holiday Monday mussing to get your noggin whirring over a glass of Pimms in the garden…

TL/DR: (Normalised) EBITDA x (Market rate) Multiple = Enterprise Value

The Basics -

The most typical way to value a creative agency is through a multiple of EBITDA. There are other methods, but for simplicity of calculating your Napkin (enterprise) Value this is the best and most widely used method.

What is “Normalised” EBITDA?

The EBITDA you report is never the figure a buyer will use when calculating your value. EBITDA needs to be "normalised" in order to find the true profit of your enterprise, against which a value may be calculated. Common positive adjustments are made against one-off non-trading extraordinary expenses (sometimes referred to as “add-backs”). Negative adjustments are also made for common reasons such as owner’s under-compensation as many owner/operators of independent agencies in the UK pay themselves minimum wage and compensate with dividends. As dividends are taken after EBITDA this needs to be addressed with an agreed “market rate” salary deduction. (Arguing add-backs and adjustments can have a material impact on your final value so it is important to have professional support at this point in the deal).?

What period of EBITDA is used for the calculation?

The EBITDA figure used most commonly in calculating the Enterprise Value of an agency is arrived at by calculating an average from a trailing period of 12, 24 or 36 months (note: some acquirers prefer to calculate averages using only full closed years, but for our purposes we will refer to the more commonly used trailing period). Always prepare a best-case and a worst-case scenario (For example 12 months and 36 month averages to see their impact).

What multiples are most commonly applied??

Multiples fluctuate with the market (the age old “supply & demand” factor) as well as elements such as your size, historical growth, skills (in-house skills versus outsourced resource), the quality and mix of clients, project business versus retainers (retained and/or recurring revenues are valued higher), your geography and so on. For a more in-depth look at these factors drop me a DM and lets chat! For the Napkin Valuation we can take a broadly general view. Current multiples for creative agencies range from 4-5X at the lower end to 8-10X at the top. For our Napkin Valuation, we'll use a 7X multiple. Still aspirational, but suitably “middle of the road” for safety.

And voila! Your "Napkin Value" is:

(Normalised) EBITDA x 7 = Enterprise Value

Of course there are other methods for valuing an agency, such as the Discounted Cash Flow method, but our Napkin Value gives you a solid start using the most commonly found deal methodology.?

Final thoughts -?

Whilst your day one Enterprise Value can be calculated using the above method, this is just one factor in a deal well done, and the figure arrived at can change significantly when you factor in other deal terms such as cash v stock, closing payment, earn out terms and targets, acquirer relevance and support and so on.

There's a lot to consider when embarking on your M&A journey, but knowledge is power so arm yourself with experienced counsel before you start, if you want the best outcome.?

I've barely scratched the surface here but hopefully the "Napkin Method" provides a useful starting point for discussion.?

If you've found this helpful please drop me a Like and a Comment and feel free to suggest which part of the M&A process I should talk about next. Deal structures? KPI you need to hit before you go to market? How to structure a leadership team to build succession planning into your business? Or something else entirely? Let me know in the comments and I'll see what I can do.

And as I've always said, knowledge is best shared and your network is your superpower, which means my door is always open and I'm always happy you called.

DM me your questions for a quick fire response or to book a call with me, no strings attached, to chat through your specific needs.

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