Agency Acquisition Deal Structure: Tips for Buyers & Sellers with Nick Fraunfelder | Ep# 717
Are you planning to buy an agency as a growth strategy? Or, do you want to make your agency attractive to potential buyers? Today’s guest started his agency journey by buying an agency as an exit from his previous career in venture capitalism. He purposely sought out agencies, seeing them as cash flow machines. He looks back on that process and offers some valuable pointers and considerations for agency owners looking to buy or sell an agency in the near future.
Nick Fraunfelder is the owner and CEO of Sure Oak Digital Marketing, an agency specializing in SEO, link building, paid media, and analytics. He shares his journey of buying a digital agency and transitioning from a career in venture capital to becoming a business owner. Despite skepticism from friends, his passion for revenue conversations, desire for freedom, and dictating his own future have led him on a highly successful path.
In this episode, we’ll discuss:
Using the MED framework for a successful agency acquisition.
Recasting expenses to unlock hidden agency value.
Escaping the agency sales trap.
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E2M Solutions: Today's episode of the Smart Agency Masterclass is sponsored by E2M Solutions, a web design, and development agency that has provided white-label services for the past 10 years to agencies all over the world. Check out e2msolutions.com/smartagency and get 10% off for the first three months of service.
Why a Digital Agency Acquisition Makes Sense on Paper
Nick's decision to purchase a digital agency in 2022 raised eyebrows among his friends, who considered it a risky move in a fiercely competitive industry. However, having spent years in venture capital, making bold investments in high-risk assets, and serving as a CRO with reporting responsibilities to investors and boards, Nick found it liberating to have the autonomy to chart his own course and pursue his passion.
When it came time to choose what type of business he wanted to acquire, he immediately thought of an agency, which in his view was a cash flow machine with high client retention rates.
Nick’s thinking was that agencies typically operate on retainer contracts, offering ongoing services like SEO, paid advertising, and analytics. The predictability and stability of this recurring revenue model make digital agencies particularly appealing to potential buyers and investors.
He advises potential buyers to prioritize operational efficiencies. By recognizing and addressing these factors, buyers and investors can capitalize on the stability and predictability that digital agencies offer, ensuring a sound investment with long-term potential.
Maximizing an Agency’s Value by Focusing on Multiples, Earnings, and Debt
The way Nick makes money in acquisition deals is through a concept called M.E.D. (Multiples Expansion, Earnings Expansion, and Debt Paydown).
Multiples Expansion: If agency owners can expand their multiple by focusing on a niche, making their agencies more sticky, they’ll have better renewal rates and a better price in the market.
Earnings Expansion: For this, focus on increasing your bottom line and get rid of unnecessary expenses.
Debt Paydown: In his case, Nick did take on debt and set out to pay it in a certain amount of time. For instance, if he buys for $5 million, he would pay it off all in five years and sell it again for $5 million, effectively securing $5 million with minimal initial investment.
In his experience, agency owners can get a very good deal if they make themselves attractive by paying attention to these elements.
Unlocking Hidden Value by Recasting Agency Expenses
The number one rule for Nick buying a business with debt was that the bank gets paid every month. He needed to make sure there was enough margin every month to both pay the bank back, make payroll, and finally, pay himself. This is where buyers should be aware of the importance of recasting expenses for better EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization).
Recasting expenses involves identifying and adjusting non-recurring or discretionary expenses that may not continue under new ownership. These expenses may include one-time investments, personal expenses, unnecessary overhead costs, or expenses related to activities that are not essential to the core operations of the business. Recasting these expenses will allow to improve the EBITDA, making the business more attractive to potential buyers and increasing its valuation.
In the context of a digital agency, recasting expenses can have a significant impact on the overall financial health of the business. For example, expenses related to marketing, operating costs, tools, or other non-essential expenditures can be identified and eliminated to improve the bottom line, leading to a higher valuation and potentially attracting more buyers or investors.
Uncovering an Agency’s Salesmouse Trap
The number one thing Nick looks for when thinking about how he could grow an agency after acquisition is what is their sales mousetrap. He considers the “sales mousetrap” as the processes and systems for attracting and converting the majority of their deals. Things he takes into consideration:
Is their revenue repeatable? What’s their churn rate? How many leads are they getting and what’s the close rate? This is crucial because if every deal they land is because of a CEO who goes to every conference and is well-known then there’s no “mousetrap” without that person.
Many agency owners struggle to diversify their sales channels, often relying solely on their core expertise, such as SEO, and neglecting sales development. Consequently, numerous agencies grow primarily through referrals, which, while valuable, are not scalable. Eventually, agencies must invest in diverse inbound and outbound sales channels.
Real sales mousetrap metrics refer to the processes and systems in place that generate leads, convert them into sales, and ultimately drive revenue for the agency. By analyzing these metrics, agency owners can identify areas of strength and weakness in their sales processes, and make informed decisions on how to improve and optimize their sales performance.
A well-structured business with established processes, where the owner is not intricately involved in day-to-day operations, is more appealing to potential buyers, as it demonstrates the potential for further growth and development.
Lessons Learned from Acquisition Legal Counsel
One of the biggest lessons Nick wants to pass on to future buyers is to get good legal counsel during the process and not let lawyers control the deal. According to him, good lawyers are there to scare you of everything that can go wrong in the deal. Unfortunately, they can also delay the process quite a lot. In his case, the process should have been straightforward but the lawyers involved made the process overly complicated, causing unnecessary delays and adding to the cost of the transaction.
His advice for both buyers and sellers is to have legal counsel who understands probabilities and can explain potential risks clearly and concisely. Instead of focusing on every possible worst-case scenario, attorneys should be able to assess the likelihood of these events occurring and advise their clients accordingly. In this case, the lawyer's insistence on minor details, such as a payroll cut-over glitch, unnecessarily prolonged the deal process and created unnecessary tension between the parties involved.
Look for attorneys who have experience in handling similar deals and understand the client's business structure and objectives. By having legal counsel who is familiar with the industry and the specifics of the transaction, potential roadblocks can be identified and addressed more efficiently, leading to a smoother and faster deal process.
The Importance of Understanding Deal Structures and Profit Margins
Understanding deal structures and profit margins is vital for agency owners looking to sell their businesses. Deal structures, such as all-cash offers or earn-outs, can significantly impact the amount of money received upfront and over time. Owners need to have realistic expectations about the value of their agency and the potential payout structure they may encounter during negotiations.
Profit margins also play a crucial role in determining the value of an agency. A healthy EBITDA margin can make the agency more attractive to potential buyers and help ensure a successful sale. By understanding their profit margins and financial health, agency owners can better position themselves for a successful acquisition and maximize their payout.
Overall, navigating deal structures and profit margins requires a combination of financial acumen, legal expertise, and strategic negotiation skills. Agency owners must carefully consider their options, work closely with legal and financial advisors, and maintain realistic expectations throughout the acquisition process.
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