A lot of agency owners are accidental agency owners. Do you remember the day that you looked around and realized that you were running a business? For many agency owners, that wasn’t really the plan. And even if it was – we’re not prepared for it. We grew up in either the account service world or the creative world and avoided anything that even smelled of math or agency finance. But now, as agency owners, we need to have a handle on what is going on in our agencies from the financial side. Where do I stand financially and how can I improve my agency’s financial health?  

My podcast guest, Donya Powell is a CFO who works with agencies both big and small, helping them with everything from succession planning and selling their agency to financial dashboards, budgets and tax strategies. In our conversation, Donya and I cover a lot of ground, including:

  • Misconceptions agency owners have when valuing their business
  • Donya’s spreadsheet for assessing your financial picture during retirement
  • Understanding agency finance your agency’s normalized EBITDA (earnings before interest, taxes, depreciation, and amortization)
  • Factors that severely impact your agency’s value in a negative way
  • What you may need to change in your agency’s books
  • Things on the financial statement that agency owners often ignore that they really need to pay attention to
  • What financials agency owners should be looking at every week, month, and quarter
  • Budgets: can modern, project-based agencies use them?
  • Mistakes agencies make in regards to taxes and tax strategies to take advantage of
  • How to know if your agency is structured as a corporation in the correct way
  • Things to think about when planning the selling of your agency
  • Factors that play into an agency sale falling through
  • Things agency owners can do right now to start improving their agency’s financial health with the idea of an eventual sale

Donya Powell has been a CPA and consultant for 23 years in the advertising/marketing industry. She learned the industry working as a contract CFO for an agency early in her career and continues to serve as a remote CFO for agencies today. She has worked through several merger and acquisition deals with agency clients as she consults with agencies across the US on operations, agency compensation agreements, merger and acquisitions and succession planning.

To listen – you can visit the Build A Better Agency site (http://buildabetteragency.com/donya-powell/) and grab either the iTunes or Stitcher files or just listen to it from the web.  

If you’d rather just read the conversation, the transcript is below:

If you’re going to take the risk of running an agency, shouldn’t you get the benefits too? Welcome to Build a Better Agency where we show you how to build an agency that can scale and grow with better clients, invest in employees, and best of all, more money to the bottom line. Bringing his 25 plus years of expertise as both an agency owner and agency consultant to you, please welcome your host, Drew McLellan.  

Drew: Hey, everybody, Drew Mclellan here. Welcome to another episode of Build a Better Agency. I am excited to be with you today and I’m glad you came back. Thank you very much for that. And you are gonna be rewarded for coming back with an incredible conversation around something that every agency owner cares about, and that’s about building an agency of greater value. So, that when you decide that it’s finally time to play golf full time or do whatever it is you love to do, you have built an asset that is selllable. We’re also gonna talk if that’s not what you wanna do, how to get money out of the agency while you are running it. So that you can build your wealth outside of the agency.  

So all of those agency finance topics, I have a great passion around as does my guest. So Donya Powell is a CPA that has an incredible depth of experience in agency life. So she has been a CPA and a consultant for 23 years in the advertising and marketing industry. She learned about the industry working as a contract CFO for an agency about 23 years ago. And since then, she has really specialized in that.  

She works with lots of mergers and acquisition deals for agencies. She consults with agencies. She is a CFO for hire. I can tell you that many AMI agencies have sought out Donya’s help in evaluating their business or walking them through building out an acquisition strategy both for internal staff or an outside buyer. And without exception, they rave about her professionalism and her depth of knowledge. How much fun she is to work with and how easy she is to work with. So you are really in for a treat today. Donya, welcome to the podcast. Thanks for joining us.  

Donya: Thank you. Thanks for asking me.

Drew: It’s gonna be great. So every agency owner suffers under the delusion that their agency is worth bazillions of dollars. So help me, help us understand what are some of the misconceptions agencies have when they think about the value of their agency. Where do they sort of get a caught up in their own numbers or their own belief of how much their agency is worth?

Donya: Well, there’s a couple of reasons why they think their agency is worth what they think. And that is, you know, they hear from other people different multiples. And so they try to apply, kind of, industry standards, so to speak, to their agency. When every agency is really unique and the process of valuing them it is really much more than just applying the multiple. And the development of the multiple, you know, involves looking at a whole lot of things about the agency that makes it unique.

The other thing that I think, the danger that they run into, is that most agencies, smaller agencies have been raised up from infancy, you know, to what they are now. And this becomes really like a child to the agency owner. And so, the emotional aspects that are tied to owning an agency really are reflected in how an owner decides what their value is. And they generally think it’s worth more than it actually is. I mean I totally get it. I understand but it’s something you have to be realistic about when you’re looking to get help.

Drew: Well, and I think the third factor is oftentimes agency owners confuse how much money they want or need to have to retire with what the business should be worth.

Donya: Exactly. And that is really one of the first steps that I put agencies through, if they haven’t already done it. They really have to look at, “How much does it take for me to retire? What is the nut that I need so that I can get out?” And when you, kind of, force the agency value into that then you may or may not come out with the right number. But I do have agency owners go through that exercise. And I think on your… You have a site where I’ve given you the spreadsheet. So that that owner can look at that and decide, “Here’s what my financial future is gonna look like when I retire. Here’s my expenses, here’s my other income, what’s the nugget that I need out of the agency?”

Drew: Yeah. And we’ll include that in the show notes everybody. So you’ll be able to download that spreadsheet and do that work for yourself. So let’s talk about the multiplier. So what is the industry, sort of, standard multiplier? And what are some of the factors that influence where you fall in that multiplier?

Donya: For an integrated agency that kind of does all things, you know, creatives, account service, sometimes throwing public relations in there. That multiples typically run between a four and a six, particularly for smaller agencies.  

Drew: Four and six times what?

Donya: Times normalized EBITDA. So…

Drew: Can you define normalized EBITDA for everybody?

Donya: Yeah. So EBITDA first is earnings before interests, taxes, depreciation, and amortization. So, you know, most agency owners, you get down to a bottom line net income. What we do when we value it is we add back interests and income taxes if they apply and then depreciation and amortization. So that gets you to an EBITDA number. And then the normalization process is pretty critical. I think that’s one of the things that you really need to assess as an owner once you’re ready to determine what your value is. Is you need to go back a couple of years and look at the owner benefits that you have derived out of the agency throughout the years.  

So, you know, most agency owners run a lot of things through their agency which is entirely appropriate. And, you know, they take deductions that may be other management would not normally take. So they run cars through, they run travel through that’s personal. You know, there’s just a lot of owner benefits that you get out of the agency. And those things are the things that have to be added back to EBITDA to get to normalized income.  

The other thing that owners do is they may set their compensation either artificially higher or artificially low. And I say “artificially” meaning, you know, based on the market. So for different reasons if you’re an S corporation, they also set a lower salary level so that they don’t have to pay the self-employment taxes or the FICA or the Medicare taxes on those. And in C corporations, they typically set really high compensation levels because that’s really the only way to extract earnings out of a C corporation without double taxation.  
So in both cases, I look at the size of the agency, that region of the country that they’re in, and the market to see what the salary typically should be for a CEO. And then I will either add back to or deduct from earnings in order to normalize it. So those are some of the things I do to normalize.  

Drew: Okay. So four to six times EBITDA, normalized EBITDA. What would determine if an agency is a four or a six, or some other number, you know, either within or outside of that spread?

Donya: There’s a whole lot of factors in agency finance. One of the things is kind of their processes and how the agency interacts with its employees and how they run things. I’m always looking at their ratio. So what you typically preach to the agency owners that you work with in AMI is the 55/25/20. And so, yeah, I definitely look at those percentages and I look at those historical percentages.  

Another thing I look at is their agency gross income by clients. So I’m looking for a spread of that AGI amongst, you know, about eight clients that are comprising the top 60% of the revenue. So, I don’t want any one client to be more than about 20%. Because obviously, the loss of that client is gonna have a huge impact on the agency. So I look at that spread of AGI between the clients.  

Drew: So if an agency had a gorilla client, that’s gonna reduce their value from evaluation point of you, is what you’re saying?

Donya: Correct. Now, I mean if they’ve had it for a very long time and the relationship is pretty solid. But I have had instances where I find out and, you know, I have conversations with employees who are aware that I’m evaluating the agency. And I found out from the grapevine, so to speak, that gorilla clients are on the bubble and the agency owner has no idea. So, yeah, that is a critical piece.

Drew: How about, how integrated the agency owner is in the day-to-day work? Does that influence the spread?

Donya: Yeah, absolutely. So if the agency owner is, you know, the one that is the primary rainmaker, there’s nobody else really bringing in new business, then that’s going to ding you on the multiple. Because there needs to be somebody in place. Obviously, in order for you to get out and get your payout, you want there to be somebody who’s gonna be able to generate new business. So, yeah, if they are the primary rainmaker or if they’re the primary operations and they don’t have somebody to step up, that’s learning that piece of it, that’s a huge factor.

Drew: So part of the advice, I guess, that we’re giving agency owners is you need to identify what your role is day-to-day in the agency. And make sure that long before you’re ready to sell, you are training your replacement.  

Donya: Correct. Yup, yup.  

Drew: Okay. But what are some other factors that agency owners sort of need to think about, in terms of, as they fantasize or imagine what their agency is worth? Are there other things that they need to be sort of thinking about as they look for those numbers?

Donya: Well, I think a lot of small agencies have… Typically, their accounting department, is, you know, a bookkeeper that handles everything pretty much soup to nuts. And they have an outside CPA who prepares their tax return. May give them some advice throughout the year, but has relatively little involvement with the agency and how it’s run. So you don’t have enough money to, or require the kind of CFO type level of person. And so what you’re working with is like I said, a bookkeeper.  

And so the most difficult part of that for me, when I step in and look at it, is they will use programs that don’t necessarily track their work in progress. So the work in progress on the balance sheet is a number where it’s shown whether you are over-billed or under-billed on a client. So, for a lot of agencies, you know, especially for media and big production dollars, you’re gonna bill your clients upfront for that so that you aren’t out of pocket when you want to go pay that. So that money comes in as income but you really haven’t performed the work yet.  

Drew: Right. You haven’t earned it.  

Donya: Exactly. So it needs to sit on the balance sheet as under an income. But a lot of these programs… You know, like if you’re using QuickBooks, that’s not gonna do it automatically. So if you’re not doing an analysis of the jobs at the end of every month, to book some kind unearned or over-earned income, then you’re not gonna have the correct financial statement reporting. So that’s one of the things that I run into a lot.  

And so getting your books cleaned up and making sure that you have either somebody in place that can do that. Or you know, you talk to somebody like me who can show your bookkeeper how that’s done. Or you get a program that’s beefier and works a little better for doing that automatically. You still need some analysis on it but, I guess, the main point is making sure that your accounting and your bookkeeping is really clean. And that you, as an owner, understand it. You know, I do see a lot of owners who still really don’t understand financial statement reporting. And so, yeah, that’s a big problem.  

Drew: Yeah. Well and we see that too. I think most agency owners grew up in either the account service world or a creative world. And sort of avoided math and finance classes in college, which makes sense as to why they don’t understand agency finance now.

Donya: Yes. Exactly.

Drew: So all of a sudden, I think a lot of agency owners are accidental agency owners. That one day they just sort of found themselves owning an agency. And they don’t necessarily have either the right educational background or the experience on the financial side, to your point, of really being able to look at their financial documents and understand what they’re saying and what matters.  

Donya: Right, right and it can be frightening. You know, that’s why, I mean I really do emphasize to all your agency owners that it isn’t just the succession planning and the merger and acquisition stuff that I can help you with. I really can help you understand those financial statements better and what they mean to you.

Drew: So what are a couple of things on a financial statement that you believe most agency owners don’t pay enough attention to? That really are important to their monthly, or quarterly, or annual running of the agency?

Donya: I would say the biggest thing that agency owners ignore, and don’t really understand, is the balance sheet. You know, looking at the income statement kind of, “Here’s my income, here’s my expenses. So X minus Y equals what goes in my pocket.” But when you ignore the balance sheet, you ignore a whole lot of other stuff.

Drew: So tell us about that.

Donya: So, if you’re not looking at your debt service and that being, so any long term debt that you have, and trying to making sure that that gets paid off in a timely manner. The cash side of your financial statements, which is shown up on the balance sheet, is kind of the piece that’s not really understood well.  

So you’ve got liabilities on the balance sheet which is your accounts payable and any long- term debt that you might have or lines of credit. As those get bigger and bigger, and your asset base shrinks then you begin to have a problem. And that’s where you see owners in a cash flow issue. So they can look at their income statement and there can be income, but their cash is shrinking. And they don’t really understand why, “How can I have income but I don’t have cash?” Well, if you’re drawing money out as an agency owner and that’s not reflected in the income statement so…

Drew: Right. Because you’re taking a draw.  

Donya: Exactly. So if you’re an S corporation or an LLC or a sole proprietor, you’re taking draws that you never see close with the income statement but it does reduce cash. So that’s a problem. And then if you have problems on your accounts receivables collection. You can bill all you want. But if you’re not collecting it, it’s not helping you. So accounts receivable is another area where I see agency owners kind of not paying really close attention to that stuff that gets in the 60, 90, or 120 days.  

Drew: So what I’m hearing you say is I hear a lot of agency owners say, “I don’t get it. We’re super busy. But I don’t seem to have any money in my checking account. I’m not making any money.” So what you’re saying is that would be a place to go look to see where all the money is going.  

Donya: Exactly. I mean agency owners every week should be looking at their accounts receivable versus their accounts payable, and their accounts receivable and cash. So doing a current ratio which is current assets over current liabilities. Making sure that you have coverage on that.  

Drew: Yeah. So what are the things that agency owners should be looking, kind of think of it as their agency finance dashboard, what should they be looking at whether it’s weekly, monthly, or quarterly basis? And again, as you know because the people that you work with every day, they’re not gonna spend hours and hours pouring over their financials. They wanna be able to look at it at a glance. So what would you recommend for an agency owner? What should they look at every week?

Donya: Every week, they should absolutely look at the current ratio. And you should be looking at your accounts receivable and accounts payable detail. And looking at that stuff that’s in, you know, over 60 days and making sure that you have somebody on it. That your bookkeeper or somebody is calling on collections. I usually like the first contact to be the bookkeeper or accountant because they can make friends with the accounts payable person on the other side. And usually gets stuff accomplished much quicker than accounts service person calling their clients saying, “Hey, we haven’t gotten paid.” That’s…

Drew: I think a lot of times the client has the process to bill on their end. The billing person can go, “I don’t even have that bill.”  

Donya: Right.

Drew: Yeah. Okay. So what else should they look at on a weekly basis?

Donya: I do have them look at cash and cash flow. So you can do an updated cash flow on a weekly basis, and that would be cash flow projections. So kind of seeing where you’re out, you know, four weeks, six weeks out. And looking at that on a weekly basis.  

Drew: What about monthly?

Donya: The monthly is… the things that are important are those financial statements. So getting your financial statements on a timely basis is really, really critical. And then looking at those ratios that you look at, the salaries to AGI. I mean that is your biggest place for adjustments. I mean it’s your biggest expense. And if you’re out of whack there, you are definitely gonna be out of whack on your bottom line.

Drew: Yup.  

Donya: So the other percentage that I typically look at that’s a big percentage, the next biggest percentage of their AGI is rent. So if you’re stuck in a space that’s way too big for you, that’s gonna become glaringly obvious on the financials. So I never like to see an agency be more than 9% of their AGI on rent.  

Drew: Okay.  

Donya: Unless again, for other reasons if they own the building and redoing it because of a tax strategy, that’s a different story. So those are the two percentages I would look at on AGI.

Drew: Every month?

Donya: Every month. And then you need to look at client profitability on a monthly basis. So you need to have a good reporting system for client profitability. Because you really do need to see where your winners and losers are.  

Drew: Yeah. I think sometimes agencies are surprised when they look at that. A lot of agency owners, as you know, don’t ever look at that or they don’t look at it very often. But sometimes, I find when I go in and work with an agency that they’re literally paying for the privilege of doing work for a client.

Donya: Yeah, yeah, absolutely. And I…

Drew: And it’s almost always the client that is a pain in the neck anyway.

Donya: Yes. And it’s a drain on everybody and the owner keeps thinking, “Oh, I’ve gotta keep this for cash flow reasons.” You see that you’re ending up making about 70 bucks an hour, it’s not worth it.  

Drew: If that, right. If that, right.

Donya: Yeah. Exactly. And that would be the other thing that a huge… I guess a benchmark that I look at. And that is to take your AGI and divide it by the number of billable hours. And then you get your actual billable rate.  

Drew: Right. And when you say that, do you mean billable hours, meaning that that’s how much time people booked that was in billable work?

Donya: Yes.

Drew: Or that we actually billed?

Donya: No. The time that people actually worked. Because that’s where you’re gonna uncover the dog client that just, you know…

Drew: That is sucking up at the time.

Donya: Yes. And sucking the life out of your people.

Drew: Yeah, yeah. Okay. Anything else on a monthly basis that folks should look at?

Donya: No. If you get those things down, you’re gonna be okay.

Drew: What about quarterly? Anything that you would add to that list on a quarterly or semi-annual basis?

Donya: For sure you need to… On a quarterly basis, most owners need to really look at their tax situation and review that with your tax preparer. That’s another thing that sneaks up on owners and suddenly, you know, you’re stuck with a big tax payment. And you either A don’t have a cash flow to do it or you can’t pay it at all. So I would say definitely quarterly, you need to be assessing your tax situation.  

Drew: What about annual budgets? Should agencies be creating an annual budget and what are the key factors in that budget?

Donya: Yeah. I mean I do like agencies to do a budget. I know that with a lot of agencies being more project oriented than AORs anymore, that’s very difficult to predict revenues and I get it. But you still kinda need to know, you know, where most of the dollars might be coming from. And you certainly need to know what your expenses are gonna be.  

And the expense part is pretty easy to do. I mean you have fixed expenses that are very easy to project and you have people. So to predict that is very simple. So then you know automatically, “Here’s my expenses then what is the AGI that I need to be working towards in order to make a certain level of income? ” And you need to factor into that any, you know, major computer or whatever fixed assets you’re gonna be purchasing. You need to factor that expenditure into it as well as far as cash flow.  

Drew: So let’s turn our head to taxes. As you know, one of the topics every agency owner loves to talk about is how they can avoid paying unnecessary tax. So what are some mistakes agencies make when it comes to the way they run their agencies, or deductions they do or don’t take around that? Where they are… And again, neither you or I are advocating anything that’s illegal. But what are some ways that people are not taking full advantage of tax code and tax law and potential deductions, and paying more in taxes than they really need to?

Donya: As far as deductions go, I don’t see a lot of people not doing what they could do. You know, you typically see people doing more than what they should do. So, yeah, I don’t… There aren’t a lot of deductions. You know, there used to be a whole lot of I think we could and those things are all gone.  

So when people, sort of, push the envelope a little bit, I mean I think it’s whatever you’re comfortable with as far as pushing that envelope and exposure to audit. I think the biggest mistakes probably are that they don’t maintain contact with their preparer. So that the preparer is fully aware of what’s going on. And because a lot of tax preparers don’t really understand advertising agencies that they’re not asking the right questions.

Drew: So what are some questions that our traditional tax preparer might not ask that someone like you would ask?

Donya: Well, first of all, you need to make sure that if you’re a cash base taxpayer and that’s a different look at things than an accrual basis taxpayer. So if an agency typically looks at their reporting based on an accrual but their cash base is taxpayer, they may not be fully aware what the tax ramifications at any given year might be. So you could have…

Drew: Because they’re not looking at the numbers that way all through the year.

Donya: Correct. And so you could be looking at accrual basis financial statements that are showing you at breakeven or at loss, the cash basis. You may have a big amount of income because you collected a huge receivable at the beginning of the year. So not distinguishing between those two things and understanding that this is what you need to be looking at as far as income is concerned, that that could be a problem.  

The other thing, you know, I would be asking particularly with S corp shareholders is, “What kind of salary are you paying yourself? And is that a reasonable salary in terms of the IRS?” Because that’s where the IRS is looking at a lot of S corporations. They don’t want salaries to be set low just so that owners could be avoiding FICA and Medicare taxes. So you do need to be paying yourself a reasonable salary. And then if you’re an accrual basis taxpayer then again, that work in progress number or that unearned income number on the balance sheet is important if you’re an accrual basis taxpayer.

Drew: Okay. So what are some other tax strategies other than the deductions that agency owners should be thinking about in terms of mitigating their tax risks?

Donya: Well, if you’re a C corp, you know, there are some things that you do that you play with as far… I always, kind of, keep C corp earnings below $100,000 so that a C corporation can take advantage of all the brackets. Because once you hit over $100,000 in profits then you pay at the highest corporate tax rate, which is, you know, higher than individual tax rate. So we try to keep earnings below there. So mitigating taxes between corporate earnings and personal earnings is one strategy for C corp, C corp shareholders. For… Go ahead.

Drew: Well, as I was gonna say I think most agencies are LLCs or S corps and I see very few C corps. How does an agency owner know if they are the right corporate structure? And is there a point in time where maybe it made sense to be an LLC or S corp but at a certain size or some other reason switching to a C corp is smart? How does an agency owner assess that?

Donya: It just depends on the goals of an agency owner. And so C corporations, they allow you flexibility in the shares. So the nice thing about those is that you can have different classes of shares. So if you want to grant some kind of shares, like preferred shares, nonvoting shares, or whatever to employees then you have that flexibility in a C corporation. The bad thing about C corporations is the double taxation. So the only way to extract earnings out of there, as I said before, is through compensation, W-2 compensation to C corp shareholder. Because if you try to get the dividends out, you’re gonna be taxed on the dividend, and the C corp can be taxed as well. So that is the down side of it.  

The S corp, you know, the upside of it was a long time ago was that you could set your salary low and you could avoid that FICA and Medicare on bigger dollars and just extract those as S corp earnings and take them as draws. Again, it is an area that the IRS is looking at. So you have to make sure you’re paying a reasonable salary.  

The LLCs or partnerships, the issues with those is that you pay self-employment tax on every dollar of earnings that’s in there. But again, you have a lot of flexibility with regards to profits and how those are distributed, where you are more just restricted in an S corporation. In an S corp, you can’t… Everybody has to get draws or distributions in their shareholder percentages. And so, the only way to adjust compensation is through their W-2. So there are draw backs and restrictions to every single single form of entity. What you really need to do is talk to somebody about, “Am I structured properly for what I want to accomplish?”