Episode 37

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Donya Powell has been a CPA and consultant for 23 years in the advertising/marcomm 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.

 

What you’ll learn about in this episode:

  • Misconceptions agency owners have about the value of their agency
  • Donya’s spreadsheet for assessing your financial picture during retirement
  • Understanding 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 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

 

The Golden Nugget:

“10 years out is not too early to start planning the sale of your agency.” – Donya Powell Share on X

 

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Announcer:

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, invested employees, and best of all more money to the bottom line. Bringing his 25-plus years expertise as both an agency owner and agency consultant to you please welcome your host Drew McLellan.

Drew McLellan:

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. You are going to 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 sellable. We’re also going to talk about if that’s not what you want to 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 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 MarCom industry. She learned about the industry working as a contract CFO for an agency about 23 years ago. 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 valuating 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, and 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 Powell:

Thank you. Thanks for asking me.

Drew McLellan:

Yeah. It’s going to be great. So every agency owner suffers under the delusion that their agency is worth bazillions of dollars. So 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 caught up in their own numbers or their own belief of how much their agency is worth?

Donya Powell:

Well there’s a couple of reasons why they think their agency is worth what they think. That is they hear from other people different multiples and so they try to apply industry standards, so to speak, to their agency when every agency is really unique. The process of valuing them is really much more than just applying a multiple. The development of the multiple 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 to what they are now. This becomes really like a child to the agency owner. So the emotional aspects that are tied to owning an agency really are reflected in how an owner decides what their value is. 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 out.

Drew McLellan:

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 Powell:

Exactly. 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? When you kind of force the agency value into that then you may or may not come up with the right number. But I do have agency owners go through that exercise. I think on your … You have a site where I’ve given you the spreadsheet, so that owner can look at that and decide, “Here’s what my financial picture’s going to 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 McLellan:

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 standard multiplier and what are some of the factors that influence where you fall in that multiplier?

Donya Powell:

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

Drew McLellan:

Four and six times what?

Donya Powell:

Times normalized EBITDA, so-

Drew McLellan:

Okay. Can you define normalized EBITDA for everybody?

Donya Powell:

Yeah. So EBITDA, first, is earnings before interest, taxes, depreciation, and amortization. So most agency owners you get down to a bottom line net income. What we do when we value it is we add back interest and income taxes, if they apply, and then depreciation and amortization. So that gets you to an EBITDA number. 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 most agency owners run a lot of things through their agency, which is entirely appropriate. They take deductions that maybe other management would not normally take. So they run cars through, they run travel through that’s personal. There’s just a lot of owner benefits that you get out of the agency. 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 high or artificially low. I say artificially meaning based on the market. So for different reasons if you’re an S-corp they often set a lower salary level so that they don’t have to pay the self-employment taxes or the FICA and the Medicare taxes on those. 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, the region of the country that they’re in, and the market to see what the salary typically should be for a CEO. Then I will either add back to or deduct from earnings in order to normalize them. So those are just some of the things I do to normalize.

Drew McLellan:

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, either within or outside of that spread?

Donya Powell:

There’s a whole lot of factors. 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 ratios. So what you typically preach to the agency owners that you work with in AMI is the 55-25-20.

Drew McLellan:

Right.

Donya Powell:

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 client. So I’m looking for a spread of that AGI amongst 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 going to have a huge impact on the agency. So I look at that spread of AGI between the clients.

Drew McLellan:

So if an agency had a gorilla client that’s going to reduce their value, from a valuation point of view, is what you’re saying?

Donya Powell:

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 I have conversations with employees who are aware that I’m valuating the agency and I’ve found out from the grapevine, so to speak, that gorilla clients are on the bubble and the agency owner has no idea. Yeah, that is a critical piece.

Drew McLellan:

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

Donya Powell:

Yeah, absolutely. So if the agency owner is the one that is the primary rainmaker, that 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 going to 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, and that’s learning that piece of it, that’s a huge factor.

Drew McLellan:

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 Powell:

Correct. Yep. Yep.

Drew McLellan:

Yeah. Okay. What are some other factors that agency owners 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 thinking about as they look for those numbers?

Donya Powell:

Well I think a lot of small agencies have … Typically their accounting department is a bookkeeper that handles everything pretty much soup to nuts. Then 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. 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, especially for media and big production dollars, you’re going to bill your clients up front for that so that you aren’t out of pocket when you have to go pay that. So that money comes in as income but you really haven’t performed the work yet and so-

Drew McLellan:

Right, you haven’t earned it.

Donya Powell:

Exactly. So it needs to sit on the balance sheet as unearned income, but a lot of these programs … Like if you’re using QuickBooks that’s not going to do it automatically. So if you’re not doing an analysis of the jobs at the end of every month to book some kind of unearned, or over earned, income then you’re not going to have the correct financial statement reporting. So that’s one of the things that I run into a lot. So getting your books cleaned up and making sure that you have either somebody in place that can do that or 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 you’re accounting and your bookkeeping is really clean. And that you as an owner understand it. I do see a lot of owners who still really don’t understand financial statement reporting. So yeah, that’s a big problem.

Drew McLellan:

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. 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 Powell:

Right. Right. And it can be frightening. That’s why I … I mean, I really do emphasis 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 McLellan:

So what are a couple 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 Powell:

I would say the biggest thing that agency owners ignore and don’t really understand is the balance sheet. 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 and-

Drew McLellan:

So tell us about that.

Donya Powell:

If you’re not looking at your debt service and that being … So any long-term debt that you have and trying to make 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 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. That’s where you see owners in a cash flow issue. 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 McLellan:

Right, because you’re taking a draw.

Donya Powell:

Exactly. So if you’re an S corporation, or an LLC, or a sole proprietor you’re taking draws that you never see flow through the income statement but it does reduce cash. So that’s a problem. Then if you have problems on your accounts receivable collections. 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 into 60, 90, 120 days.

Drew McLellan:

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 Powell:

Exactly. I mean, agency owners every week should be looking at their accounts receivable versus their accounts payable. 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 McLellan:

Yeah. So what are the things that agency owners should be looking … Kind of think of it as a financial dashboard. What should they be looking at on a … Whether it’s weekly, or monthly, or quarterly basis? Again, as you know because it’s the people you work with every day, they’re not going to spend hours and hours pouring over their financials. They want to 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 Powell:

Every week they should absolutely look at a current ratio, and you should be looking at your accounts receivable and accounts payable detail. And looking at that stuff that’s in 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 get stuff accomplished much quicker than an account service person calling their client saying, “Hey, we haven’t gotten paid.” That’s-

Drew McLellan:

[crosstalk 00:19:47] Well I think a lot of times the client has to process the bill on their end and the billing person can go, “I don’t even have that bill.”

Donya Powell:

Right. Right.

Drew McLellan:

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

Donya Powell:

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 … Four weeks, six weeks out, and looking at that on a weekly basis. Yeah, don’t do-

Drew McLellan:

[crosstalk 00:20:27] What about monthly?

Donya Powell:

Monthly the things that are most important are those financial statements. So getting your financial statements on a timely basis is really, really critical. Then looking at those ratios that you look at, the salaries to AGI. That is your biggest place for adjustment. I mean, it’s your biggest expense and if you’re out of whack there you are definitely going to be out of whack on your bottom line. And 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 going to become glaringly obvious in the financials. So I never like to see an agency be more than 9% of their AGI on rent.

Drew McLellan:

Okay.

Donya Powell:

Unless, again, for other reasons. If they own the building and they’re doing it because of a tax strategy that’s a different story but-

Drew McLellan:

Yeah.

Donya Powell:

So those are the two percentages I would look at on AGI.

Drew McLellan:

Every month?

Donya Powell:

Every month. 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 McLellan:

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 Powell:

Yeah. Yeah, absolutely. And I-

Drew McLellan:

[crosstalk 00:22:15] And it’s almost always the client that is a pain in the neck anyway.

Donya Powell:

Yes!

Drew McLellan:

Right, so-

Donya Powell:

And it’s a drain on everybody and the owner keeps thinking, “Well I’ve got to keep this for cash flow reasons.” But when you see that you’re ending up making about $70 bucks an hour it’s not worth it-

Drew McLellan:

If that. Right. If that. Right.

Donya Powell:

Yeah, exactly. That would be the other thing that I … A huge … I guess a benchmark that I look at. That is to take your AGI and divide it by the number of billable hours. Then you get your actual billable rate.

Drew McLellan:

Right. When you say that do you mean billable hours meaning that that’s how much time people booked that was in billable work-

Donya Powell:

Yes.

Drew McLellan:

… or that we actually billed?

Donya Powell:

No. The time that people actually worked.

Drew McLellan:

Okay.

Donya Powell:

Because that’s where you’re going to uncover the dog client that just …

Drew McLellan:

[crosstalk 00:23:13] Is sucking up all the time.

Donya Powell:

Yes. And sucking the life out of your people.

Drew McLellan:

Yeah. Yeah. Okay. Anything else on a monthly basis that folks should look at?

Donya Powell:

No. If you get those things down you’re going to be okay.

Drew McLellan:

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

Donya Powell:

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’re stuck with a big tax payment. And you either, A, don’t have the cash flow to do it or you can’t pay it at all. Yeah. So I would say definitely quarterly you need to be assessing your tax situation.

Drew McLellan:

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

Donya Powell:

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 kind of need to know where most of the dollars might be coming from. And you certainly need to know what your expenses are going to be. 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. 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 major computer or whatever fixed assets that you’re going to be purchasing. You need to factor that expenditure into it as well, as far as cash flow.

Drew McLellan:

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.

Donya Powell:

Right.

Drew McLellan:

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 … 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 Powell:

As far as deductions go I don’t see a lot of people not doing what they could do. You typically see people doing more than what they should do. Yeah, there aren’t a lot of deductions. They’re used to be a whole lot-

Drew McLellan:

[crosstalk 00:26:29] Right.

Donya Powell:

… do 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 they’re not asking the right questions. And so-

Drew McLellan:

What are some questions that a traditional tax preparer might not ask that someone like you would ask?

Donya Powell:

Well, first of all, you need to make sure that if you’re a cash basis taxpayer than 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 they’re a cash basis taxpayer, they may not be fully aware of what the tax ramifications in any given year might be. So you could have-

Drew McLellan:

Because they’re not looking at the numbers that way all through the year?

Donya Powell:

Correct. So you could be looking at