Increase your agency’s value and build a smart exit strategy with Gina Cocking

Speaker 1:

If you’re going to take the risk of running an agency, shouldn’t you get the benefits too? Welcome to Agency Management Institute’s Build a Better Agency podcast presented by White Label IQ. Tune in every week for insights on how small to mid sized agencies are surviving and thriving in today’s market. We’ll show you how to make more money and keep more of what you make. We want to help you build an agency that is sustainable, scalable, and if you want down the road, sellable. With 25 plus years of experience as both an agency owner and agency consultant, please welcome your host, Drew McLellan.

Drew McLellan:

Hey everybody, Drew McLellan here with another episode of Build a Better Agency. Welcome back, if you are a regular listener, glad to have you, if this is new to you, our goal with every episode is to speak very directly to agency owners and leaders of agencies that I call small to mid size. So you might have no FTEs or a handful of employees, or you might have a couple hundred employees. Anywhere in between there is sort of the sweet spot of AMI. And by the way, if you are constantly sort of talking about how small your agency is, remember that the average agency size inside the U.S is about eight full time equivalent. So you may not be as small as you think you are, you may be average or even above average.

So a couple quick things I want to think about and talk to you about today before we jump into the interview. Number one, we have some killer workshops in January. Please go to the Agency Management Institute website and check them out. Both of them are focused on BizDev. One is about how to build and nurture your sales funnel, and we’re actually going to make you build out the sales funnel while you are there. So we’re going to show you how to do it, and then we’re going to give you time and coaching on how to get it done so that you leave with a pretty robust sales funnel. You may have to flush it out a little bit after you get back, but I want you to have it at least 80% done so that you can hit the ground running when you get back in the office.

Then the second one is with our friends at Mercer Island Group. They always deliver incredible content. And this is a brand new workshop, brand new content. They have been studying the buyer’s journey that a prospect goes through long before they’re on our radar screen. And they’re going to talk to us about that, and how we can win at every milestone, even when we don’t know they’re out there.

So check those out. Those are both towards the tail end of January in sunny Orlando, Florida, which is not a bad place to be in January. So, would love to have you join us there. Also want to remind you that we are always grateful for ratings and reviews for the podcast. So leave us a rating and review wherever you download the podcast. And make sure you take a screenshot and email it to me so that we can put you in the drawing for a free workshop. So every month we give away a free workshop, either a seat in one of our live workshops, or access to one of our on-demand workshops. Both retail for about two grand. So it’s probably worth it to spend three, four minutes leaving a review and have a shot at winning a free workshop. So we’d be glad to have you at the workshop, and we’re always grateful to hear what you think about the podcast. I promise I read every one and take them to heart, so I appreciate them.

All right, so let’s talk a little bit about what I want to talk about today. So you know those days, and you may have even uttered under your breath, “I would sell this agency for a plug nickel.” There are just some days that agency ownership is challenging, so we think about what it would be like to just hand over the reigns to somebody else. And even on great days, for most of you, one of your goals is to sell the agency eventually. And to do that, you need to understand how an agency is valuated.

So, I have invited Gina Cocking on the show. Gina is a managing director and partner at Colonnade Securities. They are a boutique investment banking firm that specializes in mergers and acquisitions for clients in the services industry. So, they have worked with and helped many agencies buy or sell, and so what I want to do today is I just want to pick Gina’s brain about how we can add as much value to our agency. And again, this is true whether you want to sell it, whether you want to pass it down to one of your kids, whatever your exit strategy is, you always, of course, whether you’re going for a bank loan or anything else, we want our business to be of great value.

So, regardless of what you think the end holds for you in terms of transitioning out of the business what I’m hoping is that I can extract from Gina some real gems so that you can add more value to your business every day, and take full advantage of it in all of the ways that that’s possible, all right? So, without further ado, I want to welcome Gina to the podcast.

Welcome, thanks for joining us.

Gina Cocking:

Thank you for having me.

Drew McLellan:

So, your depth of expertise is in a category that I think is one of the places where many agency owners sort of fret and worry. Part of what I want to do in our conversation is to really pick your brain and to give them some good guidelines so that they really do have a sense of what their agency not only is worth or what they can do today, 20 years, 10 years, five years before they’re even thinking of selling it to make it of even more value. So first, why don’t you give everybody just a sense of your background, and how you have come to have this knowledge and expertise? Then, prepare yourself, because I have a lot of questions.

Gina Cocking:

Okay, great. Well, I am a long term investment banker. So, after from college I went into investment banking and I spent one year as an analyst for a private equity firm. After business school I went back to investment banking at JP Morgan, which we then, a few of us, left and formed Colonnade Advisors. I was with Colonnade Advisors for five or six years, and took a different turn in my career. Became the CFO of a number of companies. One of those was private equity backed. The other was a smaller company that we went out and raised a lot of private capital.

And I came back to investment banking six years ago. And here at Colonnade, we focus on mergers and acquisitions for business services and financial services companies. So, we do a lot of work with companies that are kind of in EBITDA, earnings before taxes of size pretty much from four million to as much as $80 million. Kind of our sweet spot are deals that end up being 75 to $125 million in size.

So, we do a lot of work with companies that are in data analytics, marketing oriented, business services companies, companies that are highly dependent on data analytics for marketing. So, call center type.

Drew McLellan:

So, I’m curious with the range of company sizes that you work with, probably most of the people listening are smaller than that. Is it not an option for them to think they can sell their agency?

Gina Cocking:

Oh, it absolutely is an option for them, it’s just kind of the field that we planned or the size that we planned. But no, if a company has enterprise value, so it is meaning it’s a value that transcends in individual. It absolutely could be of interest to a larger acquirer. When you get to the… you need a certain threshold to get the attention of a institutional investor, meaning a private equity firm. And that really is $3 million plus in EBITDA. But at smaller sizes you’re still going to have a lot of interests from what we call strategics or others in the industry that are looking to acquire [inaudible 00:08:20].

Drew McLellan:

Like potentially selling to employees, selling to another agency in the market, things like that, right?

Gina Cocking:

Exactly, exactly. And as I was stating earlier, it’s important to have that enterprise value. So, does the value of your entity transcend any one into a individual? That’s when you know you’re ready for sell. When you have a company that people are working with, not just because of you but because of what your company is known for.

Drew McLellan:

So, let’s talk about that a little bit. I know you refer to that as sort of an agency owner can kind of create a cult of personality, as opposed to a recognized company that stands independent of the owner. So, talk to us a little bit, like when you’re looking at a company or you’re doing some evaluation, what tells you? Because you know most agency owners are pretty charismatic. They are pretty outgoing, they’re pretty engaging. They’re often the sales engine for their agency. So it makes sense that a lot of people when they think of the agents you think of the owner.

So what kind of things would an agency owner have to do to diminish this idea of this cult of personality to create more value inside their agency for a potential buyer?

Gina Cocking:

Great question. We use a metric. Basically could the owner go away to an island and put away their cellphone for three months, and would the company continue to flourish? If the answer is yes, it is an enterprise. If the answer is no, it’s going to be hard to get full value for the company. What you may end up with is a glorified employment agreement. So, it’s can the company function without you? Does the team around you, can they continue to develop a new business? Maybe not as effectively as we can, but can they continue to develop new business? Can they continue to service the clients that you have?

Drew McLellan:

Okay, so it’s not really about having to have sort of another superstar in the wings. It’s really about, do you have a team around you that on any given day could step in and run the show?

Gina Cocking:

Exactly, exactly. So, I’ve run into problems with companies in the past where it’s a few individuals, and there’s always concern with buyers. If any one of those individuals left the company, would there still be a company?

Drew McLellan:

Right.

Gina Cocking:

Is it really worth paying a multiple of earnings for a company like that? So, getting buyers comfortable with that is paramount in order to get a good value for the company.

Drew McLellan:

So, I know for some agency owners, as they look down the road and they think about maybe selling, they have some key people on their team that they feel play a significant role in not only running the company, but certainly if they were to step away, those people would become even more valuable. So, are you saying they’re correct, and they need to figure out how to kind of in air quotes, handcuff those people to the company? And is a purchase deal often tied to the continued employment of those people? In other words, I’m buying your agency but I also want employment agreements that I lock in the leadership team or the key players along the way.

Gina Cocking:

Yes. The team needs to, not quite be handcuffed in, but be incentivized to stay with the organization. So, when we think about how to do that, if you have employees now, before you even go through a transaction, putting an employment agreement in place that will incentivize them first to be really excited about the transaction. So, maybe giving them, not equity in the company, but perhaps profit’s interest in the transaction would be really helpful to get the deal across the finish line.

Then, post transaction if a buyer sees that, they will help create usually an equity pool for your key employees to participate in. And, they will be able to own 1% or 2% of the company on a go-forward basis. Now, if your employees own, kind of a rule of thumb is maybe 10% of the company, that employee will be subject to a pretty strict non-compete as part of the purchase agreement.

Drew McLellan:

Got it.

Gina Cocking:

Now, keep that in mind with thresholds. It is always challenging in a people business to keep everybody engaged with the company, and everybody comfortable with the idea that we’re buying a company where people are going to continue. So, another way that this is done is through an earn out structure. So if an agency is being acquired, the buyer will say, “Okay, we’re going to pay all in just picking a number about eight times their earnings. We will pay you four times at close and one time per year, each year for the next four years.

Now you only get that what we call an earn-out, if you hit certain thresholds and it could be an earnings threshold or a revenue threshold, and you as the business owner know that in order to achieve those thresholds, you either have to have your current employees still excited and working for you, or you have to be able to replace them and continue to build the team. So that’s usually the way service business is. The deals are structured as multi-year deals to keep everybody aligned.

Drew McLellan:

And typically, how often are they expecting the agency owner to stick around?

Gina Cocking:

It depends on how the deal is positioned. At the outset, if the agency owner says, “You know what? I am not going to stay with this business.” Great. Then they’ll be expected to stay for a couple of months. The value of the agency may be negatively impacted by the fact that the owner will be leaving. Otherwise two to three years. And maybe it’s an earn-out, maybe it’s even longer, maybe it’s even four years. And the earn-out will be tied partially to the owner’s continued employment. So not only do you have to have the threshold, but you actually have to be working there. And we see that a lot with, for example, with insurance agencies.

Drew McLellan:

So what about sort of determining the value? So what are some of the elements that would make an agency worth more or less to a potential buyer? Again, whether it’s an internal buyer or it’s the agency down the street, or for some of the larger agencies listening, maybe it is an institutional buyer, but for most of my agencies who are listening, it’s not likely that a big investment company is going to come in and buy them. They’re just not that big.

Gina Cocking:

Sure.

Drew McLellan:

So nonetheless though, I would assume that the factors are kind of the same, right?

Gina Cocking:

They are. They are. I would say number one, getting back to part of our earlier conversation, enterprise value. Is this a brand name that’s being recognized? Is it a company that transcends an individual? Number two, recurring revenue is valued. And sometimes it’s hard in an agency business because you’re doing a lot of project-based work. So you’re not going to have recurring revenue from the same client. So first of all, if you’re in a type of agency where you’re doing a lot of work, where you have the possibility of having recurring revenue, ongoing engages with clients. You have a retainer that takes you through multi years, the more recurring revenue and the more contracts you have in place, the longer your relationships, the hiring value. If you’re more of a project based agency, the question is how do you get your next client?

And that’s where vertical expertise is really important. Do you have to go out and scramble each time to go find your next client, or are people coming to you? And if people are coming to you and you’re a known brand for that type of client, you have more value. So one way to do that is… And I’m a huge believer in focus, and a vertical industry focus. It’s really, it’s easier to be a Jack of all trades, than a master of none, than to say, “You know what? I am only going to really focus my agency’s efforts on working with wealth management companies. I am going to only take on wealth management companies. I’m going to go to their conferences to advertise my services. I’m going to write articles about wealth management companies, and everybody will know my name.” Now I might not just be local, but I might have a national practice.

Then everybody knows, you call Gina’s agency if you’re a wealth management and you’re looking for advisory work. If you say, “Well, I do wealth management, but I also work with fast food chains, and clothing boutiques, and higher education then your message gets a little convoluted. You can do that when you’re a large company, but as a small company, you’re not conveying a consistent message. You’re not conveying a consistent face to the world. So essential clients aren’t necessarily going to think of you. They’re not going to get that referral base that you need to almost kind of generate what looks like a recurring revenue stream, because you’re the known entity.

Drew McLellan:

So what I’m hearing you say is that is expensive for an agency to be a generalist. And there is great value in being a specialist.

Gina Cocking:

That is exactly it.

Drew McLellan:

And that just like in the medical community, no one’s going to drive by 12 general practitioners to get their flu shot, but they will drive 300 miles to get to Mayo Clinic to see a specialist.

Gina Cocking:

That is exactly right. That is exactly right. And what we see is when we see companies that are becoming successful and scaling up, and they’re becoming companies that are 10, 20, 100 million dollars, what they’re doing is they start with a focus and then they build off that focus into other verticals, or they start acquiring companies that have another vertical expertise. So when you’re a company that’s of size of less than five million in earnings, you are much more likely to have a… You have a broader acquire universe with a focus than as a generalist.

Drew McLellan:

Okay. So because my listeners have heard me say this a million times, I’m going to repeat it again. It’s not just me, Gina is saying the exact same thing which is, that it is very risky for us as agency owners to be the Jack of all trades or in my vernacular, the generalist. That not only can you grow faster, but you certainly are creating a better sense of value. Again, whether you’re going to keep the agency and you’re just going to use it as an ATM machine, or you’re going to sell it to your employees or whatever. But one of the key things is the specialist is able to attract business. And one of the key factors in determining the multiplier of value is basically how do you get new clients? And the more they come knocking on your door, as opposed to you having to hunt them down, the greater that value is going to be.

Gina Cocking:

That is exactly it. That is exactly it. Now you can come and join us here at Colonnade to help communicate that message. We talk a lot about that with companies.

Drew McLellan:

Me too. It’s a tough one. And I get why it’s scary. I get that it’s hard to imagine putting all your eggs in one basket and all of those things. But boy, when I look at all the agencies,  and I see the full financials of about 200 agencies a year, and I will tell you without exception, the healthier they are, the more specialized they are. So, yeah. Okay, so one of the values was, are you an enterprise rather than a cult of personality? In other words, is the agency functional with or without the owner in place? Another one is this idea of generalist versus specialist. Another one is recurring revenue rather than just project work. And I think that continues to be a challenge in the agency space. But even if you have a client that you keep getting more projects from, that would be better.

Gina Cocking:

That’s pretty more like recurring.

Drew McLellan:

Yep. What about the relationships, is the tenure of clients a factor that we should think about?

Gina Cocking:

Absolutely. Absolutely. And when we are working with companies, evaluating them, either if we’re working to sell those companies or we’re advising on the buy side, we are always looking at the tenure of relationships. The nature of the relationships and the tenure of the relationships, that matters a lot. If an agency has grown a lot over the past 24 months, let’s say they’ve grown the top line by four or 500%, but it’s all from new clients. There’s a lot of risk there from a buyer like, well, are they going to persist? Are they just coming to this agency because of the latest bell and whistle? Is because the agency is underpricing their services?

Drew McLellan:

Right.

Gina Cocking:

It does yield a lot of questions now that’s not insurmountable and it can be worked through, but you really have to evaluate what is the ongoing strength of those relationships.

Drew McLellan:

Yeah. What about, what are some of the other elements that add value to a potential buyer, whoever that may be?

Gina Cocking:

Diversification. So not diversification in industry focus, but in diversification with your client base. So getting back to what probably keeps an agency owner up at night, it’s losing your biggest client.

Drew McLellan:

Right.

Gina Cocking:

And-

Drew McLellan:

So what you’re saying is not having a gorilla. Right?

Gina Cocking:

Exactly. Exactly. And I totally get it. I mean, when you have a big client, it’s fantastic.

Drew McLellan:

Right? And they keep wanting to give you money and you’re not going to say no.

Gina Cocking:

Of course not. Of course not. The problem is you got to grow the rest of your business just as fast. You don’t want to see more than 20% concentration. That’s my good rule of thumb. 15% is better. But as soon as you start hitting 20%, you have a problem. And your value will definitely be less than a comparable company that has the highest concentration of 10%.

Drew McLellan:

Yeah. So at what point is concentration like a no deal? Like that’s a deal breaker. If you have a gorilla client, that’s what percentage would most buyers go, “No way.”

Gina Cocking:

Oh, I think when we’re getting to 25 or 30%.

Drew McLellan:

Wow. Because you know, there’s a lot of agencies that have clients, that have a gorilla client that’s bigger than that.

Gina Cocking:

Mm-hmm (affirmative). Here’s the reason why, typically when a business is being acquired there’s some sort of leverage being involved, some sort of debt. Either going for bank debt or some sort of loan and the lender in making that loan needs to be comfortable that there’s enough cashflow from the agency to cover the principal on the interest and the metal debt paid out. And if there’s a loss of a client that’s 25% of current income, they’re not going to make this loan payments. And so that’s usually a gating factor, just if anyone’s using a lender. Now, let’s say you have a buyer that’s not using a lender. I think it’s just, there’s a significant risk. You just bought something for… You just buy a company for eight times. Let’s say they’re making $2 million a year and you’re just bought a company for $16 million. And you find out that they then lose $600,000 of their profitability. And now they have to work to make that up. You have an investment that you are not going to get a stellar return on.

You’re bringing down the returns on your investments significantly, it’s a much higher risk.

Drew McLellan:

So you’ve used the eight multiplier a couple of times, which is a little higher than the numbers that I see as I watch agencies being bought or buying other agencies. So is there a range and does the range get smaller as the dollar amount gets smaller? So if I’m an agency, if my whole AGI is $2 million, so my EBITDA might be a quarter of a million, let’s say it’s $500,000, that would be very unusual. Does the multiplier get smaller?

Gina Cocking:

Yes, it does. It does. Scale yields higher multiples. And partially due to the fact that the larger agencies should have less volatility. You have more of a, not losing one client will destroy the agency. It won’t be, we have to lay off people. So there, you will see agencies that should be trading up six to eight, maybe nine times. But those are usually going to be well run agencies that maybe have an analytic component or something that’s pretty specialized, that are over the four or $5 million plus in earnings. At lower levels, you should be seeing, you’ll see valuations that are probably five or six times. If the valuation is less than five or six times as an owner, you should really think is that the right thing to sell? Because you’re getting a multiple of earnings.

Another way to look at it. If somebody is saying, I will pay you four times your earnings and you have to go through, you getting paid four times earnings, and you’re going to spend a whole bunch of money on attorneys to work through the documentation. You’re going to spend money maybe on another type of advisor. Oh gosh, don’t forget, you are going to have taxes. You’re going to have your capital gains taxes. You’re going to be probably subject to a, if you’re walking away from the business, you’re subject to a lockup. So you won’t at non-compete, you won’t be able to compete with the company for five years. So you have to go do something else. If you’d like to do something else, or at four times earnings, you could just continue to run your company for the next four years. And if you’re on a growth path, that could be pretty attractive. So I think what happens at the lower end of the range, you don’t have sellers.

Drew McLellan:

Right? It’s really interesting. I’ve seen a lot of agencies walk through that, walk down this path and I would say 80% of them get to exactly what you just said, which is by the time they do the math, they can make a lot more money just by keeping the thing and running it.

Gina Cocking:

Right.

Drew McLellan:

Than they can by cashing out.

Gina Cocking:

Exactly.

Drew McLellan:

So a lot of times I think it’s an emotional thing. Like I’m tired. I don’t want to do this anymore. It’s too hard. More than it is a financial decision.

Gina Cocking:

Mm-hmm (affirmative). I agree. What I would suggest to someone that still wants to grow their business, they still want, they want to take some of their chips off the table, but they’re young enough that they’re not willing to walk away, they still… Or not even young, but they still have the energy. They want to continue to do this, but they see good valuations out in the market. They hear of other people making money. That’s when I will suggest a minority investment. Bringing on an investor where that will allow you to take some of your money off the table, but perhaps giving you some growth capital, because it’s a good time for an agency owner to say, “Well, what’s really impeding me from getting from a million dollars in earnings to $4 million in earnings? Is it because I don’t have enough talented salespeople?” Which that’s kind of the bottleneck for any company in any industry, how do you sell?

And so do I need to go hire more salespeople? Well, investing in a sales person for a small company is a tough thing to do.

Drew McLellan:

It’s tough too.

Gina Cocking:

Yeah. Because you pay in advance of them actually landing anything. So you can bring in minority capital, minority equity, that will help hire those couple of people to help you build more sales. And then once you build more sales, you build earnings. And it could really accelerate your growth. And you as a business owner, will be able to take a little bit of equity off the table and you’re participating in the upside. And so maybe you are ready then in four or five years, you’re at a size where you’re getting eight times your agency.

Drew McLellan:

Yeah. Yeah. Okay. I want to take a quick break. And then when we come back, I want to talk a little bit about how somebody figures out what their agency is actually worth in terms of an audit and some of those things. So we’ll get into that, the money side and the nitty-gritty numbers side when we come back. I hate to take you away from this week’s content, but I just want to put a little bug in your ear. We have some amazing workshops coming up in the first quarter of 2020, and I want to make sure they’re on your radar screen. So there are two in January, there’s the build and nurture your agency sales funnel, which is January 23rd and 24th in Orlando, Florida. We are literally going to not only show you how to build a sales funnel, but we’re going to actually walk you through the exercise of doing it, so that you leave with a completed or near complete sales funnel.

So that’s the Thursday, Friday. And then on Monday, Tuesday, our good friends at Mercer Island Group are going to join us. And they’re going to talk to us about the prospect’s buying journey. So they’ve been working with brands and helping them pick agencies for years now. And one of the things they’ve been studying is what do prospects, or what brands do as they are beginning their early, early stages of shopping for an agency long before they’re on our radar screen, what are they doing? And how do we learn each of those milestones, even when we don’t know they’re out there. And so it’s going to be a great workshop. It’s brand new content from Mercer Island Group. If you have not been to one of their workshops, they do not disappoint. They get rave reviews every time that they take the stage. And so they’re going to be with us on January 27th and 28th, also in Orlando, Florida.

The beautiful thing about that is right in the middle of a weekend. And why wouldn’t you spend a weekend in sunny, warm Florida on Disney property in January. So hopefully you can join us for those. We also have a great workshop in March. So that workshop is in Chicago. We’re heading back north, March 24th and 25th. And that is the run your agency for growth and profits. This is an agency owner workshop. If you are not an owner, but you are a leader, then ideally your owner would come with you. Because this we’re going to talk about owner stuff. So everything from operations, to BizDev, to people, to profit, to financial metrics, all those sorts of things we’re going to cover. We’re going to cover all the big bases in terms of the internal backside of the business. How do you run the business of your business better?

And again, that is March 24th and 25th, in Chicago. All right. I hope I see you at one are those or more of those, but in the meantime, let’s get back to the podcast. All right. We are back. We are talking about valuations of agencies and how to increase the value and what are the factors that make an agency worthwhile to a buyer? So before the break, I said to Gina, that I wanted to talk a little bit about the numbers. So let’s talk about, let’s say I’m 10 years out. Well, let me, let me back up.

Gina Cocking:

Okay.

Drew McLellan:

How far out should I be before I start thinking about things like getting a valuation, or an audit to have some idea what my agency might even be worth?

Gina Cocking:

Sure. So we generally advise companies to think about, first of all, if your long-term goal is to retire, if that’s your goal, let’s work backwards from the goal. And so if you would like to retire, chances are you will need to still stay with your agency for two, three years during an earn-out. So let’s say you’re age 50, that takes you back to age 47. I would say generally takes six months, six to nine months in a sale process to actually get to close. From the time where you start the discussions, maybe hire an advisor, maybe don’t, six to nine months. But then in advance of that, you need to have your house in order. And that includes, having your financials in order and having your legal work all lined up. So that’s probably taking you out in another year.

So generally I would say, if you’re looking to completely walk away from the business, retire five years before your retirement date, you should be really working at it. Which means I always advise getting an audit. The audit is necessary for two reasons. One, a buyer needs to have comfort that the numbers are exactly what you are saying. And I hear it all the time. “Well, trust us, we keep accounting here. Here’s our bank accounts, look at this.” It actually really takes an auditor to really understand the numbers, and make sure that they’re aligned with generally accepted accounting principles, GAP. Why do we care about GAP? We care about GAP because everybody uses GAP. You can compare one company to another company, apples to apples, and that’s really important. Otherwise, a buyer doesn’t know how to value you. Number two, the reason to gain audit is lenders need audits.

It is very, very difficult to get a bank loan for a company, unless you have an audit in place. So if you’re a company that’s looking to acquire another company and you need a bank loan, the lender is going to say, “Well, let’s see the audits. We understand the numbers. So we can compare apples to apples, to other companies that we’ve worked with.”

Drew McLellan:

Right. Right.

Gina Cocking:

So getting an audit is important. Now you do not need to have a big four auditor. You don’t have to go and hire ENY. There are a lot of great, regional and local audit firms that can do it cost-effectively for you. It is painful to go through the first time, no joke. But it’s like going to the dentist. You have to go to the dentist, it’s good for your health and if you’re having  good financial rigor in your organization is like flossing.

You should do it. And we don’t all do it, but you know you should do it. And you’re better for it. Along those lines, who’s taking care of your bookkeeping. Are you doing it haphazard? Now I frequently end up working with companies that… not end up, that sounds bad. If you’re going to have the opportunity to work with companies that are founder led businesses. And so they’ve grown from nothing to something pretty incredible. Well, when they were small, they were very focused on and their core competencies, whatever their business is. And they would handle the financial side of it house, maybe themselves, or just ignore it.

They would use, we call it an electronic shoe box to keep track of their records. And they’ve grown so quickly that they’re of a size or scale they didn’t even realize, oh my gosh, I probably should have had somebody actually watching how I do my financials. Which means hiring somebody to do the bookkeeping is important. It can be outsourced and there are great accounting firms out there that will help you and come in once every couple of weeks to do your accounting for you, but then you might get to a certain point where you have enough transactions and enough volume in your business that having somebody full time watching over your financials, not only takes the burden off you as the owner for doing it, but helps position you for selling the company.

Drew McLellan:

Well, I think a lot of agency owners in particular they’re self-directed in the beginning with their books. And then a lot of times the person they have doing the books may not actually have training to do the books, right? So it’s an admin person or someone like that. He doesn’t really have any accounting background. He doesn’t really know if the general ledger is set up properly. Most agencies live in QuickBooks, which is not accountant friendly, it’s lay person friendly. So I think that also opens up the opportunity that maybe things aren’t set up quite the right way. How is an audit different than evaluation? Because an audit is really about, are all the numbers in the right boxes, right?

Gina Cocking:

Right. Right. So a valuation of the company is a party that’s coming in and they will say, “Okay, these are your earnings. These are your revenue streams. If we think you’re worth X, you’re worth X, because we’re using the following multiple range to determine your value. And we’re doing that based on other deals we’ve seen of similar type companies. Companies that are same size, addressing the same markets. And based on that, we know those companies are trading for four or five times earnings. Therefore we think you should be trading four to five times earnings, but we will also at that point at doing evaluation, look into what are your earnings?

And we’ll go through and basically test your earnings, evaluate it. That’s where having somebody that’s more than… Somebody that’s a bookkeeper, having an audit comes into place because the valuation firm will go through and look at the various line items and say, “Oh, you know what? We see here that you’ve been taking all of your marketing expenses. And you’ve been advertising those over three years. Well, you can’t be doing that. And so we’re going to add those back as an expense in year one, instead of year three. And suddenly as a seller, your earnings aren’t a million dollars, but there’s $700,000 a year.” So the valuation, they will help you figure out what you’re worth. And they will be able to identify problems you’ve with accounting, but you then have to go fix those.

Drew McLellan:

Right. So how often should a company do an audit? Is that an annual event? Is that a every six months? Every three years? What does that look like? So if you originally said about five years out, you need to start kind of getting your ducks in a row.

Gina Cocking:

Sure.

Drew McLellan:

So, okay. So I’m five years out. How often should I be doing an audit?

Gina Cocking:

You should be doing an audit every year. So going back five years, when you would like to leave the industry altogether, you would do an audit, so this is kind of T minus five. At T minus five, you start the audit process. It’s going to take you six months or so. Hopefully it’s three months, but the reality, usually is a blanker. And you get through the audit for your… You have your first year’s on it. Great. Then you get into T minus four. During T minus four, you’re getting ready for a sale. And during that process, during that year, you’ll get that year’s audit done.

And that will be part of your sales process. He’ll say, “Hey, here’s information about my company and here’s two years worth of audits.” And by the way, your second audit much, much easier than your first audit. I would say 75% easier than your first audit was, because your auditor now knows you and you now know what you need to provide to your auditor. So very, very fast. And then you sell your company. So I would say really you only need ideally one audit completed and one audit ready to be done during process of selling the company. So you don’t have to do it. You don’t have to say, “Well, someday, 10 years from now, I’d like to sell my company.” You don’t need to start at that point.

Drew McLellan:

Right. Okay. So I need to get an audit. I need to make sure I have someone qualified who’s doing my books and is sort of keeping what the auditor put in place kind of tidied up.

Gina Cocking:

Right. Exactly.

Drew McLellan:

And making sure that we’re still putting everything where it belongs. What else do I have to do from a financial point of view? So one of the conversations I have with a lot of agency owners is they wonder, do they need to leave a lot of money in the agency in retained earnings to make it look more valuable, or can they continue? A lot, most agencies are escorts.

Gina Cocking:

Mm-hmm (affirmative).

Drew McLellan:

And so what they’re doing at the end of the year is they are spending down, they’re prepaying, they’re doing anything they can to mitigate tax risk. And then they think, “Oh, I’m going to sell in a couple years, should I keep doing that? Should I not keep doing that?” So how does all of that impact a potential sale?

Gina Cocking:

Great question. So in an agency business, no, you do not need to have retained earnings. If someone looks at a seller’s retained earnings and says, “Wow, you have almost no retained earnings or they’re negative.” The seller should say, “Well, yeah, I took distributions. I’m making so much money. I’m just keep distributing it to myself.” The buyers are going to look at the earnings. So the earnings before distributions, and that’s what you’re going to get a multiple on.

Now, if a seller is doing exactly what you said, for tax reasons or other reasons is maybe accelerating some expenses into one year and not the next year, it can make the earnings look a little wonky. And that’s where an accounting firm can help you think through how to properly accrue in GAP financials for those expenses, meaning you can spend the cash in 2019. December of 2019, you’re like, “Gosh, I need to buy 10 new computers in 2020.” I’m going to do it in December, 2019 and have the expense for tax purposes. But you can then basically depreciate that expense and recognize it over a future period. And that’s where GAP and accounting is really helpful.

Drew McLellan:

Yeah. You’ve done this with a lot of both buyers and sellers. What surprises them in this process? So somebody comes to you, they think they’re ready to sell. And what are the unpleasant surprises or I guess pleasant surprises that you get to deliver?

Gina Cocking:

Let’s go through one of the pleasant surprises.

Drew McLellan:

Okay.

Gina Cocking:

One of the pleasant surprises for business owners is what we can do from an add back perspective. So as a small business owner, business owners will frequently put personal expenses through the agency. They might have some out sized pay, or you might’ve had an employee that you’ve had to let go, and you’ve had to pay severance to. We call those all one or non-recurring expenses. We add those back. So if you look at your financials and say, “Yeah, I made 100 thousand last year, but gosh, if I didn’t keep my mom on the payroll, and I didn’t put my daughter’s car through this, and I wouldn’t have fired Joe, I would have made 1.1 million.” Yeah. Add those back. That’s really what you’re earnings are. So that’s a pleasant thing. The negative part of this process is it is exhausting.

It is training. The buyer’s going to come in and question everything you’ve ever done. And when you go through that type of process, you feel like you’ve done things wrong. And in fact, some buyers will say, “You know what? We thought you were worth X, but we don’t like that you did this, this and this. And we’re going to change our purchase price.” What a seller needs to remember is that’s all negotiating, they’re just positioning. It doesn’t mean you did anything bad, it doesn’t mean you’re worth any less than what you think you’re worth. The downside is a deal fatigue. Everybody hates it at some point, I’ve had business owners that were like, “Gosh, we didn’t think it would be like this. We hate this process.” Or, “Why is it that we talk about what the deals can be [inaudible 00:46:05] like with the buyer and then the attorneys come in and they put all these words around it, and 60 pages later, it doesn’t sound like what we discussed?”

And so it’s a lot of the logistics around getting a deal done. And the negotiating, and negotiating happens at every single step. That can be very difficult. One way to get around that is to know your worth and always be willing to walk away. If you know, you know what? I can find another buyer. I don’t have to sell. I have a great company that’s growing. I can walk away. That makes the process not only more palatable, but frankly you’re probably going to sell for more, because you’re not going to care.

Drew McLellan:

Yeah. Always great to negotiate from a position of power, isn’t it?

Gina Cocking:

Exactly.

Drew McLellan:

Yeah.

Gina Cocking:

Exactly.

Drew McLellan:

Well, that seems like a fine piece of advice to end this conversation. This has been fascinating and I knew that you would correct some misperceptions, give people some clear advice, and I think you did that in spades. Thank you so much for your time. And thanks for sharing your expertise, really appreciate you coming on the show.

Gina Cocking:

Wonderful. Thank you for having me. It was my pleasure.

Drew McLellan:

If folks want to learn more about you, and your business, where might they go?

Gina Cocking:

Our website for Colonnade Advisors, my contact information is there. And that is www.coladv.com. And under our website, we do some small podcasts ourselves, nothing very special, but talks a little bit about what business owners should be thinking about when they sell their company. And we do a lot of blogging on our website, and following my company or me on LinkedIn, and we will… There we tend to post a lot about deals that we see happening and trends in the industries that we cover.

Drew McLellan:

That would be awesome. Thank you again so much for being with us.

Gina Cocking:

Wonderful. Thank you very much.

Drew McLellan:

Hey guys, this wraps up another episode of Build a Better Agency. Thanks for joining us. I will put all of the information so you can track down Gina and the company in the show notes, so you’ll have that. I will be back next week with another guest to hopefully help you think a little differently about your shop and what you have up your sleeve for 2020 and beyond. In the meantime, just a reminder, we are at the early bird pricing stage of the Build a Better Agency Summit, which is going to be in May, in Chicago. So grab your tickets now. I am confident that that will sell out, simply because we’re keeping it pretty small and intimate. No more than about 225 agency folks will be with us. So really want you to be there. The speakers are spectacular, the networking’s going to be awesome.

And right now you can get it at a bargain price. So grab your ticket now before we raise the price. In the meantime, track me down if you need to I’m at Agency Management Institute, always happy to answer your email and your questions. Otherwise I’ll see you next week. Thanks for joining us. And as always, thanks to our friends at White Label IQ for being the presenting sponsor, as you know, because I’ve talked about them so many times, they are amazing in terms of white labeling, Dev projects, PPC design projects for agencies, they’re working with agencies all over the country, lots of AMI agencies swear by them. So if you want to check them out, head over to whitelabeliq.com/ami, because they have a special deal just for you. All right, I’ll see you next week. Thanks you for joining us.

That’s all for this episode of AMIs, Build a Better Agency podcast. Be sure to visit agencymanagementinstitute.com to learn more about our workshops, online courses, and other ways we serve small to mid-sized agencies. Don’t forget to subscribe today so you don’t miss an episode.