Episode 170
It’s something we all dream about – retirement. Selling our agency for big bucks so we can sip Mai Tai’s on the beach. The agency’s name and reputation carrying on with another generation. Or just locking the door and calling it done. All are worthy ends for your shop.
Whatever your dream is – I know that it’s very personal and important to you and I want you to achieve it. But no matter which end game appeals to you, it requires some serious planning (up to a decade before depending on your exit strategy) before you’re ready to walk out the door for the last time. And you’ll need to run your agency differently in terms of how you handle the money and make other key decisions.
Bottom line – the end game is not something you can leave until the end. You’ll need to give it serious thought and as Stephen Covey has long implored us, “begin with the end in mind.”
It starts with some soul searching in terms of how, ideally, you want it to play out and what is possible or at least plausible. Once you’ve figured that out – you need to put your plan into action, so everything is in place when you’re transitioning out and the agency can survive that transition.
Over and over I see agency owners who started too late or didn’t do the homework to build out the details and specificity they needed in their succession plan. That’s the perfect way to limit your options or force you to stick around longer than you want.
I don’t want that to happen to you. In this episode, we’ll take a close look at all of your options and the criteria for each. Hopefully, that will set you up to create a win for you, for your employees, and for potential buyers of your thriving agency.
What You Will Learn in This Episode:
- Building your wealth while you still own your agency
- Succession options for agency owners
- Factors that affect the valuation of your agency when you go to sell
- Why being a generalist decreases the value of your agency
- The value of setting up sources of residual income outside your agency work
- Different options if you want to sell your agency
- How to have candid conversations with potential buyers of your agency
- Why gifting shares of your agency to employees is a bad idea
- Baking succession planning into partnership agreements
- Why you need to go slow when considering merging with another agency
Drew McLellan is the CEO at Agency Management Institute. He has also owned and operated his own agency since 1995 and is still actively running the agency today. Drew’s unique vantage point as being both an agency owner and working with 250+ small- to mid-size agencies throughout the year gives him a unique perspective on running an agency today.
AMI works with agency owners by:
- Leading agency owner peer groups
- Offering workshops for owners and their leadership teams
- Offering AE Bootcamps
- Conducting individual agency owner coaching
- Doing on-site consulting
- Offering online courses in agency new business and account service
Because he works with those 250+ agencies every year — Drew has the unique opportunity to see the patterns and the habits (both good and bad) that happen over and over again. He has also written two books and been featured in The New York Times, Forbes, Entrepreneur Magazine, and Fortune Small Business. The Wall Street Journal called his blog “One of 10 blogs every entrepreneur should read.”
The Golden Nuggets:
“An agency owner should know how they want the game to end at least a decade before the agency owner is ready to step away.” - Drew McLellan Click To Tweet “If the brand of the agency is too closely associated with the agency owner, it's not very sellable.” - Drew McLellan Click To Tweet “Without a strong and realistic succession plan, you may be running your agency far longer than you intended to -- out of sheer economic necessity.”- Drew McLellan Click To Tweet
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Ways to contact Drew McLellan:
- Email: [email protected]
- LinkedIn: www.linkedin.com/in/drewmclellan
| 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. Now on our third year of bringing you insights on how small to mid-sized agencies survive and thrive in today’s market. We’ll show you how to grow and scale your business, attract and retain the best talent, make more money and keep more of what you make with 25 plus years of experience as both an agency owner and agency consultant, please welcome your host, Drew McLellan.
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| Drew McLellan: | Hey everybody, Drew McLellan here from Build a Better Agency and Agency Management Institute. Thanks for joining us for another episode of Build a Better Agency. This is the kickoff episode of the year for us in terms of solo casts. So unlike most of my episodes where I bring a guest on and pick their brain on your behalf, this is an episode where it’s just you and me. And I want to talk to you about something that I want to plant inside your brain. And in particular I have been saving this episode for the start of the year because in January we think about, we talk about, hopefully we do some planning and I think there is a piece of planning that for most agency owners often gets either not done at all, or it gets done so late in the game that it’s not super helpful. So what I want to talk to you about is the end game. What is the plan?
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| Stephen Covey has told us for many years that we should start with the end in mind. And honestly, I’m not sure that there is a more applicable situation than the end of your agency. And what I find over and over is most agency owners make some assumptions, some erroneous assumptions, or they wait too long to make some decisions and then begin to operate their business in alignment with those decisions. And what it does is it reduces your choices.
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| I think that one of the most expensive mistakes that most agency owners make is that they don’t know, and when I say know, that’s probably “Know” but they don’t know how the end is going to play out. What they want for their agency when they are ready to retire. And that they don’t know that soon enough because knowing where you’re headed absolutely makes you decide different things at different times. And so today, what I want to talk about is that end game. I want to talk about all the different ways that you can exit your agency, the pros and cons of those.
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| Because what I want to do is I just want you to start thinking about what matters to you. And I will tell you this, that this is as much an emotional decision for agency owners, as it is a financial decision for agency owners. How you feel about what happens to your agency after you are retired is very personal. And for some of you, it may really matter that the agency carries on or that the agency name carries on even. And for others of you, it’s more transactional that you’re fine with the agency not continuing after you retire as long as you get out of it what you want. There are no right or wrong answers here, and there is no judgment. I’m just going to lay out the whole framework of what’s possible and then have you decide where your agency fits.
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| And in some cases, your agency may not fit in the option that you want. And so now you have time to build your agency to be something different so that you can have the desired outcome. So I believe that an agency owner should know, again, “Know”, how they want the game to end at least a decade, 10 years before the agency owner is ready to step away. And the reason why is because oftentimes it takes that long to prepare your agency. And we’ll talk in a minute about all the different ways that has to happen for that end game, whatever it may be.
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| But I will tell you this, that here’s a truth about agency owners that I see every day. So many, many agency owners will misappropriately spend agency money. They will overspend on staff or overhead or spend money on everybody else and they shortchange themselves. They’re the ones who don’t take a paycheck, they’re the ones that don’t go on vacation, et cetera, et cetera, et cetera, all because they think there’s a big payout that’s going to come when they sell the agency. But the truth of the matter is, most agencies don’t sell at all. Most agency owners have not built something that is sellable.
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| And so one of the underlying messages of this solo cast is, if that’s your decision, whether it’s a conscious decision or it’s just how it plays out, I want to make sure that you’re taking a lot of money out of the business while the business is active. Your business needs to serve as an ATM machine in terms of you making sure you’re making the appropriate amount of money as well, not just your team, so that whatever happens at the end, you’re fine. You really, really, really need to build your wealth while you still own the agency. And then however it plays out you’re going to be okay.
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| But the reality is, most agencies don’t sell and it’s because they are not actually a buyable asset and we’re going to talk about that down the road in a minute. But the other truth is that most agencies sell for about half of what the owners believe that it’s worth. So when an owner enters into the process of beginning to think about selling their agency, they have a number in their head. And quite honestly, oftentimes, most of the time, your number is wrong. And it’s much bigger than what someone is actually going to pay for your business.
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| The other reality if you sell your agency is, that it’s very, very rare that an agency gets sold where the buyer does not expect the agency owner to stick around for a while for transition, for biz dev, for easing the clients and the staff into new ownership, whatever that may be. So again, this is why it’s critical that you plan this out far enough in advance because by the time you’re ready to sell, you want out and you need to do this early enough that you have that two year window or so, where you can be the indentured servant to the new owner and help them ease the transition. And in most cases, because the buyout is an earn-out that you’re not going to get all your money up front in cash. You have a vested interest in the transition being smooth. And so you too want to stick around for a while to make sure it goes well.
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| I will say that for many agency owners, this is emotionally really difficult because basically what you’re saying is, “This is my baby. I’ve built this for the last five years, 10 years, 25 years. It’s been in my family for 60 years, and now I’m going to hand you my baby, and I’m going to let you raise my baby. And I don’t get to vote anymore on bedtimes or curfews, or whether they eat sugar. I don’t get to weigh in on any of that anymore.” And for many agency owners, this is really difficult to be someone’s employee in the agency that you just ran for X number of years, super difficult. So you need to factor that in as well.
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| So let’s talk about some succession options and what they look like for agency owners. Most agency owners as I said, really overestimate the value of their agency. And they’re very disappointed when they actually do a valuation. And this point I will make, and I will underline, and I will put in bold, if you’re going to do a valuation for your agency, you need a valuation CPA who understands our business. Do not go to your normal CPA, do not go to a M&A specialist who is a generalist, you need to talk to someone who specifically understands our business, because they’ll understand how to normalize your books, they’ll understand what the numbers mean. They are able to valuate accurately.
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| So if you want to sell your agency for as much money as possible, it starts with having an accurate and good valuation for our industry. And for that, you cannot go to a generalist. So if you don’t know, if you’re at the point where you want a valuation and you don’t know a great valuation CPA that specializes in the agency business, shoot me an email because I will introduce you to a couple who are spectacular and it’s all they do all day is this kind of work specifically for agencies. They’ve been inside agencies, they’ve understood agencies for years, and they will help you get the most value out of your agency by having an accurate valuation.
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| Let’s talk about the, in general terms, in layman’s terms, how this works. So you’re going to get a purchase price based on one of two factors. It’s either going to be a multiple of your pre-tax profit or EBITDA, or it’s going to be a percentage of your adjusted gross income. So if it’s your adjusted gross income and just a reminder for those of you who have not taken some of our courses or may not be familiar with that term, adjusted gross income is your gross billings, and then you subtract your cost of goods, and what’s left is the money that you actually can run the agency with. That’s your adjusted gross income. And out of that money comes your loaded salaries. So everything you pay your people both in terms of salary and benefits and then your overhead, and then the profit. So those are the three big buckets that AGI gets broken up into.
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| Anyway, if it’s going to be a AGI percentage, typically right now, the highest I’ve seen is a 1.5. Here’s what they’re going to do, they’re going to take your AGI for the last five years, they’re going to drop the high and the low, and then they’re going to average the middle three. So let’s just say that your AGI average after they drop the high and the low is a million dollars. Then your purchase price is going to be typically, and we’ll talk about some of the factors that influence the percentages. But typically you’re going to get one times to 1.5 times that average AGI. So in this example, you would get anywhere from a million to 1,500,000.
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| Or the other way that valuations are done in terms of purchase price is they look at your EBITDA. Again, they’re going to take your pre-tax profit or EBITDA before… They’re going to take five years. They’re going to lop off the high and the low, they’re going to average the three, and then there’s a multiplier. And that multiplier is right now going to be about anywhere from three times that EBITDA to seven times that EBITDA. And I’m going to walk you through the factors that influence whether it’s a three or a seven in a little bit. But that’s the basic factor that all agency purchases start with. We’re going to agree that we’re either going to buy it based on AGI or EBITDA, and then there’s this multiple.
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| A typical buyout, no matter who buys you is that on average, you’re going to get anywhere from 10 to 30% down in cash. And then the other 70 to 90% is going to be paid out. If it’s paid out quickly, it’s going to be over three years. I’ve seen it go out as far as 10 years. I would say the average is five to seven years. So whatever the dollar amount you agree upon for the sale, you’re going to get that 10 to 30% upfront in cash. And then the rest of it’s an earn-out over time. And there’s always a factor in the equation that says, “If the agency tanks, that there are adjustments to what they owe you.” And by the way those adjustments always only go down. I’ve never seen a deal where if the agency grew super aggressively after you were gone, then all of a sudden you got more money.
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| So there’s only downside to you as an agency owner on the performance adjustments. And oftentimes, as I said, the agency owner is working for the agency anywhere from a year to three years. I’ve never seen it go longer than three years. And I’ve often seen it where both parties wish it hadn’t been for as long as it was set in the contract, and sometimes that’s negotiated out. But oftentimes part of the buyout structure is salary is baked as salary because some agency owners post-sale are really more active in the agency than others. And so one of the things you want to do is mitigate taxes. And so you’re going to take your money out in a plethora of ways. And one of the ways that you’re going to take that out that is tax advantageous is a salary. So if you leave early, then you have to take it out in another way. So you have to factor that in as well.
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| Here are some of the things that influence that multiplier, that four to 7%, three to 7%. First one is, how stable has the agency been? So is the profitability been pretty stable? Have the billings been relatively stable or on an upward trajectory? But how profitable have you been overall? So if you’ve had two great years, but before that you were in the tank the whole time, that’s going to influence your multiplier, obviously in a negative way.
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| One of the other things that is a factor in the multiplier is your client mix. So do you have a gorilla that’s going to knock you down in the multiplier? Do you have a lot of long-term clients that’ll knock you up in the multiplier? Do you have no client that’s more than 15 or 20% of your AGI? Again, that’s better. So that would be an increase in the multiplier. Do you have signed contracts, annual contracts? Are you a project shop? All of those things are going to influence that scale of three to seven in one way or the other. So the more stable you appear, the more likely it is that clients are going to stick around, obviously. And the more that you couldn’t suffer a huge loss if one client goes away, all of those are going to influence that multiplier.
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| Another key factor in deciding how much your agency is worth is your management team or your leadership team. How good are they? How stable are they? How long have they been in their roles? And how vital are you the owner in the leadership or management team? If you still play a critical day-to-day role, understand that that is going to be something that reduces the multiplier. What they’re hoping is that they can buy an intact business that could run whether you’re there or not. That’s the holy grail. Is that you could pluck the owner out and the agency would just continue on just like it always has been. That’s by the way, hardly ever the case. So I don’t care if you’re two FTEs or you’re 250 FTEs, odds are you still play a critical role in the agency. So somewhere on that scale of how critical you are and how strong the management team is in your absence, that all plays into the value of the agency.
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| One of the other things that agencies are evaluated on is, your products. So if you’re a traditional agency, it might be on your creative, what awards have you won? If you’re an SEO agency, it might be the ROI that you’re delivering to clients and the reporting that shows how you demonstrate that. But it’s the marketplace’s perception of the value that you bring. So it’s really, how have you been recognized in one way or shape or form for being the best of the best?
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| Another thing that adds to the multiplier is the narrowness of your niches. So if you’re a generalist, if you serve every butcher, baker and candlestick maker, that’s going to put you on the low end of the multiplier scale. If you are very narrowly niched in a couple of industries, and you are an established thought leader in those industries and you and your team speak at conferences and all of the things that we’ve talked about many times before, that’s going to increase the value of the agency.
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| And then another factor is biz dev. So if you are still in the feast and famine model of biz dev, if you mostly grow the agency by referrals, if you don’t have a systemized process by which you fill the pipeline and work your sales funnel, that’s going to reduce the value of your agency. So these are all things, and you can hear now why I said it matters that you think about this for more than a decade, because odds are, you’re not delivering at an A plus in all of these categories today. It doesn’t mean you can’t focus on them and start to deliver on them, but sometimes there’s room for improvement here and you want to have time to make those improvements while you’re exploring how or when, or why you might want to sell.
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| Another factor in the element of value, which you have no control over really other than opening up a satellite office is location. So some people believe, and it’s interesting because I’ve seen the opposite, but some people believe that an agency is more valuable if you’re in a major market. I’ve been involved in a lot of buy, sells and all of that with agencies that we work with. And I will tell you that I’ve seen very small agencies in very small markets that have a very specific niche or skill, get gobbled up and have a great multiplier. So location is not always a factor, but the more of a generalist you are, probably, the more important it is that you are in a major market.
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| Let’s talk about succession planning and what I want you to think about before you begin down this path. And the first one is, and I said this before, but it is worth repeating. An agency owner needs to make his or her wealth while they are still working in the agency and they still own it. So you want to make sure that you are running the agency in a way that you are maximizing your salary, your dividends, how you use the profitability of your agency to get money out of the agency and start investing it in something else. And I don’t care if it’s real estate or a thoroughbred horses or… Whatever it is. Whatever your thing is. However you want to build wealth, investing, whatever. But don’t leave your money in the agency for too long. And another time we’ll talk about how much money you should leave in an agency.
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| But my point is, your agency should be building and funding your wealth while you are still employed. Do not count on a payday that may never come. And for many agency owners, this is a really harsh reality that at some point in time, sort of slaps them in the face because they didn’t take the money out, they shortchanged themselves to pay everybody else. They allowed the agency to stay overstaffed rather than trimming down when they needed to. And as a result, the agency owner always took the short end of the stick.
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| This is not what I want for you. This is not a good money strategy. You need to run your agency in terms of how you pay yourself as though you are not going to sell it for a dime. That the day you close the door is the day you stop getting money from that agency. That’s how you should think about it in terms of your own compensation so that no matter what happens, you and your family are fine. That’s what I want you to think about, all right? So do not count on a payday that may never come. Technically not about succession, but absolutely about succession planning.
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| All right. Now what I want to do is I want to walk you through the different ways you can sell your agency, the different kinds of buyers and the pros and cons of that. But first, let’s take a quick break.
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| Thanks for checking out this week’s episode of Build a Better Agency. I wanted to interrupt very quickly and just remind you that one of the services that AMI offers is our coaching packages, and it comes in a couple of different options. So you can do a remote coaching package where we would communicate with you over the phone or over a Zoom call, or we also do onsite consulting where we would actually come to your agency and work with you for a day or a period of days to solve a specific problem typically, that you’ve pre-identified and we’ve talked about on the phone. So if you’re interested in either of those, you might go over to the AMI website and under the consulting tab, you will find more information about both our remote coaching and our onsite consulting. Let’s get back to the episode.
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| All right, welcome back. We were talking about succession planning and all the ways that you may or may not sell your agency. And right before the break, I promised you I would walk you through the scenarios of how agencies get bought and sold and the pros and cons of that. But first, I have a bribe for you. So I would like to really increase the number of ratings and reviews that we have on the podcast. So here’s my deal. For the month of January, I’m going to remind you about this, but for the month of January, I’m going to keep asking you to do ratings and reviews for the podcast. So whether you download it on iTunes or Stitcher or Google, there is a place for you to leave a rating and/or a review. And what we’re going to do is everybody who leaves a rating or a review in the month of January, we are going to put all of your names in a hat, and we are going to give away one of our workshops, a seat to one of our workshops.
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| So the value of that is around 1,800 bucks. And honestly even though this is downloaded and listened to by tens of thousands of people every week, most of you aren’t going to do it, which makes me cry a little. So your odds are pretty good. So if you will, please go wherever it is you go to leave ratings and reviews for podcasts and leave us a rating and review and I promise regardless of the rating and/or review, we will put your name in hat and someone’s going to go to a workshop on us, okay?
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| All right. Back to succession planning. Let’s look at the ways that agencies get bought or… Actually let me preface that. Agencies end. With the first one, being that the agency owner closes the door and walks away. On the day that they’re ready to retire, they’ve obviously planned this in advance, they’ve wound down the business and they literally just lock the door and walk out the door when they’re done. And this is how the majority of agencies end.
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| Again, I want to emphasize this to you. This is not the abnormal, this is the normal, and there is nothing wrong with letting your agency wrap up this way. It does not comment on the value of your agency, it doesn’t comment on the value that you brought to the business or to your clients. It may very well just be the way you want it done. And oftentimes this is because the agency owner has been integral to the business. So they are still very tied to the day-to-day. And so the value of the agency is greatly diminished the minute they walk out the door or the brand is closely associated with the owner.
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| So if you as an agency owner are this well-known person in the industry and you haven’t built that up in any of your other people, I do want you to be well-known in the niches that you serve, but it can’t be just you, right? You need to have other people who have this depth of knowledge. But if the brand of the agency is super closely associated with the agency owner, then oftentimes it’s not sellable. If you have no leadership team in place, or that leadership team is pretty fluid, or they’re a leadership team in name, but they don’t really actually help run and lead the agency.
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| Obviously, if your metrics aren’t great, if you haven’t been making a lot of money, if it’s been a lifestyle business, which again, there’s nothing wrong with this. I have lot of agency owners who make a great living running an agency that is a lifestyle agency. So do not think for a minute that this is a bad choice. And again, also, if you’re a generalist firm, if all of those or many of those are true, odds are you’re going to close the door and walk away, which means it’s critical that you run the business knowing that that’s what’s going to happen so that you’re not waiting for a big paycheck that is never going to come.
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| The most common way that agencies, and by the way, the most successful way that agencies get sold is when they get sold internally to employees. And the reason why this works so well is because the buyer’s a known entity. So there’s no disruption to the internal team, to the clients. It’s really a pretty smooth transition typically. The clients already know and trust whoever’s buying the agency. So there’s less scattering after the purchase that we often see in some of the other scenarios. But you also have to understand that the buyer probably doesn’t have a lot of money for this. So the agency, if you think you want to sell to your employees, you need to be thinking about how you’re going to help them fund that purchase. And oftentimes it’s through a bonus program or something else that you build specifically so they can build up assets to buy the agency.
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| The buyer’s also going to need a lot of grooming. So I don’t care if they’re a great AE, art director, whatever it is they’re good at. They have probably not been on the back side of the house running the business side of the business. And if you’re an agency owner, you remember what that was like when you started and you were deer in headlights going, “What do you mean P&L and this and that?” We had to learn it. And so you have the opportunity if you identify the buyer early enough to teach them a lot of this stuff while you’re still around. So you can coach and mentor them so that they are much better prepared to run the agency perhaps than a lot of us were, who started our agencies from scratch. They’re going to need a ton of grooming. And so, again, this is critical that you are talking to them and you have a plan and they know exactly what the plan is far in advance so that the two of you could be working on this together.
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| One of the big mistakes I see is that agency owners will have this abstract conversation with an employee like, “Hey, would you like to run this joint someday?” Or, “You know what? You’re my succession plan.” We drop those little hints. And of course the employee is flattered, and of course, they’re not going to say, “No, I don’t want it.” But that’s a very different conversation than sitting down and saying, “You know what Drew? I think that you are the future of this agency and I would really like to talk to you about buying the agency over time. Would you be open to having that conversation? Yes or no? Is that something that you want to do? Do you aspire to that? And if so, then I’m going to go through the process of getting the valuation, defining the equation of how we’re going to define the value of the agency and we’re going to walk through what it takes to actually buy this agency so you know exactly what you’re getting into. And then I want a letter of intent from you.”
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| And then all of a sudden, now you’re having a real conversation. And now it’s getting very serious and very tangible about what they’re agreeing to. When someone just holds out a present says, “Do you want this present?” We all would go, “Well, of course, I want to present that’s beautifully wrapped and who wouldn’t want a present?” When someone says, “Would you like this present? There’s a snake inside and you have to feed it live rats, but it is the best security system for your house that you’ll ever have and there’s all these benefits.” But there’s also the reality of it which is sometimes not so pleasant. Now I have to decide, “Do I really want that present? Are the upsides worth the risks, worth the costs?” Because as we all know owning an agency does not come without consequence. And some of the consequences are beautiful and awesome. And some of them are challenging.
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| So the mistake agency owners make is they don’t have those candid conversations around money, around timing, around choices and sacrifices early enough. So you think that the buyer wants to be the buyer and they think they want to be the buyer. And then you bring them inside and you show them what’s behind the curtain. And they’re like, “No, thank you very much.” So we worked with an agency that had this conversation with their employees but it was very superficial and they knew that they were going to have to buy it. I’ll talk about gifting it in a second. They knew they were going to have to buy it, but they had no idea what the numbers |