In Part 3 of a series, columnist David Rodnitzky answers questions you may have surrounding the acquisition process, from whether you should wait for suitors to if you should hire an investment banker.
In the movies, an agency acquisition would probably be shown as a quick montage: The agency founder gets a call, gets on a plane, has a meeting in a fancy conference room with a bunch of guys in suits, signs a contract, pops some champagne and jets off to the Bahamas to celebrate.
The reality isn’t as glamorous. The process is a lot longer, and often quite boring, and there is usually little time to celebrate after the deal is signed.
Two ways to sell: Run a process or wait for suitors
Someone once told me that “good agencies are bought, not sold,” and I think that is often correct. If you build a great business, acquirers will eventually find you and want to buy you. That doesn’t mean, however, that you should always avoid contacting potential acquirers to avoid looking too eager to sell.
The most common method of selling an agency is setting up a “process.” A process consists of several steps:
1. Creating a memorandum about your agency. A memorandum is around 25 pages long and contains key information about your agency: top clients, revenue concentration, historical and projected revenue and EBITDA (earnings before interest, tax, depreciation and amortization), executive bios, competitive differentiators, awards and so on.
2. Identifying potential acquisition targets. Usually, there are two types of acquirers: other agencies and “strategics.” A strategic is a company that needs your agency to improve their business but is not an agency. (This might be a consulting firm, a large business that wants to make you their in-house marketing team or a services business that wants to start offering agency services.)
Creating a list of acquirers really comes down to doing a lot of research: Do these companies have “corporate development” teams (M&A experts)? Have they done acquisitions in the past or publicly stated that they plan to in the future? (If the company is public, they may discuss their acquisition strategy during their earnings calls.) The number of targets ranges, but I’ve seen lists from as few as 10 to as many as 50 potential acquirers targeted at this stage.
3. Reaching out to potential acquirers to inform them of the process. Because your memorandum contains a lot of sensitive information about your business, the memorandum is not mailed to every potential acquirer initially. Instead, a letter or abbreviated version of the memorandum is sent out with top-level information and a request to respond if there is interest in receiving the full memorandum.
If you are using an investment bank (which I will talk about later), it is common at this point to not reveal the name of the agency at all. (The letter might say something like “A fast-growing SEM agency based on the West Coast is considering an acquisition or investment to further accelerate company growth.”)
4. Signing a Non-Disclosure Agreement (NDA). This is to ensure that your financial and client data is not shared with competitors. It is also important to keep the very fact that you are considering an acquisition confidential — competitors can use this to try to poach clients and staff.
5. Sending the memorandum to interested parties. Not all (or even most) companies you contact will be interested in your business; this does not mean that you have a terrible agency (well, it might, but that is not usually the case!). Acquirers have many reasons not to pursue an acquisition: They may not have the cash to do an acquisition, they may be too busy, they may not need your services.
For those that are interested, you may end up sending slightly different memorandums to different acquirers. This may be to customize your story to the specific acquirer, or it may be because an acquirer is a competitor, and you don’t feel comfortable revealing all of your data to the acquirer at this stage.
6. Setting up in-person meetings. Agencies are service businesses, so an acquirer will insist on meeting as many people in the company as possible before buying the company. As a best practice, however, M&A experts recommend against informing your team of an acquisition until it is absolutely necessary to do so. (Team members can draw incorrect inferences, rumors can spread, and if a deal doesn’t go through, the team may think this reflects poorly on the company.)
So instead, the agency management team will usually take one or more meetings with each interested acquirer. In many cases, these meetings will take place off-site to keep the discussions confidential. This is an opportunity to present your memorandum in person, but more importantly, to have a chance for both sides to see if there is a cultural fit between the management teams.
7. Accepting letters of intent (LOI). After in-person meetings, a deadline is usually set for parties to submit letters of intent. A letter of intent is a non-binding offer letter to acquire your company. It will usually spell out the financial terms (cash, stock or a combination of the two), and whether there will be an earn-out (an amount to be paid at a date after the acquisition, based on either company performance or key team members staying at the company for a certain period). It will also detail any other legal requirements the acquirer believes are important to state up front.
8. Signing a “no-shop” with the best acquirer. After reviewing all the LOIs, you have a chance to counter any of the offers to try to get a better deal. Once an offer is reached that is acceptable to all parties, most acquirers will ask the agency to sign a “no-shop” agreement. This is a legal document that prevents you from talking to other acquirers for a specific period — usually 30 to 90 days. This shows your seriousness about the offer you’ve received and sets a deadline for everyone to get a deal done.
The alternative to an entire process is to run a mini-process. The only difference is that instead of creating a huge list of potential acquirers, you limit your conversations to companies that have proactively reached out to you. This means that you still have to create a memorandum, request LOIs and sign a no-shop; you just decide not to reach out to acquirers.
There are pros and cons of both approaches. A full process might uncover a great acquirer that for whatever reason hasn’t discovered your firm yet, but a process also signals more willingness to sell (in other words, you can’t play “hard to get”), and there is a greater chance that your confidential information might leak.
A mini-process is faster and keeps you in the “hard-to-get” category, but if the mini-process is too mini, you might not get the offer you want, or any offer at all.
Should you hire an investment banker?
There are dozens of investment bankers who specialize in buying and selling agencies. The pros and cons of working with an investment banker are pretty clear-cut. On the pro side:
• Investment bankers have “been there, done that.” You are paying them for their experience in agency M&A. A good banker should be able to tell you which acquirers are actively looking for an agency like yours, what deal terms different acquirers generally offer, whether there are any red flags (personalities, business issues) with acquirers, and whether there are “gotcha” deal terms in the LOI and beyond. This is all pretty valuable information.
As with online marketing, if you think an expert is expensive, wait until you see what an amateur will cost you. In this case, if you sell your company without an investment bank, you are the amateur!
• Investment bankers send a signal of seriousness to acquirers. With an investment bank by your side, an acquirer is unlikely to try to pull a fast one on you. The acquirer also knows that you are truly considering a sale if you have partnered with an investment banker.
• Investment bankers save you time. As your agency grows, you are likely to get more and more inquiries from potential acquirers. Screening all of these suitors, and even having initial conversations, can be distracting from your day-to-day business — investment bankers will handle this heavy lifting for you.
• Investment bankers will play “bad cop.” M&A can often get contentious, especially on sticky issues like earn-out periods and valuation. Given that you are going to have to work with the acquirer for at least a year or two, it’s best if you can keep an arm’s-length distance from any heated arguments. Your investment banker will gladly play that role for you.
• Investment bankers may get you a better deal. Bankers know what other companies like yours have sold for, and they know how to play acquirers off against each other.
And now for the cons:
• Investment bankers are expensive! Bankers usually ask for a monthly retainer, a minimum success fee upon selling your business and a performance incentive if they get you a particularly high price. Price ranges vary a lot depending on the size of your deal, but don’t be shocked to end up paying your investment bank $1 million or more to help you sell your agency. Note that you can and should negotiate the terms of your relationship with your banker.
• Beware the “tail.” Investment bankers almost always put a clause in their contract called a “tail.” The tail states that if you fire the bankers but sell your company during a period of time after the termination (usually between six and 12 months), you still have to pay your banker a success fee. This is to protect the banker from getting terminated a few days before a transaction and getting nothing for their work.
But in cases where you have a bad relationship with the banker, fire him or her, and then end up selling your business yourself to another company, you still have to honor “the tail.”
• Investment bankers aren’t 100 percent aligned with your goals. Once you sign with a banker, most of their compensation comes from their success fee and performance incentives. This is usually a good thing, because it aligns expenses. If, however, you start to get cold feet about selling the business, you may start to feel pressure from your banker to follow through with a sale.
For the record, when we sold 3Q Digital, we did use an investment banker. (We ran a mini-process.) We paid them a lot of money, but I am confident that they earned their fee many times over, for all the “pro” reasons stated above.
In a previous column, I had promised to discuss choosing the right acquirer, non-financial deal terms, and working with lawyers in this piece. Given how long this article already is — and how much more I have to say on the topic — I’ll cover these in another column in a few weeks.