Lots of agencies are contacting Capital A right now and wanting to know what their options are, the COVID crisis has forced business owners into thinking about a sale or going into administration.
With that in mind, you need to get a realistic valuation calculated. What tends to happen is that companies heading for distress get realistic offers, which they refuse and then they get into trouble and have no option but administration.
The valuation by a specialist
Firstly, if you ask a valuations specialist to value your company they will always give you a high valuation.
I don’t know why valuation experts do this, as it sets a high expectation that you will never reach when you go to market. Particularly if your business is turning over less than £5m.
Valuations vary wildly anyway, but always depend on what the buyer is prepared to pay and this is always less than a seller would prefer to sell for.
The biggest reason agency owners walk away from offers
The biggest reason is that sellers want to walk away a millionaire, actually £500k is a very life changing amount of money too, so this need for a million in the bank seems quite arbitrary and is just a cultural phenomenon.
It’s a shame because in my experience it’s significant in scuppering a lot of potential deals in the first instance and actually if sellers were more realistic there would be a lot more transactions closed and happy sellers.
I’ve explained how to value your agency below. As there is no single way to value a company, then this needs to be used as a guide.
Also bear in mind that I work with agencies which are service companies. More often than not agencies do not own any IP, stock or real estate and so the valuations are fairly straightforward. If we are valuing AV, publishing or tech businesses then the valuation would need to include IP or stock also.
How to value your agency
Firstly you need to get your EBITDA which is essentially your operating profit. Accounting nerds will argue the toss on this one, but it’s basically your bottom line profit before you’ve paid tax on it. You need this number for the last 3 full trading years. Some companies will ask for 5 years but they are a** h****.
You then need to adjust your EBITDA for any dividends you have paid out to shareholders who work in the business and don’t take a full salary via PAYE. I’ve explained why before in this post, so won’t explain again, suffice to say that if after your company is bought and you are now a full time employee, the cost of you will need to be removed from the profits we are trying to predict going forward.
You then need to multiply your adjusted EBITDA by a multiple. This is where the random element comes into play, as obviously any movement on this number represents a whole year of profits and also money in your bank account.
How many multiples
Businesses turning over less than a million will not command huge multiples, often they could only get 2-3 times multiples at this level. Over a million but less than £5m turnover, you should expect 3-5 times multiples.
Over £5m with a healthy profit margin of 20%+ and you should definitely be leaning towards 5X, over £10m multiples can be double the multiples and can sometimes start being valued at multiples of revenue rather than profits. Crazy, I know, but that’s why you should be talking to me about being part of a roll up!
If you have a healthy business and you don’t need to sell, I would say hold out for a 5X, you should be happy with yourself with 4X, especially with a 3 year earn out as you are getting paid for year 4 for profits you don’t need to work for. Every company should be getting 3X at least, unless you are in distress or you want a quick sale.
The formula looks like this:-
EBITDA – DIVIDENDS * MULTIPLE
Example of a company valuation turning over £2m
An example would be a company which for the last 3 years has averaged £200,000 EBITDA, the director and single shareholder is paying themselves £100,000 per annum. Our normalised EBITDA is £100,000 and we negotiate a multiple of 4, as we are doing a three year earn out and are a motivated seller. So the valuation of the business is £400,000.
So even though the business is turning over £2m, can you see how the business is not worth millions? Expectations from the seller is that because they are seeing millions coming into the business that they must be worth millions, but actually a 10% net profit can be quite normal and then an owner operator would be paying themselves in dividends.
Why you should be happy with less than a million for your agency
Now, I’m going to explain why you should be happy with this valuation, as I see so many owners of agencies pooh pooh what they are considering a low valuation of less than half a million.
So let’s say you get a fairly standard offer of 50% up front and a three year earn out. In year one you will be paid £200k on day one and then you will earn £100k by the end of month 12 as salary.
Year two, day one, you get another £66k of your earn out and by month 24 you have another £100k salary, the same goes for year three and then a final sum at month 36.
How much you really get paid
So you can see why the valuation less than a million quid is actually a good deal for the seller if they finish their earn out, you will be paid £400k in cash taxed at 10% and £300k in salary taxed at 40%, so the total after tax is £540.
If you had continued in the business as you were, you would have taken home £240k over the 3 years assuming you pay around £20k in tax each year.
Now, is that going to make you a millionaire? Not yet, but after three years when you have finished the earn out, assuming you were able to live on the £80k take home you were on before, you should have £300k left in your bank.
This’s enough to put a deposit on a property worth £900,000 or to buy another business turning over £6m. It certainly gives you more options than if you had of continued as you were for the three years.
Bloke down the pub
I know many big shot CEOs will argue that they would rather stay in control of their own destiny than sell out for £400k, but the reality is that left in charge of the same business without any major reinvention most businesses hit a ceiling of a few million and actually without fresh eyes or some investment don’t change much over a longer period.
Even agencies within larger holding companies tend to max out just over £5m turnover and don’t really grow substantially beyond that.
Now that’s not to say that you can’t grow a business over £5m, but there is usually an outside factor like private equity or some other kind of investment event that boosts these companies into the bigger leagues.
The real reason you want more than £400k is so you can say to the bloke down the pub that you sold your business for millions and you don’t have to work anymore. The reality is that many entrepreneurs that sell their companies can’t wait to get onto the next business idea. You will have funds to grow that business this time around.
Also, you have to understand that this is extra money in your bank, usually you are spending the £100k you’re paying yourself as it comes into your account on living expenses. £400k of free liquid money in your account is massively life changing for most people. Don’t let your ego keep you on the hamster wheel.
At Capital A we find buyers for your agency quickly. We can get you in front of hundreds of potential buyers very quickly, all under the radar as your company isn’t advertised on any notice boards and no identifying details are released until potential buyers are in strict NDAs. Contact us here for a discreet chat about buying or selling agencies.