Prepare Your Agency for Sale: M&A Tips from Jonathan Baker

Mergers and acquisitions: a situation where you can't be overprepared. With more preparation, you’ll have a more lucrative, smoother M&A process from beginning to end.

But preparing for an M&A is tough because it’s not a skill most business owners get a chance to hone. Unless you love starting and selling businesses, it’s something you only do once – hopefully – if you do it right.

That’s why I wanted to sit down and talk with Jonathan Baker, one half of the agency consulting powerhouse Punctuation.com. As the co-owner of a craft brewery who was left at the M&A altar, Jonathan wanted to “help other business owners figure out how to do this better.”

“I thought the valuation was like a spreadsheet that everyone just agrees on, and then we just move forward,” says Jonathan. “Turns out, it's a lot more nuanced – and a lot more emotional, particularly for the sellers who have built this agency that is their baby and are trying to figure out how to transition it to someone else.”

Valuation has a lot of nuance, which means rules only take you so far. “A lot of it is buyer-dependent,” Jonathan says. “It’s hard to tease out how a particular buyer is going to value things until you're in the middle of it.”

However, here are the elements he keeps an eye on:

Positioning: What is your unique value proposition?
Client concentration: How much revenue comes from a single large client? The higher the percentage, the higher the risk.
Percentage of recurring revenue: The lower the percentage, the stronger your pipeline will need to be, to keep your team’s utilization up.
The seniority of your leadership team: If experienced people have their hands on the reins, a buyer will see this as a sign of maturity and lower risk.
Financial trends: Are your profit margins going up or down? Is your AGI going up or down?

Essentially, all these elements come down to reducing risk for the buyer. After all, in a service-based business like an agency, there are no physical assets to back the business if things fall apart. As Jonathan says, “It’s just client relationships and the people, so you have to hedge your bets against losing clients and losing people.”

Part of that hedge comes with deal structure – as the seller, you’ll have to put money at risk in the future. Although every deal is different, Jonathan says that the average deal for small to mid-sized agencies would be a 50% upfront payment and then two 25% chunks for the next two years, contingent on hitting certain targets, such as top line revenue.

That means any potential seller needs to think about staying on board for about 2-3 years after the merger. It’s not just about getting to the closing table, shaking hands and walking away. The post-transaction period is something to think about very carefully, both when determining M&A timing and choosing the right buyer.

When to Start Planning for an M&A

When it comes to M&A, the biggest mistake I see is companies thinking they can just flip the switch: Yesterday they’re not thinking about getting acquired; today they’re ready to be bought.

A lot of owners get to a point where they are burnt out and ready, if not to get out of the business entirely, at least to get out of the risk part. But the path to a successful deal – both in terms of the finances and in terms of the post-transaction period – takes much longer.

“What you're trying to do is really back into, ‘When is the right time based on when I think I'm going to run out of steam? How much gas do I have left in the tank? Are there other things I want to do with my time?’” Jonathan advises, if the post-transaction period could be 2-3 years, you're going to want to give yourself a year or so for the sale. That means owners should start thinking about an M&A about 3-4 years before they want to be completely out of the business.

Here’s why you should know your exit strategy on day 1: Read Want to 'Work Less, Earn More,'? Ask Yourself These Questions (summitcpa.net)

Steps for a Successful M&A

In that 3-4 year period, what are some of the steps an owner can take to be prepared? What should companies be thinking about in order to make themselves more marketable, even when they're not necessarily thinking about selling quite yet?

Get your books in shape. That's going to be key. As Jonathan says, “Frankly, it sends the right signal to a buyer that they're buying something that's buttoned up, run like a business.”

“Stop running personal expenses through the business. Make sure that you understand everything on your balance sheet and there's no bs. Make sure your chart of accounts makes sense. You also need to be running your books on an accrual basis, if you're not already.”

“That's just for you as well as an owner,” Jonathan adds, fluently speaking our CFO love language. “That's going to help you run the business better, but it also will help a buyer understand the business more quickly and will help you get through that process more quickly.

Get a valuation sooner rather than later. Even if you're not ready to sell, you need a starting point number to know how far away you are from getting there; then you can strategize accordingly. (Tracking this progress is part of our long-term revenue forecast process.)

Check out when Jonathan Baker recommends getting a valuation in the video below.
Create marketing materials. Once you have a valuation and the general terms that you think you can get, you’ll want to spend a few weeks to a month to get ready to go to market. Jonathan sees the process of digging up enough interest as taking around three months.
Be ready for due diligence. “The first thing I'm talking to companies about when they're even thinking about doing a sale,” Jonathan cautions, “is that the value can go down pretty quickly. If due diligence is happening and they give you a request list, and it takes you four months to pull it and half the stuff you're giving them is wrong and you can't answer questions. You have to know your numbers inside and out and be willing to provide that data quickly to not scare companies away. You want to be able to react quickly once you're ready.”

From clean books to due diligence, the whole process can easily add up to a year. “Six to nine months is the average we see,” says Jonathan, “That's if you are 100% ready to sell and the books are in good order. But oftentimes the books are not in good order, so we need to go back to the beginning.”

How to Prepare for a Successful Post-M&A Period

Owners have a lot of pride in what they're doing, and oftentimes the new company is going to change things about the existing company. So how can an owner prepare for those years when they’re still in the business but in a different capacity.

“Effective preventative maintenance: We don't want them to get into a relationship with someone who is going to change things too drastically.”

Consider the following:

What is the buyer's long term vision?
Why are they buying this agency and how does the purchase fit into the puzzle?
What changes do they expect to make to the business and over what period of time?

Are they going to run it as a standalone, keeping the name and the payroll, or are they going to roll it into their name immediately?

Beyond the business implications, all of these decisions have emotional implications. “A big part of what we do is trying to understand where the principles of the sellers see themselves thriving most in a new organization,” Jonathan explains.

“Sometimes it's in a similar role, sometimes it's in a new role. If the buyers have good leaders in the wings that can often be an option. We've dealt with buyers who have acquired multiple firms and, over time, the principals at those firms have completed their earn outs but are still employed at the firm because they're just having fun.”

“Sometimes selling is more about getting out of the risk part of the business. Maybe you fall in love with the M&A process, and you want to be a part of the M&A team. There are options when you are selling to a larger company. That is one thing that I think folks don't take into account: Oftentimes selling to a larger company is good for your employees because it gives them upward mobility they might not have had.”

Is Now a Good Time to Sell My Agency?

The market for agency sales softened in 2023 after the post-Covid money artificially inflated valuations. Now we’re seeing that market start to pick back up – just from our own client roster, we’re seeing a lot more agencies start the M&A process than in recent years. Don’t expect prices to return to 2021 levels, or for interest rate cuts to make a huge difference in this space (small to mid-sized agency buyers are less likely to need external financing). But considering the 3-4 years it takes to fully complete an M&A, now seems like a good time to lay the groundwork.

If you need help getting your financials in order for your upcoming business goals (whether or not you plan to sell your agency), reach out to our virtual CFOs for a free consultation.