ADVERTISING INDUSTRY ACQUISITIONS & INVESTMENTS FROM THE SELLER’S PERSPECTIVE
A great deal of time, anguish and expense can be saved if the Seller faces a couple of hard realities about selling before setting out to find a buyer or entertaining an offer to purchase the agency. Here’s a checklist of what a prospective seller of an agency should consider:
[ ] Is the Seller Ready to Accept a Salary?
The Sellers will be confronted with the need to put a market value on the services they provide to the agency. The Buyer, for purposes of calculating the purchase price and the payment structure will necessarily make a determination as to the market value of the agency principals’ day to day contribution. From the Buyer’s standpoint, it must determine what a replacement cost would be after the principals have received their earn-out and are no longer running the agency. The Sellers should be fairly compensated for the services they provide over and above payment for their equity. A highly compensated Seller must confront the market place realities in valuing his or her services. Many negotiations have been brought to a screeching halt when it is pointed out that the parties have wildly disparate views of the appropriate salary to pay the principals for their services during the earn-out period.
[ ] Is the Seller Ready to Have A Boss and Lose Control?
Many agency principals have had the independence of owning their own shop for so long that they have forgotten what it is like to have to be accountable to someone else. Establish early in the discussion the acceptable limits on control over hiring and firing, staffing, pitching, accepting and resigning clients throughout the earn-out period. Faced with having to report to someone else to soon after the owner made deal or over too many aspects of the ordinary course of business, choose not to sell.
[ ] Give Up What Is Most Prized
Insisting on protecting certain individuals or otherwise maintaining relationships with clients, suppliers or the office space may kill a deal. It is wise to analyze what, if anything, are the preconditions to a deal since certain buyers may have strong inclinations to reconfigure or otherwise jettison parts of the Agency that the owner holds dear. Identify these sacred cows at the outset and make sure that they do not impose a restriction which cannot be overcome.
THE SELLER’S MOTIVE
The Sellers’ reasons for selling should inform the deal. Often money is not the only major motive. Buyers need to be sensitive to sellers stated and actual motives:
[ ] Cash-Out. The most common motive is to exit. Three to five years before quitting, the owner of an agency should make a deal. The best deals will involve an earn-out. In house succession will usually be less lucrative than sale to a public company. In a cash-out deal the Seller is interested in maximizing the purchase price and the assurance of payment. The amount of the down payment (the guaranteed payment) may determine when management control can pass from the departing owners to new owners.
[ ] Cash-In. If the owners’ goal is to simply take out some money, while continuing to work beyond the earn-out, they will want to continue to control operations. Acquisitions of only a partial interest should be considered. Indeed, the discussion of who ends up with a minority or majority interest will provide the opportunity to clarify the Sellers’ goals and intentions. Management issues are most difficult to resolve.
[ ] Trade Up. Owners of an agency may conclude that they have hit a wall. Additional capabilities, services, geographic scope, or simply investment to grow may be the goal. A merger with another entity or office of a multinational may be the best form of deal. Motivating the sellers to accomplish the Buyer’s goals for the future of the merged or otherwise larger agency should inform the structure of the deal and the incentives of the continuing management. The Buyer should emphasize its own capabilities and its practices and philosophy. The Seller needs a strategic fit and a culture it can successfully adopt. The Seller has to accept the Buyer’s structure and the established patterns of interaction between sibling entities. The Buyer is not going to change these to accommodate a particular acquisition.
A deal must fit the Sellers’ reasons for selling. Buyers often presume that price is the only important issue. Rushing the Seller into a letter of intent or no shop agreement based merely on an agreement on the formula for valuation and payment schedule tends to cut short the process necessary to obtaining agreement on mutually acceptable goals and objectives. This may result in difficulties in defining the appropriate management controls and responsibilities and terms of employment agreements. These terms are extremely important to Sellers. The Buyers’ insensitivity to these issues and tendency to “cookie-cutter” deals may turn off a Seller who could otherwise have been wooed and won.
VALUATION
[ ] Normalize the P&L. The first step is to drop to the bottom line any compensation to owners in excess of a market rate compensation package for the function. Owners are free to pay themselves whatever the agency can afford (and then some). The Buyer will project profits and margins based on necessary compensation packages. Earnings from normalized operations are the key to valuing the agency. The goal is to project future earnings. The means is to look at past earning and projected growth. Sellers tend to think they should receive an amount equal to 100% of Gross Income (all monies from servicing clients less all payments to third parties on behalf of clients). In fact, deals are more properly based on a multiple of earnings. If earnings equal 20% of gross income, then a five multiple of earnings will equal 100% of Gross Income. But if earnings are only 15% of Gross Income, a five multiple of earnings would be only 75% of Gross Income. A deal will be made along the range of typical multiples (5-9x pre-tax earnings or 8-15x profit after tax) based on: 1) margins - the % of Gross Income that drops to the bottom line as operating earnings; 2) growth rate, 3) strategic fit, 4) geographic location and 5) hot areas of expertise such as the currently favored: on line, technology, medical/pharmaceutical. The Seller is selling 1) talent, 2) client relationships, 3) an operating entity and 4) a lease and tangible assets. The strengths and inherent value of these assets should also determine the applicable multiple.
LAYING THE GROUNDWORK
[ ] Confidentiality Agreements
An appropriate confidentiality agreement should be easy. It is important to maintain the sellers’ negotiating position as well as its client relationships and employees. Confidential information as well as the fact that you are engaging in discussions should be kept confidential.
[ ] No Shop Agreements
Care must be given before entering into a no-shop agreement particularly with respect to limiting the time frame in order not to undercut the Seller’s negotiating position and the Buyer’s interest in not spending a lot of time educating a Seller who has not yet made the decision to sell. The Seller should not agree to this until it has determined that all deal breaking issues can be resolved satisfactorily.
[ ] Information Exchange - Due Diligence
The Seller should be forthcoming with relevant information. This will include full financial information, historical as well as projected, balance sheet as well as profit and loss statements and profitability on a client-by-client basis. If you’re serious about selling, you should seriously address pulling together the relevant information in the best and most usable form possible. Keep in mind that at some point you will have to stand behind the information you present. Exaggeration is not a good strategy. The Buyer will want to take the raw information and re-cast it into a business plan going forward. Ultimately the value of the acquisition to the Buyer is the profits that can be generated from the assets purchased. The Buyer will make assumptions about its own management of those assets and about the addition of other assets and resources (generating the elusive “critical mass”). The Seller should engage in the same exercise in order to make the most compelling presentation to the Buyer of the value of the assets. Since in all likelihood an earn-out for a substantial portion of the purchase price will be part of any deal the Seller should candidly present what is necessary to the profitability of the agency. A Seller who pitches a plan which it cannot effectuate will end up with a bad deal.
THE NEGOTIATION
[ ] Let the Buyer Go First
It has often been said the art of any negotiation is to let the other person speak first. The Seller who has divulged all relevant information has every reason to expect the Buyer to propose a deal. In order to induce the Buyer to speak first, the Seller should indicate the flexibility of one who is able to structure the deal however suits the Buyer recognizing that the Buyer will need to approach the deal so that it fits within other plans, other deals and other people’s expectations and recognizing that Sellers’ interest can be accommodated by money. A Seller who attempts to dictate the terms will find the Buyer not interested.
[ ] Remain Flexible
The Buyer, recognizing that it must leave room for negotiation and sweetening the deal, must also put enough on the table to keep the discussion going. Consequently, the Seller benefits from getting some idea of how the Buyer values the assets. Also the Buyer’s needs relative to the Buyer’s plans will become more apparent giving the Seller an opportunity to reconsider the sacred cows and other assumptions that may have been misguided. The Seller must remain flexible and willing to re-evaluate. Something that at first blush appears to be a deal breaker may be resolved contractually or with money. Professionals working with you should be able to offer up a variety of compromises and solutions to any problems posed. Do not make anything a deal breaker in the passion of the moment. If you want the deal, there is always some way that you can be compensated for the emotional issue that brings you to the brink of killing the deal.
MAKING A DEAL
[ ] Projections
Each Seller should project what he can take out of the agency over the period that he is willing to continue to work. He will sell only if the deal will yield more. Confidence about the future must be balanced against the security of the buyer’s cash. An earn-out protects both parties’ interest in hedging against the uncertainty of the future.
After all, the posturing and explanation of positions, the exchange of information and the arguments of what each will do for the other, the deal terms should begin to take shape. Now is the time to take a look at the overall deal without getting hung up on any particular point. Discuss with your advisors whether a deal within these assumptions and parameters is going to be doable. Evaluate the deal from the other side in terms of whether anything of value have not been taken into consideration. Determine the “must haves” and prioritize the “like to haves”. Issues of management control, termination of employment or of Sellers’ control during an earn-out should be addressed at this stage, since they may be deal breakers. The important terms should be nailed and the deal should be reducible to a memorandum of understanding or Letter of Intent. If it’s a deal breaker, it should be addressed at this stage. Going forward will be extremely expensive in terms of time, energy, aggravation and legal and accounting fees. Now is the time to determine whether or not to proceed.
BASIC RULES
[ ] See the Deal from the Buyer’s Side and Avoid Self-Righteousness
If the deal sounds too good to be true, it probably is. When you reduce it to writing and it’s reviewed by financial professionals any misunderstanding is not going to remain as part of the deal. Look at the deal from the other side. Put yourself in the shoes of the person you are negotiating with and understand the issues from his or her perspective. Do not try to win a point. Approach it from the standpoint of why your resolution is mutually beneficial and fair. Most of all, avoid self-righteousness. The light of self-righteousness will blind you completely.
AGREEMENTS
[ ] Have Your Lawyers Negotiate the Terms
The Buyer should propose documents. The Seller will now be relying heavily upon professional advisors. Much of what will take place in protracted negotiations is selecting among different terms for the deal that are appropriate given the structure you have adopted. It is essential that the Seller have confided in his counsel on all issues, liabilities, sacred cows and any other embarrassments so that they can be taken into account before precise language in a document puts them at issue.
The sale of an advertising agency is different from most acquisitions. There are many issues beyond price that will kill the deal. Assuming that an agreement on price is sufficient to make a deal is often an expensive mistake. Sellers care passionately about the creative product and about their people and their clients --- or least some of their clients. Consequently, the control over the day-to-day operations — hiring, firing, staffing, pitching, servicing clients, selecting clients — as well as accounting for client conflicts during the transition or earn-out must be considered key elements of the deal. This is not simply an acquisition of real estate, manufacturing and distribution facilities, and an existing product line. Professionals unfamiliar with the advertising industry and its peculiar customs and practices often fail to take into account these differences. The Buyer often holds back on its position on important (emotional) issues in the hope that they will disappear in the drafting of the language of the agreements. This tactic may succeed, if the Seller is poorly represented.
CLOSING THE DEAL
[ ] Leave Adequate Time to Resolve Final Issues
There will always be some final issues raised at the end. Allow sufficient time for final hammering out of documents and tying up loose ends: Are any consents of outside parties necessary? Is any financing a contingency? Are there any open issues of due diligence? Finally, many Sellers will get cold feet or Seller’s remorse. Some final concession at the end may be helpful to getting a signature. While it’s essential that both parties feel good about the deal and therefore are working to bring it to a conclusion, it is an emotional experience for the Seller. It is in the final stages of the deal that the goodwill of the principals will determine whether the deal closes.
