The gruelling quest for an M&A: Lookout points for the smaller guys

From Accenture Interactive’s acquisition of Droga5, and Publicis Groupe buying Epsilon last year, to the legal battle that ensued between WPP, Grey and the former leads of Yolk, those looking to get acquired still have to navigate uncertain terrain to achieve their goal. Unless the individuals have experience with getting acquired or have spoken to those who had, it is safe to say that there are no clear, standard guidelines for small agencies to adhere to, especially those that are looking to get acquired.

Having gone through the acquisition process, Prantik Mazumdar (pictured below left), managing partner of Happy Marketer which was acquired by Dentsu Aegis Network (DAN) in 2019 to join the Merkle brand, knows how tough the process can be when seeking a potential buyer. In a phone conversation with Marketing, Mazumdar said the two things that helped tremendously with its acquisition process were a capable advisory firm and law firm.

Its advisory firm, SI Partners, helped Happy Marketer, in restructuring its business and investment narrative, which enabled the agency to secure a good valuation. “Over the course of two years, SI Partners took us to the market, introducing us to a few different buyers including agencies, consulting firms, and Chinese and Indonesian independent businesses with large capital reserves looking for investment opportunities. The independents were predominantly family-owned businesses looking to invest in digital firms to access new markets,” he said. Mazumdar added that SI Partners’ experience of having done deals globally was also helpful in navigating potential pitfalls.

When considering offers from strategic buyers, Happy Marketer’s law firm Gibson Dunn also played a key role. According to Mazumdar, sometimes, it’s not just about how good a lawyer or his team is, but the size and relevant sector expertise of the law firm. He explained that bigger networks often work with big law firms and when they see that counsel representing the seller is from a small law firm, “they could bulldoze their way through negotiations”.

“These law firms charge in hours, and the bill for even a quick transaction, can end up in the hundreds of thousands of dollars. That’s a lot of money to invest, given at the end of the day the deal might not happen after all,” Mazumdar said. Besides money, agency founders also invest time when trying to suss out and evaluate potential acquirers.

Chemistry between the buyer and seller, and deal rationale is critical to the success of the partnership.

Founders and acquirers alike often elect to invest in exploring the relationship in depth before entering into formal negotiations. During the two years when Happy Marketer was exploring partnership options, Mazumdar said him and Rachit Dayal (pictured above right), the agency’s founder and CEO, would have to run the business in the day, but set time aside at night to oversee the financial and legal negotiations.

“Agency businesses looking to be acquired should only get into [the acquisition process] if they are genuinely serious. It can’t be ‘Let’s see how it goes’ kind of mindset, because then you are unlikely to commit time and money. And that in turn means that the entire process will likely fail without professional guidance and support” Mazumdar explained.

Aspects to consider pre-acquisition

When Happy Marketer first met with the Merkle team, the latter spent plenty of time sharing about its people, products and solutions. From that session, Mazumdar said the team realised that both agencies overlapped in terms of media, content, UX, SEO, consulting and training. Besides that, Happy Marketer could also bring to the table its expertise in marketing cloud and loyalty CRM, two main areas which now he says sets it apart from the rest of DAN agencies. Right off the bat, there was a product-solution fit, he said.

Happy Marketer also did its due diligence prior to acquisition and dug deep into understanding Merkle’s business plan for the next five years. The founders needed to know how big or small a role it would play in the grand scheme of things, as well as the organisational structure of the firm. Thereafter, Happy Marketer had casual conversations with its top clients to test the waters and see if they would react positively to a potential acquisition.

There was also a cultural and leadership fit, especially since chairman and CEO, David Williams, willingly spent time with Mazumdar and Dayal to further understand Happy Marketer’s business. “The emotional connection with Merkle’s leadership was very valuable,” Mazumdar said, adding that Merkle had more of an American culture. Besides the alignment in service offering, Merkle was open and the employees were entrepreneurial.

Meanwhile, Happy Marketer also created joint business plans with DAN and Merkle to understand how they could maximise their offerings to obtain higher returns. The joint plan also mapped out how much revenue each entity would commit over the coming years.

“We also made conservative projections on how much money we can jointly make in Southeast Asia. It was a series of discussions that we had with Merkle – product-fit, culture-fit, and product-market-fit,” he explained. Another layer of validation that Merkle was the right fit was that it is partners with Google, Adobe and Salesforce, which are also brands that  Happy Marketer had very close partnerships with.

“When our partners such as Google, Salesforce and Adobe, continued to mention Merkle’s solutions and culture unsolicited, this was the secret vote of confidence we took to continue going down the aisle with Merkle.” he said.

“We saw a tremendous opportunity to work alongside strong global agency brands within the Dentsu Aegis Network to accelerate our own growth across APAC.” he added.

Calculating your agency’s valuation

For the uninitiated, calculating an agency’s value can be a confusing process. Hattie Marsden, director at SI Partners, told Marketing in a phone conversation that at its simplest, valuation is derived by what a buyer is willing to pay, and how much a seller is willing to part ways with its business for.

At its lowest, the value of a company is that of the net assets of the company, or its assets less its liabilities. In simple terms, this means everything that a company owns (eg. cash, money owed to it, the value of physical goods) less what the company owes to others (eg. any loans, tax payable). This is the value that shareholders would derive if they had to wind-up the business, and usually would not account for any brand recognition or IP that a smaller agency has developed.

Another way to look at valuation is based on the value today of the future cash flows that a business may provide to the shareholders. This can be useful when shareholders are looking at restructuring business ownership between them, or looking to bring more junior staff in as partners. However, the rights attached to the shares being sold should be considered carefully. “If those shares being sold are only for a minority percentage of the business, the shares tend to be valued lower,” she explained. “This is because you do. not typically have control over a business unless you own 51% of the shares or more”.

A third way to look at valuation is based on past deals, and what strategic buyers are paying in the market to acquire 100% of the shares of a company. One of the common concepts within valuation, when selling to a third party, is multiples.

Many independents sell to the network agencies which will typically buy them on a multiple of their profits. If a business is making SG$1 million in annual EBITDA, for example, it could value the business at the point that the deal is closed at four times EBITDA, which is SG$4 million.

However, almost all deals in the space are combined with an earn-out, which means that agency owners can derive value from the future successes they have in growing a company with their selected acquirer. “Whilst many of our clients can be nervous about this concept, an earn-out can be the best way to increase your overall valuation, as it allows business owners to realise value from the company’s growth past the point of sale” says Marsden.

For example, if the same independent grew to make an average of SG$2 million in annual profits, at the end of the earn-out, the agency could be revalued on a multiple of the SG$2 million, meaning there is lots of upside potential for successfully growing the business. For example, if a six times multiple was paid on the SG$2 million, this would value the business at SG$12 million, meaning the shareholders would stand to gain an additional SG$8 million after the initial payment made at the point of the deal closing. This could be seen as a 12 times closing EBITDA multiple, or 4 times depending on the story being told.

Therefore, in general, Marsden cautions against talking about multiples without the full context, “The valuation impact of a multiple can vary greatly depending on what it is being applied to. The effect of averaging, payment timelines and how you define profit can all have a much greater impact on overall valuation, than moving the multiple up a notch.”

When performing valuations for their clients, the team at SI Partners looks at all of these three aspects and picks the right valuation method depending on the objectives of the valuation. That said, Marsden explained that agency founders regularly expect to get a higher valuation than what might be appropriate for the situation.

This misconception stems from the fact that people are always talking about multiples and share the highest they have heard about in the market.

However they often drop the context, such as a very ambitious performance criteria that needs to be hit or what is being multiplied – such as OPAT, EBIT, or EBITDA. This is all before we get into revenue multiple based deals.

While Marsden did not give a specific number when asked what the highest multiple is, she said the team has closed deals with double-digit multiples. However, this does not necessarily mean a bigger valuation. “Someone might be paying you in equity rather than in cash, there also may be no earn-out. This could be seen as riskier as the value of a buyer’s equity in many cases hasn’t been proven until it can be liquidated into cash,” she explained.

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How do you decide on the multiple?

The industry standard, according to Marsden, is that the buyer will typically put forward the first offer. The team will typically have a view of the value that it thinks a business might be worth based on a range of factors, such as how much similar businesses are selling for. However, SI Partners also considers five key criteria:

1. How contemporary is the offering?
2. How capable is the management team? This is important as Marsden said companies are often trying to buy talent often. A stronger management team would improve value;
3. How strong is the client base and are client relationships spread across the team?
4. How fast the business is growing?
5. How profitable is the business?

Aside from the financial deal being offered, SI Partners also asks if the acquisition will help the agency grow faster.

“We always try to have our initial discussions with agencies on the factors that will enable their growth, which allows for the best overall value. If the buyer can help the business grow from SG$2 million to SG$6 million in EBITDA, for example, it does not matter if the multiple being applied is lower. The shareholders will achieve a higher overall valuation because the profit number they are multiplying with is a lot larger,” Marsden explained.

Additionally, Marsden said a typical earn-out period in Asia’s marketing and advertising scene is between three and five years with technology enabled businesses being at the lower end.

The average timeline is slightly longer than in Europe and the US. However, some of the agencies it deals with are reluctant to do deals with a long earn out and prefer an immediate pay out.

The reason for the four to five year earn out is largely because, for many buyers in Southeast Asia, the primary acquisition criteria is more often to get access to talent, over other factors such as access to clients or new technology. “In the marketing services industry in Southeast Asia, deals are frequently driven by people trying to close their talent gaps. In less mature markets, buyers such as holding companies for example, might be driven by the need to service global clients at the same level of quality as they do in more mature markets,” she said. 

Other areas to note to avoid surprises

Before acquisition, it is important to consider which brand the agency will be housed under, Happy Marketer’s Mazumdar said, especially when the holding company has plenty of agencies under it. “If that agency brand is not a strong one, you could be in trouble. We are lucky as one of our considerations was to sell to a new brand with lots of growth opportunity. Merkle was just entering the Southeast Asia market, and so we had seats on the table and could focus on creating a business and market”, he added.

“The bigger picture for us was that we would be associated with a strong holding company, wherein our strengths in data, analytics and CRM would create synergistic opportunities with the creative and media lines of business in the network. It was a chance for us to leapfrog exponentially.” he further explained.

Integration costs is also another area that agencies should consider when they are seeking to be bought. According to Mazumdar, DAN and Merkle had a dedicated individual driving integration planning across IT, HR, finance, sales and marketing throughout the negotiation process. This gave the Happy Marketer team a better idea of the type of IT systems it would be transitioning to better alignment in hiring policies, as well as change in organisational structure. The type of roles Happy Marketer would have in DAN’s leadership team were also mapped out.

“Six months down the road, senior partner Sanchit Mendiratta, Dayal and I are in certain leadership councils within DAN. We have visibility of what is happening at DAN’s senior leadership level. It is not like I am silently sitting in one corner and have no idea. Credit to DAN Singapore’s CEO Prakash Kamdar for involving Happy Marketer in key decisions in the network,” Mazumdar explained.

While most acquisitions materialise, there have also been instances where the deal falls through, sometimes even at the last minute. For the founder, Mazumdar said this is equally an emotional journey as it is a financial journey. As such, it is important to manage expectations and emotions.

“Convince yourself whether you should sell or not. Dayal and I experienced a massive roller coaster of emotions where every other month, we would go ‘What are we doing?’. Rarely have I met founders who would say ‘Let’s go, let’s sell our business’. It is only cases where it is a distress sell, but that is not a good position to be in as the business will not get value or love,” he explained.

One valuable piece of advice Mazumdar gathered from Marsden was that despite all the negotiations, until the signature has been inked above the dotted line, there is no need for the agency’s owners to sell.

Just like a buyer can back out, the sellers can do the same as well.

“You genuinely don’t have to sell unless you really feel it strongly. Think about 100 reasons why you should not sell. Go through that emotional process. If you feel someone is being shady or if it does not click in your hearts, do not go for it,” he said.

According to Mazumdar, the worst case scenario is that everything looks good pre-acquisition but things turn sour post acquisition. He said that would be a sad situation to be in because the owners have already lost control of the company after selling it. “You can negotiate and play politics but that’s not a great place to be in. That’s why most of the times in such cases, the founder eventually leaves,” he added.

How to mentally prepare your employees

There have been several cases where the buyers insist that the sellers only inform their staff of the acquisition once the deal happens, Mazumdar said, which would obviously be a huge shock to employees. Barring certain things that cannot be revealed due to contractual negotiations, Mazumdar said the mental preparation should start at least a year before the deal happens. Here are some steps Mazumdar said owners can put in place:

1. Feed the message to the staff

Mazumdar and Dayal both told their employees why they were looking to sell and what they would gain from the acquisition. “We were very honest about why we chose this path and also offered employees the right to refuse. We also explained that given the way the industry is shaping, consulting firms are coming into the scene and it is important to scale up and regionalise quickly. We can’t remain small forever,” he added.

Initially, not all employees were pleased with the idea as they were concerned about their career prospects and the potential change in the culture that we had nurtured but we talked this through over some townhall sessions and eventually, the #happytribe appreciated and were excited about joining Merkle and Dentsu Aegis Network as they saw the benefits that it would bring to the agency and ultimately propel the way they work as well. “Many of them appreciated the honesty, that was the big factor,” Mazumdar added.

2. Start nurturing the next layer

It is important to grow the next generation of leaders who can take over your duties when you are busy with acquisition negotiations. This also helps in valuation and discussions with the buyer, he added, as the buyer will realise that the company is not heavily reliant on merely one to two founders, and that the next generation is ready to take over.

As always, seeding the next generation of leaders will also have its set of challenges. Agency owners should also be transparent with the up and coming leaders and discuss if they think it is still worth while remaining in the company. Also, this would be a good time to address any concerns the new leaders might have.

“There will always be issues we can’t address, but let’s put it out in the open. We had this dialogue a year in advance and it generally address the concerns of most of our employees and I think that process has to continue,” he added.