What you need to know about Valuation and Term Sheets
Are you considering selling your firm? Or maybe you are considering an acquisition.
Valuing a PR Agency is an Inexact Science and a complex process. It takes financial expertise, knowledge of the marketplace and an intricate understanding of how buyers create term sheets/offers.
Every Valuation is different, as is every PR firm. Being a service business, to reflect actual financial performance, requires “recasting” the P&L’s, including several adjustments and considering intangibles and other critical factors as a second-tier of management, quality of clients, retainer-based billing and location(s) will also influence valuation. The age(s) of the owners and second-tier of management will also be considered.
Although there is an element of subjectivity in valuing a PR firm, there are also objective guidelines that must be followed. In addition, there is extensive due diligence performed prior to the actual valuation. What most don’t realize is that a majority of the agreed-upon value will be paid in an earn-out based on “future” performance. When we do valuations, we do a line-by-line analysis of the past three full years of financials plus the interim financials for the current year. We also request a projection for the next twelve months, if available. A prospective buyer will certainly request it.
Term Sheets, presented by buyers to sellers, are customized based on many factors, including financial performance, management expertise, client concentration, scalability of client revenues, the brand, specialties, competition, the economy and other marketplace factors. Other items of importance include client contracts, operating systems and the quality of the accounting year-end financials. The term sheet outlines the basic components of the offer, including the potential value of the agency “in the eyes of the buyer.” It also outlines the model for acquisition i.e. percent or amount of downpayment and number of years of buyout, model for the annual payment based on net revenue growth and profitability, proposed salary of the seller post-closing, bonuses to incentivize key staff for performance and generating new business. “Terms” can be more important, and more valuable, than price.
Buyers may offer a revenue-based model, instead of a recasted EBITDA (profitability) model. The buyer will want the seller-owner to do a minimal of client service work and concentrate mainly on marketing, The buyer will be responsible for operations and profitability. A revenue-based model can be quite lucrative for a seller who is a rainmaker. In some cases, for whatever reason, the seller may not be very be profitable. It may be due to poor staffing, inexperienced back office, excessive rent, lack of investment capital or simply being too small and losing pitches to larger firms.
By selling to a larger firm the seller will have the financial and intellectual capital needed to grow both top and bottom lines. It may be a win-win for seller and buyer.
Contrary to popular belief firms are not valued at a multiple of net revenues. For example, a buyer will not pay 2x net revenues for a $3 mill firm, $6 Mill. That would be imprudent, with huge risk for the buyer. It would most likely take many years to get the ROI needed to make the investment.
For a buyer the down payment is their initial risk. Buyers typically pay 20-35% of the current valuation at closing. The balance will be paid over a three-to-five-year period, based on performance, the earn-out model.
The goal is that the proposed terms are fair for both buyer and seller. The seller wants to receive maximum value and the buyer needs a targeted return on their investment.