By Rick Gould, CPA, JD
I have been valuing PR firms for over 20 years, initially as the CPA firm for many seller firms, and then since I started my Mergers & Acquisitions Firm, Gould + Partners in 2001.
Valuing PR agencies is a complex process. It takes financial expertise, knowledge of the M&A marketplace and an understanding of how buyers create offers/term sheets.
- Recasted Operating Profit for the past three full years plus current interim period operating profit (i.e. seven months ended July 31, 2014).
- Net Revenue (Fees + Mark-ups) growth for the same periods.
- Net Worth of the firm.
- Working Capital (current assets less current liabilities) position as of sale date.
- Other intangible factors as second tier management, quality of staff, quality of clients, office lease, client contracts in place, what percent largest clients comprise of the total client portfolio and other factors are all considered when a buyer prepares a term sheet.
The goal is that the terms are fair for both seller and buyer. There is no cut and dry statement that can be made about how a buyer values a seller.
Contrary to the belief of many sellers, firms are not valued at a multiple of “net revenues”. I was recently called by a client saying he read that firms with 25% operating profit may be valued at 3X revenues. He was ecstatic thinking that his $4 million firm is now worth $12 million. He also was told if the agency had an operating profit of 25% (his was 26%) the seller could get half the value, $6 million, at closing for his $4 million PR agency. I, assured him that, in my opinion no buyer would ever offer terms this favorable.
Buyers need to minimize risk. The down payment is their risk. For a $4 million agency with a 25% operating profit the seller may get 20% – 35% at closing. The seller may also get less, depending on many factors. The balance will be paid over 4-5 years and based on “performance” what we call an “earn-out” model. The past determines the down payment percent. The future determines the ultimate amount to the seller. The multiple used for valuation and payment has been averaging around 5x times EBITDA (Earnings before interest, taxes, depreciation/amortization). Often a sliding scale is created, where the multiple may be less or more if certain goals are met regarding top & bottom line growth. An earn-out can be described as a deferral portion of the purchase price which is conditional on the seller’s achievement of predetermined operational or financial goals within a specified time frame.
Firms that have historic flat net revenue growth and operating profit of under 15% will receive lower multiples, lower valuation and lower down payments.
There may be other “Revenue-based” models offered by buyers in the term sheet. In a revenue- based model the sellers main function will be to bring in quality business. The buyer will manage and be responsible for the operating profit. A revenue-based model can be very lucrative for sellers who are good rainmakers but, for whatever reason, have not been very profitable due to poor staffing, distracted by back office, lack of capital, excessive rent, losing pitches as a result of being too small, etc. With a larger firm the seller will have the financial and intellectual capital needed to grow in both top and bottom line. The revenue based model has become much more prevalent in today’s PR M&A marketplace. I believe it is a valid option for many sellers to consider.
The key point is there is no general rule to apply. Any PR practitioner considering selling their firm should do two things:
- Have a valuation completed by a qualified appraiser, knowledgeable in the industry.
- Have experienced representation using professionals that know and understand the PR M&A marketplace and the nuances of firm valuation and deal structure.
I have included a link to a June 2014 article on PR M&A, authored by CPA/O’Dwyer columnist Richard Goldstein. I was a contributor to his column. Navigating mergers and acquisitions in PR