The Basics of Agency Valuations
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Do you know the value of your agency? If your answer is no, wouldn’t you like to? We’re guessing yes.
There are tons of reasons why you should be aware of the value of your agency. But, if you’ve never done an agency valuation, you could be asking yourself many questions, like:
Which factors will influence my agency’s valuation?
How can I calculate the value of my agency?
Just like knowing the value of your vehicle or real estate, knowing the value of your agency business can open up new frontiers. So, let’s begin by broadening your horizons.
Scroll on to learn the basics of agency valuations.
Methods of Agency Valuation
First of all, agencies are valued using multiples.
In a nutshell, the more your agency is earning, the higher your multiplier gets. In other words, the more revenue your agency business is bringing in, the less it’ll be viewed as risky—and thus its value increases.
But let’s put multiples aside for a moment.
Two other very important terms that come up in agency valuations are earnings and revenue.
What you’ll need to determine your agency’s value are your:
Net income, EBITDA or “Earnings”—the net amount your agency is making
Revenue—the entire amount of billed services you’ve had in a year (how much money your agency is billing), subtracted by any expenses you’ve paid on behalf of your clients
OK, what’s next, you may be asking?
Well, whether you were conscious of it or not, your agency falls into a certain revenue category. That revenue category will determine the multiple we mentioned previously, which will be one of the main factors that influence your agency’s overall valuation.
Agencies will be valued using either a multiple of annual earnings or a multiple of annual revenue.
Now, let’s move on to understanding which multiple is assigned to which revenue category.
Determining Your Agency’s Revenue Category
Your agency can fall into one of the following categories of agency revenue:
Up to $1 mil per year
From $1-3 per year
From $3-5 mil per year
Over $5 mil per year
This is how your agency’s valuation will approximately look like per each revenue range:
Under $1 mil per year: 0.8-1.4 x Revenue or 2-4 x Earnings
From $1 – $2 mil per year: 1-2 x Revenue or 4-6 x Earnings
From $2 – $5 mil per year: 1.5-3 x Revenue or 6-12 x Earnings
Over $5 mil per year: 2-4 x Revenue or 8-15 x Earnings
The Top Metrics That Determine Your Agency’s Value
Now you might be thinking: I get it, revenue is important, but that’s probably not the only thing…. Which other metrics determine my agency’s value?
There are over a dozen of them, so let’s go through them all.
1. Your Agency’s History of Earnings
Ancient Romans knew it: history is life’s teacher. And, well, to teach you about your agency’s value, you’ll need to gather your agency’s history of earnings and revenue.
When looking into your history of earnings and revenue, three periods are most important:
The past 12 months
The past 3 years
The past 5 years
If your agency’s growth has been over 30% in revenue in the past 3-5 years, your past 12 months will be key in determining your agency’s value.
However, if your agency business has been steady in terms of revenue or declining in the past 3-5 years, your valuation will be an average of the past three years.
2. Monitoring project statuses and deadlines
As said, the largest factor that will influence your agency valuation is revenue, but the amount of revenue your agency makes isn’t the only important thing here. The type of revenue that your agency is making is almost equally as important when it comes to agency valuations.
Ask yourself questions like:
How long are your agency’s contracts?
Are they recurring (retainer) contracts or more project-based contracts?
Do you know your client retention rate?
How dispersed is your revenue?
Agencies with a bigger amount of retainer-based work will get a higher valuation as opposed to agencies that have more project-based work. The type of revenue your agency makes won’t be taken lightly. Take into account that yearly contracts are more valuable than monthly contracts.
3. Seasonality of Revenue Income
Whoever’s in the agency business knows that revenue income has its peaks and falls. Summertime is usually slow, while pre-holiday campaigns can make optimal resource planning a nightmare for agencies. Even though agency revenue does generally even out for most, this will be another factor that’s taken into consideration in getting your agency’s valuation done.
4. Your Leadership or Management Structure
Agencies that make anything from $1-9 million USD in revenue per year owe a great deal of their growth and success to their leadership team and/or management structure.
Why your agency’s leadership team or managing board will influence your value on the market is quite simple: buyers will want to know how your agency can function once it’s sold. Because your agency business is, in a way, a living organism. How your agency is led. how it operates on a daily basis and how it can continue to live on will influence its overall value.
To be able to understand your agency’s value in the sense of leadership or management structure, try answering the following questions:
Who are the key employees vital to your agency’s operations?
Which roles do members of your management team carry and how long have they been working for your agency?
Is your management team committed to staying in the agency even after you potentially sell it or merge with another agency?
5. Your Agency’s Diversified Risk
Like with any time of business, to get your agency’s valuation, your risk portfolio will matter. To understand your agency’s diversified risk you’ll need to know your monthly overheads, client churn rates, your new business pipeline, loans, and/or multi-year projects.
6. Competitive Advantage or Your Agency’s Niche
Another factor to take into consideration when evaluating your business worth is your competitive advantage, i.e. your agency’s niche. Are you specialized in content writing or SEO writing? Does your agency do only product development? Are you focused just on serving one industry? You get where we’re going—the more niche your agency is, the higher its value will be.
7. Your Agency’s Brand Image or Reputation
If your agency has a reputation for winning awards—be it for socially responsible projects, creativity, or being the employer of the year in your country—your image will have a positive impact on your agency valuation.
8. Location, Location, Location
Back in 1944, Harold Samuel, founder of one of the UK’s biggest property firms said: “Location, location, location.” Though he was talking about property, and though we live in a remote-work world, agencies still have at least office spaces, and geography matters. Your agency will have a higher value if it’s nested on Champs-Elysees or a hip corner of Manhattan than, naturally—a less developed metropolis.
9. Time In Business
Similar but not directly tied to how good your agency’s reputation is, how long your agency business has been on the market will influence your valuation, too.
Let’s say that your agency has been in business for 10 years, with 3 years of steady growth. It’ll be perceived as more experienced in the field than a younger, equally financially successful agency. However, if you’ve been around for 15, or 20 years and have been experiencing a decline in revenue, that’ll be a negative influence on your agency’s valuation.
10. Client Concentration
Do any of your agency’s clients make up over 10% of your yearly revenue? If yes, beware—because this will negatively affect your valuation.
11. Client Retention
Retention rates are almost as important as retainer agreements. Constant client churn may be a sign that your client relationships aren’t set up right, that communication with your clients isn’t what it should be, and that this could be a potential problem in selling your agency.
12. Transition Structure
If you’re looking to sell your agency, buyers will want to know what your transition plan is. What will the process of acquiring your agency and keeping business flowing look like? If you plan on handing over your agency business within just a few months, this may negatively impact your agency valuation. On the other hand, if your transition structure is planned out in phases throughout, for instance, six months—this could positively influence your agency valuation.
13. Other Assets
Has your agency business produced a patent, technological product, or a valuable industry-specific knowledge base? Any similar intellectual property can only positively influence your overall business valuation. How about your growth potential? You can intrigue strategic buyers if the industry your agency is focused on is forecasted for increased economic growth in the upcoming decade.
Why Get an Agency Valuation Done?
Of course, things like “brand image” or “transition structure” can seem immeasurable at first, but in the digital agency business and the world of marketing, they will be counted in alongside basic financial metrics such as your earnings and revenue.
But why is getting a valuation done important? To sum up:
It’s insightful for agency owners to know how much their agency is worth and be able to benchmark
To get an understanding of what comprises your agency’s value
To learn what you can improve to increase its value on the market, grow or change shape
To understand opportunities for mergers and acquisitions