Preparing for M&A as a Digital Agency Owner with David Sheehan

Russell Benaroya: Hello, everybody. Welcome back to another episode of the Stride 2 Freedom podcast. I am your host, Russell Benaroya.

The Stride 2 Freedom podcast is the place where we help leaders get and stay in their zone of genius. What is your zone of genius? Your zone of genius is that thing that you do as a business leader or owner, where you really lose track of time, where you get the greatest amount of energy and fulfillment.

So often in business, as we toil away and all of the things associated with trying to get this business going, we get out of our zone of genius. Our responsibility on this podcast is to bring guests and expertise to help you find partners that can keep you in your zone.

The Stride 2 Freedom podcast is brought to you by Stride Services. We are an outsource back office, bookkeeping, accounting, and fractional CFO services firm for MSPs and digital agencies. Our zone of genius is helping you use data to make better business decisions.

Okay, let’s get into the episode today. I am absolutely thrilled to be introducing you to my friend, David Sheehan, the managing partner at Athru Partners. Hi, David, how are you?

David Sheehan: Russell, great to be with you. Thank you for inviting me today. I’m looking forward to it.

Russell Benaroya: It’s really such a gift. You have such an illustrious background in the marketing agency space. For those of you that have not copiously researched David beforehand, he is a longtime entrepreneur. He ran for almost 20 years, an agency that was ultimately sold to a private equity-backed group, which I’m sure he’ll tell us about, in 2015.

I’ve interacted with David over the course of a couple of years as we’ve gotten to know one another. I’ve been able to observe the work that he does for agency owners to help guide them on the journey toward realizing a great exit value for their business.

That’s really the purpose of today’s conversation. How do we help digital agency owners get positioned and prepared for the unlocking of the value that they’ve created in their business but aren’t quite sure the path to take to get there? David is going to help us walk us through from beginning to end and transition to increase the probability that you can, in fact, traverse that journey yourself.

David, tell me about the history of Athru and why you started the firm.

David Sheehan: First of all, Athru is kind of a funny word. A lot of people always want to say, “Are you misspelling Arthur?” I always tell them no. My name is Sheehan, which is of Irish descent and heritage. My partner is a guy named Bill O’Donnell who actually is a resident of Ireland and passed for dual citizenship in both the United States and Ireland.

Athru, in Gaelic, which is the native tongue of Ireland, is the word for change. It’s also a very popular rock group in Ireland. Some of you may know it from there. The reason we selected that term really was because we wanted to be change agents.

Russell, much as you talk about the importance; business is all about changing dynamics all of the time. Being able to navigate those changes and to understand when you need additional help, when you need your organization to step up in a different way, when you need to pivot to do new categories and new services, it’s all about change.

We felt that we wanted to be agents of that change, helping those business services, marketing services, digital agencies with the changes that they undergo. By using some of the knowledge and experience, we’ve been able to work with so many clients across so many different sizes and shapes, and configurations. We’ve made mistakes. The mistakes that I made as a business owner, I’ve been able to help some of those people navigate how not to make those same mistakes, which can be a big contribution in being able to enact change quicker and more successfully.

Russell Benaroya: What are the circumstances upon which a prospective agency client comes to you? What are they feeling? What are they thinking? What’s happening with them at the moment?

David Sheehan: It falls into two camps. One is, agencies that are on the growth, that are in a good place, that have good momentum, but they may not be seeing incremental increases in revenue. They may be struggling a little bit with profitability. More often than not, it’s more of a revenue and growth issue. They’ve done a nice job of building their business to 4 million or 5 million or 10 million, but they get stuck.

I have a great appreciation for that. My business ultimately got to about $38 million in revenue, but I got stuck in several different parts of the business. So part of it is on the growth, and that’s what we really talk about, growth consulting. Then part of the people that come to us are people that have reached that stage of the business, either because they feel they’ve done everything they can do or they need additional resources, or they simply want to go on to something else. And they’re thinking about a potential transaction.

They want to find out: are they transaction-ready? Have you done the things? Does their business have any value? We will help them determine that honestly and carefully. If it does have value, we can potentially help them if they do want to transact. And by transaction, I mean, a potential sale, a merger, a divestiture, or internal sale to existing employees, all of the options that exist as relates to a potential change in control of the business.

Russell Benaroya: I’m hearing two paths. One path is, I want to break through some barrier that’s typically associated with growth. I want to break through a growth bear, and we’ll talk about that in a minute. Or, I want to be on the track of preparedness to exit my business and determine whether or not I can position the company to realize an exit via mergers and acquisitions-related scenarios.

You said, “If they have done the things to be prepared for that possibility.” Could you talk about the top five things that come to your mind when you talk about the things to be prepared?

David Sheehan: Obviously, fundamental and critically important, and certainly an area that you know and appreciate the value of, which is excellent financial stewardship. Being able to understand what’s driving your business, what are the financial drivers? What are the financial dashboards that you need to be using to determine some of the key steps that you’re going to take to continue to drive growth?

So, financial is critical, without any question. Organizational is another. Many smaller businesses that can’t afford the luxury of having an individual HR person. Many times their hiring practices and all those things tend to lag. They struggle to get the right kinds of people. They struggle to retain people. That’s a critical part of it. How is your organization put together? Is it a sustainable organization? Is it a scalable organization?

Third is, what are you doing from a growth perspective? Many businesses grow up and do very well by attracting what we call the friends and family referral network. They are really good at generating business from people they know, from former clients, from a junior client that leaves to go to another client, and now hires them again. But where they struggle is when they’re in a fair or equal competition with other like agencies or agencies that are in a larger class than they are, how do you win those?

How do you know who to target? Where is the greatest value? We find that a lot of agency owners chase categories that in our mind don’t have as much value. Obviously, the categories that have value from a buyer’s perspective are those that they know are going to be reasonably consistent. Certainly, nothing is recession-proof, but there are industries like health care, for instance, that have been proven to be resilient and recession resistant.

Marketing is a big part. Organizational is a big part. Financial is a big part. Then there are other dynamics in and around training people. That’s a key piece for that. And having a fundamental understanding of what are the services and/or categories that I should be playing in?

That’s another area where you end up growing up doing what you know, and then the question is: well, what do I need to add? Sometimes those decisions can be very difficult to understand what really brings value versus just additional cost. We’ll try to help them identify that and help to steer them into the kind of verticals that we know are going to have high value when a buyer is going to come to call.

Russell Benaroya: David, I’m assuming that some clients come to you and have this desire and fantasy to make changes in their business that are going to either accelerate growth or put them in a better position to be attractive from an M&A point of view, but it does require a fair amount of organizational redesign, going back to the roots of what our value proposition is, maybe shifting how we deliver products and services. I’m assuming this is not necessarily for the faint of heart.

What does a client need to be prepared for in working with a company like yours to really get the most out of doing so?

David Sheehan: That’s really a really good point. Being open to change is difficult, even if your business isn’t what I would call high performing. It’s probably performing to a level that is providing you with a very comfortable living, and you’ve reached a level of comfort with the size, the configuration, and the services that you’re doing.

But it’s the old expression, “nothing changes if nothing changes.” I think that’s one of the things that we have to help owners through, which is to be prepared for what’s the potential fallout. More often than not, it doesn’t have significant downsides because, many times, companies that come to us are stuck in the mud a little bit. Better to lose 10% of your business with a chance of potentially doubling it in the next three years in the short term.

If it isn’t organizationally driven changes, then that’s where it really gets difficult. But many times, the owners know in their hearts when they need organizational change. What they need is an affirmation of that by someone, and we can provide that. In some other areas of change, oftentimes, what you don’t know is what’s holding you back. That’s where we can fill in those blanks.

Russell Benaroya: Talk a little bit about how you fill in those blanks. What is the method of how you work or approach a client that is uniquely Athru’s to deliver?

David Sheehan: We have various ways of working with them. One of the things that we have found through trial and error that has been really successful is we have a thing called the Attractiveness Readiness Assessment. Even if the agency is still in growth-minded mode and not really thinking of a transaction — although what I have found is everyone has it in their mind, and/or there’s an ultimate goal that they would like to extract value from all of the sweat and blood and tears that go into their business.

I think the Attractiveness Readiness Assessment that we’ve generated is a very comprehensive tool that looks at 74 different key parts of their business, from organizational to financial stewardship, to the services that they offer, to things such as how often clients are changing over and why, all those kinds of things. This comprehensive overview allows the founder-owner to take a pretty objective snapshot of where the business is, and how that business looks in comparison to other businesses of their size, similar configuration, etc.

We simply present the results. We don’t try to editorialize too much about those. Then we let the owner, founder, or executive team say, “Here are areas we need to fix.” More often than not, they do know it. They just have been reluctant to do it, or they haven’t felt they had the “time,” or it hasn’t been something they felt was urgent to do.

That’s the same for every business owner today. You’re spinning so many plates. What is it you’re going to do to drive the business forward? Many times, it’s the thing that’s on your list for today. It is a forward-thinking thing because you say to yourself, “If I don’t fix this, there won’t be a forward.” So you kind of talk yourself out of it.

Our Attractiveness Readiness Assessment has been super successful. Then we have a program where we work with founder-owners on a quarterly basis to do a report card on a lot of the key drivers that they should be looking at. It’s tailored to the marketing services space. So it’s not a general business blueprint. It is specific to marketing services and what we have seen in working with over 100 clients over the course of the last five years.

Russell Benaroya: When you talk about the Attractiveness Readiness Assessment, is that something that you make available to prospective clients on the front end as part of your process? Or is that something they only take once they’ve committed to working with you? Because I could see that being a really effective foot-in-the-door to just baseline?

David Sheehan: It normally is one of the very first assignments that we’re involved in when we came in to work with a client. Again, it requires effort on the part of the ownership or executive team to fill it out. We make each individual do it separately so that we don’t have groupthink shaping the answers. Then we’ll look at all of those, compile, and consolidate. Sometimes we have to do some additional follow-up.

If there are issues related to the client, we’ll do a little bit of voice of the customer research. We’ll compile all of it and then we’ll overlay that with our understanding and our best practices counsel as relates to what we’ve seen. It’s a subjective rating system, based on a one to five scale. But we have a database that shows what best-in-class agencies are performing at in those areas and how they’re performing. And if you don’t fit within those quadrants, then we’ll flag that as an area that’s probably holding you back.

Russell Benaroya: Out of curiosity, when you talk about the 100-plus clients that you’ve worked with over the years, you use the term marketing services. Your focus is on marketing services. Are there sub-segments within marketing services that you could break down so that if anybody’s listening to this and says, “Yes, I’m technically in marketing services, but more specifically, I’m in SEO, or more specifically, I’m in web design and development.”? I’m curious about what you think about that.

David Sheehan: That’s a good question. As all of the listeners will certainly recognize, the agency business has become a business of specialists. It used to be generalized, end-to-end, integrated agencies. Today, that’s certainly not the case. In fact, there’s probably less demand for those integrated agencies.

There are certain segments of clients that still want an end-to-end solution, but many times, there are media-focused agencies. We characterize them more as performance media and marketing agencies — agencies that are focused on SEO, SEM, traditional media planning, all the strategies around that, and how to put together who you want to reach in the most effective fashion.

There are certainly content agencies and agencies that build out content and creative elements and can do video work. There are agencies today that have become specialists at various channels; the direct-to-consumer marketplace. There are agencies now that specialize in that. There are agencies that specialize in influencer marketing. In fact, there were two transactions this week from the largest holding company, WPP, that purchased two mid-sized influencer marketing agencies, and those agencies do nothing more than help source, set up, and design the programs and develop all the content. So they are end-to-end suppliers around everything to do with that influencer segment.

Even in the experiential area, we’ve had several clients work in product sampling, or things like that where they’re more specialized. I think there are six or seven or eight categories. One of the categories that have become more pronounced over the last several years is agencies that focus on one particular vertical. We are all about healthcare. We are all about life sciences. We are all about Pharma. We are all about direct-to-consumer. We’re all about B2B.

Many times, we can segment based on that. Specialization has become the watchword for successful agencies. Again, based on what we’ve seen, agencies that are specialized are the ones that are in the highest demand, irrespective of what size they’re at.

You can be a $5 million agency that specializes in influencer marketing, and someone may want to come and buy you at a fairly aggressive multiple because they want to tack that service on. The ability to get clients and expertise and processes all in one swoop versus having to try to build it brick by brick makes a lot of sense for them.

Russell Benaroya: That may be the single most powerful takeaway from this podcast, which is focus, focus, focus. Know your customer segment. And while we all know it intellectually, it is so hard as a business owner to decline a business that is outside of your segment because we also want the revenue. I appreciate you doubling down on that comment.

A question for you around the state of the acquisition marketplace today. We obviously go through cycles, and some cycles are hotter than others. Talk a little bit about the cycle that we’re in today. Then specifically, what is the minimum threshold of financial performance that increases the probability that a deal can get done?

David Sheehan: Everyone listening here probably could speak to this much better than I can. Across the clients segment we have of 44 clients currently, there are economic headwinds out there that are impacting marketing budgets, and therefore, impacting agencies’ growth.

We had a couple of good years where there was pent-up demand. The year-over-year numbers were good and the profitability numbers were good for a couple of years even with the higher cost of labor. This year, we’re seeing more year-over-year numbers of either flat to up very small percentage points — 4%, 5%.

That has meant that those people that are looking to purchase agencies have become a little more selective. The buying dynamics are driven by: is this a business that is scalable? Is this a business that’s demonstrating that it’s scalable? Many times, your financial performance metrics, buyers want to see an agency that’s performing at 15 to 20% annualized growth.

They want to see an agency that’s performing at a margin of between 25 and 30%. They want to see an agency that is in services that are being utilized year-over-year, so it’s recurring revenue versus project work. Those are the critical dynamics.

You want to have 70% of your revenue tied up in recurring revenue. 30% of it can be projected and that won’t penalize you. A growth track of 15 to 20% a year, which as we know, there’s always an attrition factor. You may have to be growing at 30% because you’re going to lose 6%, 7%, or 10% a year, maybe through no fault of your own.

Then being very cognizant of margins. To me, it all circles back to, if you don’t have the right dashboards, or if you don’t have the right financial acumen to be able to understand those dynamics and to be measuring those dynamics on a month-to-month basis, you’re putting yourself in jeopardy. Not only are you putting your business in short-term jeopardy but you’re jeopardizing the opportunity to potentially ever sell.

Russell Benaroya: What I’m hearing is, unless you have the instrumentation to be able to know how you’re flying and where you’re flying to, it’s a little difficult for you to not only run your business but for other people to look at your business and assess it in a clear, logical fashion.

David Sheehan: For sure, you stated that correctly. It’s difficult for the owner to operate it; it’s impossible for an outside buyer. It’s impossible and improbable that they would ever look at a business that doesn’t have that information.

Russell Benaroya: I’m hearing 15%- 20% top-line growth. I’m hearing 25% EBITDA. I am hearing specialization and I’m hearing recurring revenue, ideally representing about 70% of your top line.

What about in terms of minimum size? When do things start to get interesting? Do we need to be at seven figures of operating profit?

David Sheehan: Usually, when you have a million dollars of profit, there are at least some interested buyers in that. Again, it depends on the audience. Private equity firms, who are adverse to risk even though they tell you they’re not because they’re using other people’s monies, oftentimes make these transactions.

The ideal candidate is you’ve got $10 million dollars in top-line revenue, you have $3.5 to $5 million in EBITDA, your business has been stable for the last five years and growing, and you’re in the categories that they’re most interested in. That bullseye doesn’t come along very often so there have been some shifts on that.

I have seen agencies as small as $6 million in revenue — gross revenue being add in all the pass-through expenses, production, and/or outside media costs. I’m talking about $6 million to an agency that might have an EBITDA number of about $2 million, somewhere in that area, or $1.5 million. If you’ve got the right basket of services and you have the right client list and the right vertical, they may look at you as what they call a bolt-on potential opportunity to an existing platform that they’ve already begun to build.

We have seen activity in that area. Underneath those, I think it’s a very opportunistic marketplace. There are some agencies that will come in to look to buy you. Many times, the agencies don’t have the financial resources.

If you’re an owner that says, “I’m not going to sell my agency unless I can receive 70% of the value of the transaction at close,” then many times you’re not going to sell to an agency because they often want to provide you with an urn out of over a two or three year period of time, based on performance metrics. And/or give you stock in a newly configured company that is the combination of the two entities that are being pulled together.

An outright sale means that you have to have the right financial dynamics to be eligible to the buyer segment that can potentially have the financial resources to provide that for you.

Russell Benaroya: What I’m hearing is, if you’re in the $6-$10 million net revenue range, you’re in the seven digits, ideally, in the $2-plus million of EBITDA, you could be perceived as what we call a platform acquisition. A financial buyer like private equity might come along and say, “Let’s use that as the foundation.”

Otherwise, you’re probably going to be subject to a bolt-on, which you could be in various cases of a size where you’re getting strategically acquired for that unique capability that you provide, whether it be your customers or the specialization. That’s where focus assigns a premium value because people are willing to pay for that unique niche that you seem to own.

David Sheehan: Exactly correct.

Russell Benaroya: Thinking about Athru and how you guide in that process, if I come to you and I say, “I think I either have the attributes to be a bolt-on or a platform, but I might be a year or two away, or maybe I’m not, and I’m ready to traverse the journey,” how do you guide them end to end? Are you going out to the market and finding prospective buyers? Are you negotiating term sheets?

David Sheehan: At the very least, if we don’t do a full Attractiveness Readiness Assessment, which, to some degree, is a surrogate valuation of your business, we would bring in someone to help us do a reliable financial valuation for that owner, which can give them a range that shows you similar businesses within their subset how they’re performing.

Once that’s determined, if it is determined that it is buyer eligible, then what we would do next is help them put together what’s called a Confidential Information Memorandum (CIM). That is a very comprehensive look at the agency with a strong point of view about what this agency does extremely well, and why a buyer should be attracted to it. It includes information on critical players, key accounts, financial dynamics, the work that they’ve done, the accolades they’ve received, and all of those things.

We have several lists of private equity firms. We have lists of what we call strategic buyers. They could be printing firms or consulting firms, or other firms who have looked to make acquisitions of marketing services agencies. Then we have a list of other agencies, either holding company-based or just independent agencies of enough size, where they are primarily creatively driven and would benefit from having a performance media marketing team attached to it.

You go to them and say, “Does this make sense?” The expression is, “Where does one and one equal four?” The answer to that question is, yes, we would help on the valuation. We would help to build out the CIM. From the CIM, we would do what’s called a Teaser. We would then go out to a selected highly curated list, we would see where the interest is, and then we would help the seller in the negotiation of the right terms and conditions.

We will also try to qualify the buyer in advance. As you can imagine, all of this takes a lot of time and energy. You don’t want to be distracted in all of these conversations, when in fact, you’ve got a business to run. So we can qualify the buyers.

If the buyers don’t meet those parameters, then we never get to the next conversation. If they do meet those parameters, then we’ll set up introductory meetings, we’ll do the NDAs, and then we’ll begin the process. We can guide the due diligence if it gets past those first two or three introductory get-to-know-you meetings.

Russell Benaroya: If I’m an agency owner and I’m ready to go down that path with you, what should I be prepared for and how should I be thinking about this? Because there are no guarantees, obviously. Am I looking at a wholesale exit of the business and I’m living in Zihuatanejo or something, or am I taking another swing at this but just part of a bigger sandbox? How do you guide?

David Sheehan: For most founder-led businesses, the one thing you have to go into it with is an understanding that, to some degree, the buyer is buying you. Therefore, this would not be a situation where, at close, you hand them the keys, they hand you a check, and everybody goes their separate ways. More than likely, you’re going to be a part of the business for at least a two-year period of time, potentially a three-year period of time, in which you would transition the business.

You need to be able to continue to be as committed to it as you were before, but just to begin to think differently about the opportunities for growth now that you have additional financial resources that surround you. That was the one thing that I learned, but it is a difficult transition.

I was a marketing services agency owner for 25-plus years. I did sell my business to Bare Cap, a private equity firm. Suddenly, now I had a board that I answered to, and it did change the dynamics. I also had a lot more financial resources. So if I wanted to go out and make an acquisition of another small bolt-on, I suddenly now had a new sandbox to play in.

So there are a lot of pros, there are some cons. Again, most founder-owners are entrepreneurially driven. They have a vision for their company. That vision does change, but it doesn’t necessarily mean it upsets it completely.

I always begin conversations with people who are interested in selling to say, “Anyone that comes to us from a buyer perspective that says, “Nothing is going to change if we buy you.” Immediately, we walk away from that because they’re not being honest. It will change.

Russell Benaroya: What advice would you give to agency owners that might be listening to this and thinking about whether or not they want to take this next step? How can you help them organize in their heads where this fits in terms of priority of all of the things that they have going on to keep the plates spinning in their life and in their business?

David Sheehan: It’s obviously a complex question. It depends very much on the life stage of the individual and financial condition. At the end of the day, we always “start with the end in mind.” There has to be a strategic reason that you’d want to make a transaction along with a financial reason to make the transaction.

If it’s strictly financial, then it’s probably going to be a struggle, to be quite honest with you. It has to be strategic because the strategic part of it is what’s making it fit with the buyer. What the buyer is gaining is an opportunity to grow your business exponentially at a rate that potentially you were not able to do.

I think it’s a very personal decision, but it’s a very strategic decision. I think you’re smart to use counsel and guidance from consultants like us or others. There are other folks like us that can do that work as well. Again, your family and those kinds of considerations are critically important because life does change.

Many times, it changes for the better for people who sell. But in some cases, there’s a loss of control and a loss of something that has been very important to you. I know many founder-owners that feel that loss severely after transactions.

I spoke to someone today who sold his agency four or five years ago to a holding company and ultimately decided to buy it back. It ended up not being a good transaction for the holding company. And even at an advanced age, he decided to buy it back. Now he’s transitioning it in a different fashion with employees rather than through the holding company. That speaks to a little bit of the landscape and complexity of that decision.

Russell Benaroya: I appreciate you, David, for laying out the realities of this journey. Even in the best case of scenarios, even when you are growing 15 to 20% a year, even when you are generating 25% EBITDA margins, it’s still a complex decision.

If people listening to this wanted to learn a little bit more about Athru and the resources that are available by working with you, can they just go to your website? Do you have some resources available?

David Sheehan: They can go to www.athrupartners.com. Feel free to reach out to me directly. If there are questions that I can’t answer, I’m willing to put you on to other people or other consultants that can help you. We have lots of resources out there. We work with really good folks.

We only will take on opportunities with new clients if we feel that there’s a real added value for that client. If we can’t do that, we’re not a 60-person firm, we’re not going to take it on. And/or on the transaction side, if we’re not reasonably confident, I would say within a percentage of about 60-70%, that we can find a buyer, we also would not take on that transaction.

There are firms that are more dealers, that will just put you out there with a million people and see. As I mentioned, we believe the strategic fit is every bit as important as the financial fit. If those two things aren’t put together, ultimately, it’s not a successful long-term sale.

Russell Benaroya: David, one of the things I’ve always appreciated about you, you lead with very high integrity. You are clearly a give-first entrepreneur and consultant. So I would highly endorse that anybody that comes to you to learn whether they engage you or do not engage you will walk away with something of value to help them drive their business forward, which is what the Stride 2 Freedom podcast today was about.

Not just getting ready to sell your business, it may be on the journey of achieving some of these growth targets first before you’re in the luxurious position to have the privilege of looking at some of your financing alternatives. You helped lay that out really well, David. Thank you.

David Sheehan: Thank you so much, Russell. It has been a pleasure to be with you today.

Russell Benaroya: Thank you, David. Thank you everybody for listening to another episode of the Stride 2 Freedom podcast. We will see you next time. Have a great day. Bye