What is my creative agency worth?
You might turn to Google and search these exact words if you are thinking about selling your agency, applying for financing, preparing for a merger, or restructuring. Likely, you come across “rules of thumb” that seem to simplify calculating the value of your agency. Determining an agency’s value using these “rules of thumb” is tempting because they’re quick, easy to understand, and inexpensive. However, business valuation, regardless of industry, is more nuanced than a few simple rules or guidelines.
Relying on an industry rule of thumb can lead to a significant over- or understated value, increasing the risk of poor, costly decisions. Relying solely on a rule of thumb is one of the most common shortcuts untrained valuation professionals use. In short, rules of thumb do not reflect a business’s unique characteristics and metrics.
What are Creative Agency Valuation Rules of Thumb?
Creative agency valuation rules of thumb are often based on general industry formulas passed along by word of mouth over time. Usually, these formulas are based on outdated historical transactions or financial metrics not relevant to current or future industry dynamics. At best, rules of thumb represent an average. In the real world, there’s rarely such a thing as “average.” As an agency owner, you are more than aware that each creative agency is unique and not created equal. Rules of thumb create a false sense of precision and can be a dangerous approach. You may leave money on the table if you’ve built a thriving, unique creative agency.
One of the most common agency valuation rules of thumb involves a multiple of EBITDA (earnings before interest, taxes, depreciation, and amortization). Other agency rules of thumb are based on a revenue multiple.
Challenges of Rules of Thumb
Beyond undervaluing (or overvaluing) a creative agency, rules of thumb create other challenges to the valuation process. The two main drawbacks? Lack of adaptability and failure to consider an agency’s unique characteristics.
Let’s dissect these challenges below.
Lack of Adaptability
Rules of thumb lack adaptability. Creative agencies (including advertising agencies, digital marketing agencies, or one-stop marketing agencies) aren’t static; they evolve with ever-changing market conditions, technological advancements, and marketing platform and strategy changes. Since rules of thumb are generally based on historical metrics, they often don’t reflect recent industry or market shifts. They also don’t provide solid or verifiable market data to support a specific rule of thumb valuation multiple.
In the creative agency industry, among many other industries, one major issue is the wide range of acquisition multiples seen in industry transactions. These multiples vary significantly across the board. While looking at average or median multiples from past data may provide a helpful reference point, actual transaction data reveals that acquisition multiples are all over the map and don’t fit into the predictable, narrow range we would hope to see. For that reason, the use of a rule of thumb based on general industry transaction data isn’t a credible way to value your creative agency.
The true value of your agency can only be determined with established valuation methodologies utilizing agency-specific factors.
Failure to Consider an Agency’s Unique Characteristics
There is a range of financial information and metrics needed for an accurate agency valuation including size, operating profit margins, debt levels, owner-related expenses, and rates of growth, among others. Many rules of thumb fail to accurately account for these financial metrics.
In addition, nonfinancial metrics unique to an agency can dramatically impact an agency’s value and are often missed or difficult to capture by these “fast-track” valuation methods. Examples of nonfinancial metrics include:
- The degree of product and/or service diversification
- Established lucrative agency niches
- Recent and future anticipated growth potential
- Agency client concentration
- Client retention rates and recurring revenue
- Key person/owner-specific attributes and risks
- Intellectual property
- Volatility of revenue and earnings
- Market position
- Brand value
Adjusting an Industry Rule of Thumb to “Fit” Your Agency
Even if you try to make upward or downward adjustments to a general industry rule of thumb multiple to “fit” your agency, making the right adjustments will be difficult. As discussed above, there are too many factors, both financial and non-financial, that will impact the right multiple for your agency. Trying to capture all relevant factors in these adjustments comes with great risk and oversimplifies agency valuation.
We suggest choosing a valuation method that reflects these nonfinancial factors to capture the true nature and value of your creative agency, including strengths and weaknesses.
Example of Rule of Thumb Limitations
Let’s compare two agencies, Agency A and Agency B. Agency A and Agency B each have EBITDA of $1.5 million during the most recent year. While the two agencies might be similar in terms of EBITDA, there are significant differences:
- Agency A receives 60% of its revenue from two large clients, while none of Agency B’s clients represent more than 15% of its revenue.
- Agency A’s EBITDA over the past three years is down 10% overall and has been volatile, while Agency B’s EBITDA has increased steadily over the past three years at an average annual rate of 14%.
- Aside from the agency owner, who started the creative agency and holds many key client relationships, Agency A’s management team is relatively inexperienced, with an average tenure with the agency and creative agency industry of six years. On the other hand, Agency B has a talented and experienced team with an average tenure and industry experience of 18 years.
- Agency A is using some outdated processes that decrease team and agency efficiency. Agency B has recently updated and streamlined many of its core processes, which has led to a 12% increase in its agency’s EBITDA margin.
When comparing Agency A to Agency B, it’s clear that Agency B should likely have a higher, and perhaps significantly higher, valuation. However, if you use a simple rule of thumb multiple of say, 3.0x EBITDA, it would be difficult to account for the financial and non-financial differences between the two agencies and, without adjustment, use of a general rule of thumb may even value the two agencies equally. If you try to adjust the rule of thumb multiple upward or downward for Agency A and Agency B, how do you determine how much you should adjust the multiple and ensure you’ve captured the appropriate adjustments?
Consequences of an Unreliable Business Value
An inaccurate marketing agency valuation leads to poor decision-making that can be costly for the agency you’ve worked tirelessly to build. Whether you’re looking to sell to an internal team member or outside potential buyer, applying for financing, or considering the acquisition of another agency, it’s important to get the most accurate value for your agency. A miscalculated valuation can lead to a significant underpayment or overpayment in situations involving a majority or minority shareholder transaction, such as a sale of the agency, shareholder buyout, or employee buy-in.
While a rule of thumb shouldn’t be your first go-to method of valuation, rules of thumb can still provide a secondary market value to compare to a more thorough income and/or market-based valuation. If there is a significant difference between the valuation approaches, you can dial into them and examine why they are so different. Using a comparison method can uncover unique agency features (or even errors) that can be highlighted or addressed.
At the end of the day, rules of thumb can only be a rough estimate of your agency’s value rather than a true measurement of your agency’s worth. It’s best to use a valuation approach that considers all angles of your agency, unique characteristics and market positions, and current market conditions.
If you’re attempting to complete an accurate valuation of your creative agency and feeling stuck, our valuation team is here to support you. Learn more about our services and the associated costs by requesting a meeting below.
