Private equity firms have become an increasingly important buyer of marketing communications agencies – especially of specialized firms. During a recent session for PR Council members, Alex Halbur, Managing Partner at Prosper Group, moderated a discussion to help educate Members about the current PE buying activity and how to develop a strategy for attracting PE firms. Below are the key takeaways from that conversation:

Find a perfect fit

First, have a vision for where your firm is going and how it will get there. Be clear about how a PE partner can help your firm achieve your vision.  Understand if there is alignment between your vision and the goals of a PE partner.

A platform company is viewed by PE as the foundation for building their vision. It is an agency that the PE company feels can grow through organic growth and through acquisition.  The platform company is typically the first acquired agency.  Then, subsequent acquisitions (“tuck-in acquisitions”) are integrated into the platform agency to fuel growth. The goal for PE firms is to grow the revenue for both platform and tuck-in companies 3X or 5X over five years.

Platform companies generally have a minimum of $5 million in EBITDA.  PE leaders acknowledge that there are few available firms this size. Smaller firms that want to sell as a tuck-in need to build a case for why the platform will benefit from buying versus building. How long would building take? What’s the cost? What’s the probability of success? Since PE  companies want significant growth over a limited five-year period, generally growth will be faster with a tuck-in acquisition strategy versus a grow strategy, so position your company that way.

PE buyers urge owners to understand the difference between what the business is worth to the owner and what the business is worth to others, such as private equity.  It is helpful if owners have qualified, industry experts develop a fair market valuation of their agencies to help set financial expectations.

Finally, PE firms focus in different industries and have varying growth strategies, so make sure you are talking to the right type of PE fund and they invest in PR firms. While sources of funding are varied — large PE buyers get funding from pension funds, labor unions, institutional money managers and smaller firms get funding mainly from smaller companies and high net worth individuals — all firms will have an investment strategy.

Criteria for PE investors 

Some of the ways PE firms identify potential acquisition targets include networking, reading the trades and learning about award winners. They are looking for founder-owned companies so are not interested in companies that have other investors. Long before investment is needed, owners should be continually accepting and requesting meetings with different PE firms.

PE firms are going to focus on a number of different criteria, based on their investment strategy, but most require a streamlined and efficient infrastructure, an understanding of which services can be added that will increase the multiple, and sector expertise that is market-leading. Other considerations include the amount of debt already on the balance sheet and the mechanics of the deal.

It is important that your agency have deep intellectual property reflected in products, proprietary methodologies and platforms.

One PE leader shared three criteria: Quality of the fee clients (is the revenue repeatable?), quality of the employee base (will the right employees stick around?), and quality of the executive management team (does it  have enough gas in the tank to go on a 3-5-year journey with us?).

The art of the deal

Financial aspects of PE deals are varied but typically the founding ownership team will sell the company 100% at a fairly high multiple on historical EBITDA.  Then, the PE firm will require that 20-35% of the initial sale proceeds be rolled back into the company.  So, as a seller you are receiving 65% to 80% of the value of your firm in upfront cash and you retain 20% to 35% ownership in the agency.   The PE buyer will almost always require that the CEO and management team stay and will want them to still feel like owners and be excited to make good bets for growth.

Beyond the mechanics of the deal, as an owner you want to have a connection and a relationship with the PE firm leadership.  A shared vision is critical, as is chemistry between the investing PE group and management team. PE firms have different operating styles (coaches, hands off, very involved, etc.) so make sure the style works for you.

A second bite of the apple

The big benefit of PE investment is the opportunity for owners to get a second bite of the apple.  When PE invests in a company, they will typically set growth goals and want to be out within five years. To play this out, if an owner sells today and rolls money back in (20-35%), they are getting equity for that percent, so when the company sells, the investment is monetized.  Depending on the growth and sale price, the second sale can be worth MORE to the selling owner than the initial sale.  This is the key sale differentiator for agency owners, a second sale that can be much larger in terms of sales price than the initial sale because of great growth over five years and a very high multiple applied to earnings.

In short, most owners will find that it is compelling to go with PE once you do the math. By selling to PE and rolling money back in, an owner will come out further ahead than selling to a strategic partner.  That said, owners should only sell to PE if they love running the company and enjoy waking up every day and working to build the biz.

 

Prosper Group exists to help owners of independent communications agencies achieve their ambitions and maximize the value of their life’s work.  For more information, reach Alex at [email protected] or 310/936-3774.