Transcript: 2Y3X M&A Secrets

Felix Velarde

Hello, yes, today I want to talk about the secrets of M&A and I want to talk about it from the perspective of a serial agency founder who sold a bunch of agencies, got it wrong so many times, learnt loads and then switched sides of the fence. So let me tell you a little bit about my backstory and then I'm going to share with you some secrets of the perspective and the motivation and the drivers for acquirers and this is the stuff that they will never tell you and it's the stuff that the brokers won't tell you either about why discount factors are so important to the acquirer and what you can do about it. It's also going to give you insights into how to negotiate, so if you are thinking about selling this is critically important for you.

So a little bit about me, my name is Felix Velarde, I'm the chair of the 2Y3X program which does what it says on the tin, it triples revenue in two years but I'm also the chief strategy officer of Ava Acquisitions and Scale at Speed Capital in the US and we buy agencies and apply the 2Y3X program to those agencies after we've bought them and you'll see why we do that in the course of this presentation. So I started my first agency in 1994, I sold it to my business partner a couple of years later, I started another agency, Head New Media, that became the digital arm of Lowe Worldwide and after 2000 I then had a whole slew of other agencies, so I in fact I founded six agencies and I sold five of them and I sold one of them twice. By the end of my agency founder's career, which was about 20 years, I was the CEO of an agency roll-up, one of the first virtual roll-ups in the UK, The Conversation Group and that roll-up, talking to about 100 owners about being acquired and then bringing 12 agencies together in a group was a really really good learning experience for me.

I then finished that career, took a long break, went off to Burning Man, blue hair, everything, had a great time, decided to come back and teach people like me, founders, who perhaps didn't go to business school, who had never been employed, in fact I was never really successfully employed and which is one of the reasons I became a founder actually, is so that I wouldn't have a boss and that comes into M&A again later, so I'll talk about that in a bit. So I became this advisor to founders and CEOs of independent agencies who wanted to sell and the 2Y3X program grew out of that advisory service and the way that the 2Y3X program grew, I had discovered that there were various mechanisms for how to scale agencies, how to break through the growth plateau, how to get past the feast and famine and so these formulas became really really important when I wanted to scale agencies fast. But the starting point for 2Y3X was actually wasn't about scaling, it was about maximizing the exit value, maximizing the amount of money that I would get when I sold my agencies and in fact maximizing the amount of cash I would get as opposed to long-term earn out and as you already know, when you're going to sell your agency, the buyer will look at your agency, he'll go through, he'll do his due diligence and they will look at some key factors in the way that your business works.

Now those are called discount factors and the seven key ones that I tend to concentrate on, the 2Y3X program focuses on, are client balance, do you have any clients that are riskily large, so if you have a client that accounts for 40% of your revenue and they leave, then suddenly your business is worth significantly less than it was if I bought it with that 40% client. Profitability, I need to see as an acquirer whether or not you are consistently profitable because that gives me confidence that you will continue to be consistently profitable. What else, differentiation, are you different to your competitors in the eyes of your customers, that differentiation can be fed by things like fame or novelty or the fact that you win more awards than anybody else, but differentiation is really, really important.

What else, pricing models, do you really understand how you make your money, I mean I remember being interviewed by Andrew Robertson who was the managing director of Abbott Mead Vickers in the late 90s when I was a punk, I had colourful hair, I was breaking things in the advertising world, we were doing amazing digital creative stuff and we were the most awarded digital agency in the world at the time and he said so how do you make your money and I said by being great and winning awards and he said no, no, no, how do you price the services that you sell and I said "Oh I don't really know, we kind of wing it", and looking back on it, the kind of this youthful naivety and enthusiasm for just hoping that we would be successful because the work was great, in retrospect doesn't really stand up, so understanding your pricing models and how you make your money is critically important and then attached to that financial rigour, are your books absolutely bomb proof, do you account for things in the correct way, do you use gap or accrual based accounting, is your cash flow forecasting rigorous and accurate and so on, so financial rigour really, really, really important as a discount factor and then scalability, can you grow and one of the limiting factors on scalability is being perfectly optimised for the size that you're at right now because if you're perfectly optimised for the size that you're at right now, clients that are twice the size won't hire you because you're not optimised for clients their size, so you have to figure out how to break through that barrier and in fact that's what the 2Y3X program really focuses on for the whole course of its two-year span and then finally a succession team, when you go and you will go because you didn't start an agency in order to have a new boss and you'll suddenly have a new boss, so 60% of founders leave before the earn out is finished because they can't hack having a boss and being told what to do or how to do it, so having a succession team in place is a really, really important thing and again there's one of the things that's delivered very, very early on in the 2Y3X program is the creation of the future succession team. Now those discount factors are really important, you'll have heard of them already, I'm sure your broker if you started investigating this or your colleagues or any of the agency communities, they will have started talking to you about mitigating your discount factors. Now you've got to ask yourself why are these discount factors so important and when you ask other people why these discount factors are so important, the answer universally is, oh the buyer doesn't want to risk giving you a couple of million for your agency and then have a client walk away or you walk away or your profitability to not actually be particularly stable or your differentiation to not be as marked and as useful as they thought it would be because they don't want to waste a couple of million.

Now that's a perfectly sensible way of looking at it but it's not the true picture, it's not the whole picture, so I'm going to tell you what the secret is. You all know about multiples of EBIT, most agencies valued based on a multiple of your EBITDA and in the UK at least where multiples are higher than in the US, I'll use the UK example just for the sake of ease, but say you're doing 400,000 EBIT, so your net profit is 400,000 which is great right, so you are probably doing 2 million revenue at that point if your profit is 20 percent, so your multiple, the multiples that a buyer might pay for you might be four, so four times 400,000, so your valuation is 1.6 million which is great, it's not enough but it's great. Right now the buyer, their EBIT is 10 million, not 400k, and if their EBIT is 10 million and they are listed for example, then their multiple, the multiple that they are valued on will be 20 times EBIT and 20 times 10 million is 200 million, and that's how you get these great mega groups like, I don't know, Stagwell and people like that who are valued hugely based on a profit that they've aggregated by pushing together all of these agencies, so they now have a net profit 10 million multiple of 20, they're worth 200 million, so they buy you for your four times 400k, for your 1.6 million, and you rub your hands with glee and you say I'm rich and it's great.

The moment that you have signed on the dotted line and they've signed on the dotted line, that very second your 400k of EBIT gets aggregated into their 10 million of EBIT, and so your 400k suddenly has a 20x multiple applied to it, and 20 times 400k is 8 million, so the second you signed on the dotted line, your value has gone from the 1.6 million they paid you, to the 8 million you are now worth to them, and that's the thing that nobody tells you. Fascinating, right? I found that my head, it was just amazing. I thought oh, so if I addressed all of my discount factors, then it's not about their risk, it's about their reward, so addressing their discount factors actually gives the buyer confidence that they're going to the difference between 8 million and 1.6 million, they're going to make 6.4 million and it's not going to fall to bits later.

That's a great deal for them, so that's fine, now you understand, so what do you need to do? You need to increase your value to you, not to them, so how do you do that? Well, the 2Y3X program, it takes you in, and over the course of two years, it's going to either double or triple your EBIT, and that means your EBIT is going to go from 400k to 800k, let's say we double it, right? 2x. Now, at 400k, your multiple is going to be around 4. At 800k, your multiple might actually get up to about 6, especially if you're addressing all the discount factors, which you will be in the program, so suddenly you are 800,000 EBITDA and a multiple of 6, and that means that your valuation is 6 x 800, which is 4.8 million, so in two years, you've gone from 1.6 million value to 4.8 million value, that's 3x. You've tripled the value of your company in two years, just by doubling your EBIT.

Let's take it a step further, 2y3x, as I say, actually, it's two years, 2Y3X, not 2x, so if you triple your EBITDA, and you go from 400k with a multiple of 4 to 1.2 million, which would probably get you your multiple of 8, 8 x 1.2 million is 9.6 million, and so you've gone in two years from 1.6 million in value to 9.6 million, this is 6 x multiple on your value to you. Now, the buyer, obviously, makes enormously more than that, and fantastic, good for them. You are there to try and maximize your value.

So the 2Y3X program, actually, our threshold for our performance bonus is we, at minimum, must double your EBITDA, because that triples your value. And then if we can get you to 3x, then fantastic, that's going to 6x your value. So you can see now why we do this.

You can also see and understand why I've gone from running agencies, founding agencies, selling agencies for a small amount of money, which I did several times, actually. I did several of those 400k x 4 multiple type deals. I've gone from that to figuring out how agency group dynamics work, to creating a program for addressing the discount factors and doubling or tripling EBITDA so that I can maximize the value for agency founders, to actually now working at Scale at Speed Capital and AVA Acquisitions to buy agencies, and then apply 2Y3X to them.

If you want to find out what your main discount factors are based on the current state of your business, go to https://2y3x.com/scorecard. And there's a free self-assessment, takes about five minutes. You'll have to put in your email address to get past the gate.

But it will give you a list of the discount factors that you need to address in what order, in order for you to be able to be most likely to double or triple your EBITDA in a couple of years. It'll also tell you whether or not you qualify for the 2Y3X program. And if you don't, how to get loads of free advice.