Your EBITDA multiple isn't measuring what you think

This year I've been on some great podcasts and spoken at several excellent events. In almost every case I've opened with the same reframe about the EBITDA multiple, because the multiple you get isn't what many agency owners think it is. Once you see what the multiple really is, you build your business differently.

The reframe is this: your EBITDA multiple is a measure of a buyer's confidence in the future, not a reward for what you've built. Their confidence in the future comes from two places:

1. One is money: how sure a buyer is that the free cash flow you're presenting will hold and grow over time.

2. The other is strategic value: whether you own something an acquirer wants badly enough to pay up for, because it's worth more inside their business than yours.

The second is where you’ll find much higher multiples, often two or three turns above the first. What you've built can drive both, but only if the component parts are right.

Why is a reframe needed?

As an owner, you're steeped in your agency's history: the stress, the late nights, the wins and, more painfully, the losses. A buyer sees none of that. He or she doesn't see it, doesn't value it, and doesn't price it. What they're doing instead is reading risk. They look at your business for quality markers that lower risk and gaps that raise it. Quality does matter, but only as a signal. The quality a buyer can tie to a lower chance of your numbers wobbling once they own you is quality they'll pay for. Quality they can't connect to reduced risk earns nothing. The hard work and the intangible value you feel every day sit in the same place. They're real, but they don't touch the price unless they can be seen as lower risk.

The reframe is needed because, to achieve peak value, you need to focus on the dimensions of the business that shout quality and reduce risk from a buyer's perspective, not yours. Leave the stories of the years of toil, the late nights and the rest of the pub chat in the pub. They're buying the future, not the past.

The other route

The second route to value creation is finding and matching disproportionate strategic value, where a capability or a position makes you worth more to a particular buyer than to yourself. Let me show you what that looks like.

A friend of mine sold a UK agency at decent scale to an overseas group, and the multiple came in at eight times against a backdrop where four to five is more usual. Three things drove it, and not one of them sat on the agency's own balance sheet as value.

1. First, geography. The buyer wanted a London foothold, and this was the agency that gave it to them.

2. Second, the client base. The buyer had few brands that meant anything in Europe, so they were buying a reputation they couldn't build quickly themselves.

3. Third, margin. The buyer ran a large delivery team offshore and could restructure the work to earn more from the same revenue.

None of those three things was worth much to my friend’s business on its own. Geography is only valuable to a buyer who hasn't got it. A blue-chip client base is worth more to an acquirer with nothing comparable than to the agency that already has it. The offshore margin didn't exist until the buyer applied their own operation to it. The value was real, but it lived in the match between what the agency had and what one particular buyer needed, not in the agency itself.

That's why strategic value can pay two or three turns more than free cash flow, and it's also why you can't bank on it. You can't manufacture an overseas buyer who simply has to have a London office. What you can do is understand what you own that a specific kind of buyer would pay more for, and make sure it's visible and defensible when the right one comes along.

Where this leaves you

Both routes come back to the same discipline. Understand what gives a buyer confidence, on the money and on the strategic fit, and shape the agency around it. Do that and you'll be building a lower-risk, higher-value business, whether you ever choose to sell or not. If you're not sure how a buyer would read your agency today, that's worth knowing long before anyone makes an approach, and it's exactly the conversation I have with owners every week.

You can find out more about how I help to engineer value in agencies by looking at my system-based approach to value creation.