About eight years ago, I founded 3Q Digital (initially named PPC Ad Buying, then PPC Associates). I founded the company mainly because I was tired of working for other people, and online marketing was something that people would happily pay me to do.
I certainly didn’t have any visions of creating an organization with hundreds of team members and clients and eventually selling the agency to a public company. But that’s what happened in March 2015 — the most exciting day of my business career.
Since then, a lot of folks have asked me for advice on how to sell an agency. Given that I’ve sold one agency and acquired another (3Q Digital’s acquisition of iSearchMedia in 2014), I’ve seen both sides of the negotiating table, which I think gives me a good perspective. Over the next few articles, I’ll provide some pointers that will hopefully make it easier for you when you decide to sell your agency.
Starting out right: incorporation and taxes
Everyone knows that the first thing to do when starting a business is to incorporate. Incorporating protects you from being personally liable if someone sues your business.
You generally have three incorporation choices — a “C Corporation,” an “S Corporation” or a “Limited Liability Company (LLC).” Most agencies that start out as a one- or two-person shop elect to incorporate as an S Corp or an LLC, primarily because you can avoid “double taxation” (being taxed at the corporate level and the personal level). And indeed, when I founded my agency, I went the LLC route.
In hindsight, I should have registered as a C Corp, for three reasons:
1. Acquisition tax headaches. If an LLC acquires a C Corp, it creates a taxable event for the owners of the C Corp, regardless of whether the sale is completely or partially equity-based (where no actual money changes hands). This is exactly what happened when we acquired iSearchMedia, a C Corp, and this created all sorts of unnecessary tax problems for us.
2. Acquirers and investors prefer C Corps. For whatever reason, big companies prefer to acquire C Corps over S Corps and LLCs. I’m not sure why this is the case, but I have been told my numerous people that being incorporated as a C Corp is better for mergers and acquisitions (M&A).
3. Qualified Small Business Stock. If you’re like me, you don’t avidly read the latest updates in tax law, so you’ve probably never heard of Qualified Small Business Stock (QSBS). But here’s the gist of it (Note: I am not a lawyer, so ask a professional rather than relying solely on this article):
If you incorporate your business as a C Corp, and you are in a qualified category of business, and you are worth less than $50 million at the time of sale, and you are a C Corp for at least five years, and you registered your C Corp after 2008, you may be entitled to a partial or complete exemption of long-term capital gains.
Here’s what this means, practically: Let’s say you qualify for QSBS, and you sell your agency for $10 million, and you own 50 percent. You get $5 million — nice job! The IRS would normally be entitled to 20 percent of your $5 million payout, but with QSBS, you may have to pay … nothing — a $1 million tax savings!
Starting out right: Freelancers, remote employees, benefits
I started 3Q Digital in a coffee shop, by myself, and could barely afford coffee, let alone employees. As the agency grew, I had to hire to keep up with demand.
My earliest employees were all remote freelancers without benefits, again, because that was all I could afford. As soon as I could, however, I converted these people into full-time employees, I opened offices, and I set up a benefits program.
There are a lot of resources that enable small agencies to provide these services affordably (ASOs and PEOs, for example, can manage your payroll and benefits for you, no matter how few employees you have), so the investment is likely not as daunting as it may seem.
And from an acquisition perspective, full-time employees and offices are really important. As I’ll discuss in a subsequent article, agencies are generally acquired for one or more of the following reasons:
Revenue
Geography
Unique services or technology
Client base
Many clients demand full-time employees (#4), offices give you geographic strength (#2), and revenue growth is dependent on a loyal employee base (#1). So there a lot of good M&A reasons to bring employees on full-time, in offices, as soon as you can.
To be clear, that doesn’t mean that you can’t have remote workers (We have many great remote team members, including several senior executives), or hire freelancers from time to time. At the point that you want to be acquired, however, having the trappings of a “traditional business” will make you more desirable to acquirers.
Coming up in subsequent columns
In the next column, I’ll talk about why agencies get acquired. I’ve mentioned the basics above, but there are several more points to discuss, including:
What is “Enterprise Value?”
What’s the “tipping point” for revenue?
What matters more, revenue or profit?
Does technology matter?
I’ll follow that up with column three, about the mechanics of being acquired, including:
Should you use an investment banker?
Working with M&A lawyers.
Should you run “a process?”
Non-financial terms you should consider.
When should you tell your staff?
How to choose the right acquirer.
And lastly, column four will discuss what happens after the acquisition, including:
What’s an “earn out?”
How to keep your employees happy.
Being realistic about “synergies.”
How to work with “corporate.”
In the interim — before these columns are finished — if you have specific acquisition questions that I should discuss, please tweet me at @rodnitzky!
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