Our Approach to Agency Acquisitions: Valuation Drivers and Deal Breakers

Sei-Wook Kim (00:03.085) On today's episode, we'll be talking about agency acquisitions, specifically about how we evaluate agencies and think about valuation at Barrel Holdings. Peter Kang (00:12.398) All right, Sei-Wook, so you were recently on a panel to talk about agency M&A. I'm gonna pepper you with some questions about agency acquisitions. First question, let's start with just in general, why buy versus build? Obviously we've built most of our agencies, but why are we thinking about acquisitions? Sei-Wook Kim (00:34.222) A lot of it is about accelerating the growth of these businesses, and buying an agency that's established with a team, with a set of clients and systems and processes really helps get the businesses off the ground a lot quicker. As you mentioned, we've built a lot of our agencies and some of that was driven by the business that we saw and opportunities. For example, we saw some Webflow work at Barrel and we decided to start up BX Studio as a result of that, where it didn't quite fit the focus that Barrel was going along, but we did see a big opportunity in Webflow. So we decided to build that agency. But the further along we go in this process, we're thinking about how do we keep growing at a faster pace. Peter Kang (01:28.02) Right. I think the other piece we talked about was just on who we partner with as an entrepreneur. And with some of the build ones, we saw an opportunity there. Sei-Wook Kim (01:39.096) Yeah, definitely. Having a motivated entrepreneur who can operate the business is critical when building a business from the ground up. So the right person with the right business opportunity definitely drove our rationale for building versus buying. Peter Kang (02:00.173) Great. So when it comes to buying an agency, there's a term, especially in the entrepreneurship through acquisition community, they call it the buy box. And that's the criteria that we have for buying the agencies that we want to buy. What would you say is in our buy box at Barrel Holdings? Sei-Wook Kim (02:19.043) Yeah, the buy box currently — and this is evolving — we're looking primarily for US and Canada based agencies at about two to $10 million in revenue. And then specifically EBITDA 15% or more, a strong leadership team in place, diversified client roster, and some kind of specialization niche — vertical, platform, technical specialty. All of those would be what we're looking for when we're looking for an agency to buy. Peter Kang (03:02.569) Yeah. And just in terms of constraints, how would it evolve and in what ways do you think it could evolve in the future? Sei-Wook Kim (03:13.356) Some of this is driven by the amount of cash we can deploy and how we finance or structure a deal. So over time, I would say we would explore larger deals or smaller deals. One specific nuance is we're looking to buy either standalone businesses — keep existing brands, typically in areas where we don't have an existing business — or do a tuck-in to an existing business in our portfolio. Depending on that, it slightly shifts. We might consider smaller deals if it's a tuck-in to an existing business, or as time goes on, we might consider even larger deals. Peter Kang (03:52.949) Yeah. And just on the specialization bit, maybe dive a little bit deeper into what we're actually looking at with specialization and why we care about it. Sei-Wook Kim (04:03.479) Yeah, a lot of it has to do with the business and how they attract clients. Specialization really helps when going out for your sales and marketing efforts and being clear about who your ICP is when you're going down those pathways. And it really helps when landing and converting the clients that you're attracting through a variety of sales and marketing efforts. In addition to that, the clearer your focus is, how your team does the work gets more and more refined. So your internal processes are usually tighter, who you're hiring and their expertise is a lot clearer — versus if you're a more generalized agency, you'll have a lot of different capabilities where you may not be as deep in one area, but you're covering a lot of surface area. Peter Kang (05:02.075) Yeah, and that's not to say there aren't really quality generalist agencies. It's just that for us, we've decided to take the specific path. And part of it is just there's a degree of defensibility and profitability for the long term that specialized agencies bring to the table. Sei-Wook Kim (05:24.213) Yeah. And the focus that we've also taken a look at is, is there a platform that's growing that we see a lot of opportunity in? So for example, Webflow or Shopify as technology platforms — where as the platform is growing and the businesses themselves, the platforms are investing in reaching a broader market share, aligning ourselves closely with them in that growth can help accelerate the growth of an agency. Peter Kang (05:53.092) Right. So moving on, we have our buy box and we're targeting these agencies, passing on the general ones and engaging in conversations with the specialized agencies. What would you say are the value drivers for these agencies? What's going to help them sell for more, get a higher number from us? What are the things that we're looking at? Sei-Wook Kim (06:16.971) Yeah, so we definitely have a spectrum when we think about valuation, usually a multiple of EBITDA. From the higher end — what we value and what takes you to a higher valuation — specialization is one area, and how deep you are in that specialization. Recurring and retainer revenue: the more we can predict future revenue with some level of certainty, that definitely helps increase our valuation and how much we're willing to spend on a business. Related to that, long-term contracts, multi-year relationships where you might be one year into a three-year contract — that gives us some certainty of future revenue. We talked about leadership beyond the founder. We want established teams that aren't so dependent on the founders. If the founder is going to leave the business, do we need to replace them with one, two, three people, or are they already at a stage where they've taken a step back from the day to day and there's a leadership team in place or someone who could become the next CEO of the business? So these are some of the things that we definitely value. Peter Kang (07:41.498) Yeah, and just going into the recurring revenue aspect of it — one of the things that we do look closely at is historical revenue. One thing that disqualifies a lot of agencies is when they've had a dip in revenue or they've had some uneven years. We want to see at least a degree of consistency. Maybe some degree of growth is okay, which we'll talk about later. But some degree of consistency is at least what we look for. Sei-Wook Kim (08:10.58) Yeah, consistency helps give us the confidence that future years will look like the past years. If there's a lot of fluctuation where one year they went through huge growth and doubled in size but the next year came back down quickly, we have to figure out what the next three, four, five years are going to look like for the business. And without the historical context, it's really hard to gauge that. So the recurring nature of it or the consistency is super important for us. Related to that is understanding what their sales and lead gen process and engine is. Is there a clear way — even if there could be businesses with short-term contracts, project to project — but if they have a very clear funnel of leads that they're converting to new clients on a consistent basis, at least that gives us some assurance that there is some predictability to the business. Peter Kang (09:12.593) Right. And just related to client concentration — at what point are we scared off or is it iffy for us when we look at deals? Sei-Wook Kim (09:27.839) Yeah, it's tough to say. Generally, ballpark, if a client is larger than 15 to 20% of overall revenues, that's a flag. Because if you lose that one client, that's a pretty big impact to the business. And from the size that we're looking at, we also want companies with a diversified client base — so at least 15 active clients that they're servicing, without one client taking up a big percentage of that revenue. Peter Kang (10:04.827) Yeah. And you could argue, even if a particular client has a large concentration, there's some nuance to that as well. That agency could be working with a lot of different stakeholders, a lot of different business units within that one client. So it's not always just a clear blunt number that we're looking at. Sei-Wook Kim (10:25.052) Right. Yeah. In our diligence, we look at the clients, the business lines, and then also revenue by client by month, just to see if there's cyclicality to that work as well. Peter Kang (10:38.395) Yeah. How would you gauge things like agency reputation? Is that something that we look at? Sei-Wook Kim (10:47.985) Yeah, reputation is important to us and some of the ways that manifests itself — getting a lot of organic deal flow is often an indication that the agency has a lot of positive reputation. That's either past clients referring business, other peers referring business, and generally speaking you can look at some of the public review sites or things that can give you an indication of the reputation. But a lot of that would manifest in the organic deal flow to the business. Peter Kang (11:28.52) Nice. Great. Any other value drivers for agencies that we like to consider? Sei-Wook Kim (11:35.763) Yeah, thinking about the source of BD — we also don't like to see a lot of concentration there. If an agency's leads all came from one source, like Webflow for example, there's a huge concentration there. That's a risk, more of a detractor to the business. So if there are many sources of new business, that's a positive for us too. Peter Kang (12:10.454) And then on the recurring revenue side — we talked about that being a big function of client retention. Anything else on the retention side? Sei-Wook Kim (12:29.206) Yeah, a lot of the things we're talking about are from a revenue standpoint — new business revenue, durability. The other area that's important for us obviously is the margin. How efficiently are they doing the work? The team makeup — is there a lot of turnover in the team? That's definitely a flag for us. Seeing long-tenure team members is important. And also how they're structured — oftentimes, is it all US-based talent? Are there offshore or near-shore aspects of the business that help with the margin and scale? And do they have clearly defined SOPs for the work that they're doing, or is every project unique and they're figuring it out every time? Usually all of those things manifest in the gross margin and the EBITDA of the business. Peter Kang (13:30.249) Yeah, that's a great point. The funny thing is we have these rules of thumb and guidelines, but there's so much nuance to all of this. Even thinking about employee retention — in general employee retention is good, but then in some cases you could argue that performance management hasn't been robust there. They've kept some underperforming employees for too long out of a sense of loyalty, or they just didn't want to make the tough choices. So there's a lot of maybe bloat or people dragging down the org. And so it's about digging into some of those things during due diligence. Sei-Wook Kim (14:10.759) Yeah, we've definitely seen a good range of that. And usually for that, if they've kept team members for too long and they have performance management issues, hopefully you would see that in the numbers also. Peter Kang (14:24.453) Right. It's reflected in the margins as well as the growth. Okay. Makes sense. All right. And then let's talk about what's less important. Maybe from the outside, people might think something is an important value driver, but it's not — and I guess for us, what's not as important as a value driver when it comes to acquiring agencies. Sei-Wook Kim (14:52.637) Yeah, one of the things that comes to mind is some agencies have invested in building proprietary technology within the agency, which in some cases helps them do the work or they're selling to the client as a value add-on. That's not something we typically add big weight to in our valuations. For something like that, it's either a separate business that should be run as a separate business, or once it's combined with the agency, it's usually taking away margin from the work — and you'll see that also. People will justify low margins because they invested in technology, and it's something that needs to continually be invested in, especially if it's custom tech they've developed. Another thing is really rapid growth without maintaining margin. We've seen agencies double, triple in size year over year, but as they've grown, their margins have continued to shrink, which shows maybe they haven't invested in the process to scale profitably. And with that speed of growth, there's also the risk that things could come down very quickly. If they've hired quickly to meet the demand, they might be holding a lot of expense if revenues were to decline at all. Peter Kang (16:28.085) Right. So with growth rate, we're really looking at whether the quality of revenue might degrade with the growth rate potentially. That's always something worth digging into. Going back to the proprietary tech piece — I think there's inherent risk in that as well, the overhead to keep it relevant. Some agency owners are going to argue that the proprietary tech allows client lock-in and retention, so maybe it is their secret sauce that makes it work. What's our argument against that, or why do we tend to stay away from it? Sei-Wook Kim (17:14.57) It's the risk profile that we're looking to take on. Whenever there's custom technology, proprietary technology, it's the risk that things could go wrong. And even though you're holding the client, that could also lead to client churn if something goes wrong with the technology that you're selling in. But the bigger thing is the cost of maintaining and building and supporting that technology for the long term is an additional burden on the business that may be supplemental to a point, but definitely not part of the core business that we're looking to acquire. Peter Kang (17:59.917) Yeah, it just introduces a layer of complexity that in our journey of acquiring companies, we just want to stay away from at this point. Sei-Wook Kim (18:08.708) Yeah, definitely. Peter Kang (18:10.754) Okay, let's talk more about how the seller's goals — the agency owner who's selling their agency — might affect the valuation as well as the deal structure. Sei-Wook Kim (18:22.779) Yeah, we've spoken with many business owners who are looking to sell their businesses for a variety of reasons. Some people want to get out of their businesses as soon as possible, so they value speed to close, exit, and potentially cash up front and walking away. Other business owners want to see upside in the business. They really believe in our mission, our process, and how we can help businesses grow, so they want to come along for the journey and capture much of the upside in the future. The goals vary drastically, but it affects how we structure the deals. Typically when we're structuring deals, it's a combination of cash upfront — either through our own balance sheet or taking on debt — seller financing, which means we're essentially taking a loan from the seller and paying them back over a three to five year period, a combination of profit share for the future, and then in some cases rolling over a minority amount of equity into the new entity that we're creating. All of these factors affect how much cash we need to put up front and how much debt we potentially need to service as a business. And really the seller's goals affect how we value the business and what multiple we put on it. Peter Kang (19:55.723) Right. And it just boils down again to risk. If the seller's not going to stick around for long and they're going to be gone a couple months after close, we probably want to price a little bit of that risk in, because it's going to be on us to make it work and there's going to be very little guidance afterwards. So that's going to discount the valuation. Whereas if they're going to stay along for a certain time, we want to incentivize them in a certain way, and that can impact the valuation. Sei-Wook Kim (20:26.906) Yeah, for sure. We have general guidelines that when we think about multiples, the more risk that the sellers are willing to take on along with us, they can see a lot more value in this transaction beyond the typical ranges that we see. There's a lot of flexibility in how we look at the transactions and structure deals. Peter Kang (20:53.956) Right. I'd say the piece that is also important — you talked about the different types of seller goals. I think there's also some emotional aspects of it that really get factored into these discussions. Some of the things that we've seen are sellers who care a lot about the legacy of the agency and how the buyer is going to treat that asset. There are those who might be willing to take less money if that means the brand gets to live on, much of the team structure and the clients are kept under that agency brand, and the processes are preserved — they see value in that, so they're willing to give up some value for it. Another might be those who are really motivated to close with speed. Maybe something has come up in their personal lives that means they need liquidity quickly, and they're willing to take less but with the certainty that the deal might close much faster. Sei-Wook Kim (22:08.29) Yeah, there are definitely life situations on that last point that could drive the need for cash quickly. And those are areas where we're essentially taking on the risk of that and moving quickly, so pricing that in for a deal. It's a very emotional process. It's not just about the numbers, and even the numbers have a lot of stories behind them. But each person doing a deal cares a lot about what is the story that we're telling to the world through this transaction, whether it's a tuck-in to an existing business or acquiring and keeping a brand independent. Because ultimately it's somewhat their legacy that is continuing on beyond the theory of transactions. Peter Kang (23:04.393) Right. Yeah, so we've covered a lot of ground on how we think about valuations. I know there's a whole other world that we could get into around terms, deal structures, and all those other things, which we'll talk about next time. I think we can wrap it up here. Sei-Wook, thanks for all your insights and we'll see you next time.