Growing your agency through an acquihire

What is it, when is it a good idea, and how do you protect yourself?
Agency Leadership Podcast

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Buyers purchase agencies for all sorts of reasons — to expand geographic reach, extend capabilities, grow revenue, or pad profits. Since it’s a talent-based industry, the other reason that agencies may be sold is for their people.

When the primary reason for an agency purchase is the team itself, it is often referred to as an “acquihire.” It’s something that has been popular for many years among tech companies in Silicon Valley who often buy small, struggling startups to quickly augment their engineering teams.

But even without a fancy name, these types of acquisitions have been taking place in the agency space for a long time, too.

Chip and Gini talk about how acquihires work, when they are a good idea, and how to structure it by looking at both sides of the transaction (buyer and seller).

Resources

Transcript

The following is a computer-generated transcript. Please listen to the audio to confirm accuracy.

CHIP: Hello, and welcome to another episode of the Agency Leadership Podcast. I’m Chip Griffin.

GINI: And I’m Gini Dietrich.

CHIP: And we’re here today to hire you you the listener we are going to acquihire you bring you on board and make you the third co host of this podcast

GINI: as it well I was gonna say as if it could use a third co host but we do that on inside PR so I guess

CHIP: yeah, and and you know the in that acquihire, we will gladly pay you exactly what we pay ourselves. Nothing. Yes.

GINI: Big Fat zero.

CHIP: Yes, that hand gesture did absolutely nothing, Gini because this is not a video pod. I said yes. Yes. Those of you in listener land, which is all of you because again, we don’t make the video available for really good reasons. She held up a zero.

GINI: And I said

CHIP: yes. So this is yet another in the topics that comes from Gini’s favorite websites in the world. Nobody She would rather be other than read it. In fact, she hangs out there even when she’s not in the agency, or the agency subreddit.

GINI: That is not true. No, there is no read it for me. No, no read it for you. It scares the crap out of me. People are mean, I don’t like mean people. I’m not good for me. It’s bad enough. I have to read about our president. I do not need to be anywhere where people are me.

CHIP: There we go wandering down the political land. I know. Stay out of

GINI: we’re about to go to war. So

CHIP: yes, and for those of you listening, hopefully, we have not already gone to war. This is being recorded in early January, but will not broadcast until I don’t know late January only because we’re actually ahead of the game for changing and recording the shows we are we’re not recording and then having me try to rush it out the same day. So look

GINI: at us getting ahead. Even with the holidays in there, we got ahead, look at us.

CHIP: Well, in fairness, it’s probably because of the holidays. We took two weeks off from recording and republishing over the holiday. So it allowed us to get a little bit ahead of the game. But any case, so this post on Reddit is it was about scaling creative agency with freelancers in their client book. And so the question is, I’m curious if any of you who have experienced hiring a smaller Freelancer in the same field who already has a book of clients, and so while this post doesn’t use the term acquihire, this is about acquihires and acquihires are something that are being talked about more and more frequently in the agency world. I know it’s something that comes up often when I’m speaking with smaller agencies. But Gini, why don’t you start by telling us what is an acquihire?

GINI: Well ship it

CHIP: is it that you want to

GINI: feel like we’re on a radio show. Let me tell you about Kleenex.

CHIP: Well, that that is the idea here. podcast is kind of like a radio show. Just not

GINI: that formal. Um, so an acquihire is like you’re acquiring the person, their talents and their book of business. So it’s not just You’re not just hiring a freelancer, you’re not just hiring a solopreneur. You’re not just hiring an employee, you’re bringing in their book of business and their talent.

CHIP: And this is something that became popular. Not not originally, but probably most popular in Silicon Valley where a lot of big tech companies are looking to increase their engineering talent in particular. And so they would do acquihires of small startups that really hadn’t gotten traction. And it’s a way to in bulk hire a bunch of people along with whatever business they may have, but it’s, it’s easier than going out there and trying to, you know, hire one at a time. Or sometimes it allows you to get talent that wouldn’t otherwise be on the job market.

GINI: So have you ever done this? I have, and

CHIP: it can work. So I’ve actually I’ve been involved in a couple of acquihires. And so here’s the thing with an acquihire, you have to really be clear about what Is that you are buying as a buyer and what you’re getting as a seller. And it is it is not a typical transaction of an agency that paperwork doesn’t look the same. It’s it really is more about the employment situation and then figuring out how to those clients that are coming over how do you value them? And how do you compensate the individual on them. So it’s, it’s sort of it’s somewhere in between an actual business transaction and a sales commission plan. Typically what you end up with in these situations and that they go wrong if if both sides you’re not clear about it, and it’s it’s very easy to go wrong because the the buyer often gets way more excited about the clients that are coming over than they really ought to and the seller, often confuses it with a real business sale where they’re going to get lots and lots of cash. Right? When in reality it’s it’s really just it’s it’s a it’s a move typically where the the agency being sold. And typically these are solo agencies, or maybe two or three person shops at most. Yeah, but sometimes they do happen at a little larger scale. But then they start to look a little bit more like a typical transaction. So, you know, it’s a situation typically where the owner of the agency, the small agency, doesn’t want to run the business. They like servicing clients, they don’t necessarily like the building of the business. That’s typically when you see someone who wants to exit and goes to an acquire.

GINI: So I’ve done this twice, and both times they were complete disasters. In both instances, none of the other person’s clients came along. Wow. Yeah. Um, the first time it was a really tough lesson and the second time, you know, we worked really hard to make sure that it happened and there was some unethical behind the scenes things that happened that I was unaware of So I guess the question then becomes how do you make sure that just like you would in any, I think any merger or acquisition, how do you make sure that that book of business, which is usually why you’re hiring somebody who’s senior level, not just because you need some senior level talent, but you have to, they have to support their salary? And if they don’t bring clients with them, they don’t bring a book of business with them? How are they going to support their salary?

CHIP: Well, and I think that as a buyer, the first thing that you have to do is say, what I want this person even without the clients, because if you are doing it, and it if you are doing it, primarily because of the clients and the book of business, you’re doing an acquihire for the wrong reason. There’s a reason why hire is part of the acquihire term. And so you know, it certainly it can make the individual more affordable to you if they’re bringing business over but it might be the reason why they come over. Because you I mean, ultimately you’re going be working with this person?

GINI: For sure. Yeah.

CHIP: So you want to make sure that you feel like they’re, they’re additive and clients all go away at some point. So, you know,

GINI: really in one fell swoop, however, know

CHIP: that that’s, I have to say I’ve seen a lot of weird scenarios. That’s one I’ve never seen before where any kind of transaction you lose 100% of the business, but I mean, what was the What was the reason that what was it the unethical behavior that caused the the loss of clients or was it something else that was at play?

GINI: I mean, hindsight is 2020. But my, I think, was the second one. It was because this person sued about the clients that she had. She didn’t actually have them. And she made the books look like they that they had been paying and most of the clients have not been paying for six months or longer, but she had to cook the books a little bit to make it look like they referring clients. Gotcha. Okay.

CHIP: Yeah. So so that’s that’s obviously a problem. But it would it brings up as a good point, which is that it from the buyer side of this kind of transaction, you want to make sure that it’s structured so that most of the compensation, if not all of the compensation is tied to the revenue that actually comes to Yeah. So you know, you would, you would give them a certain base salary. And that’s really what you’re putting at risk for whatever period of time, you know, you’re guaranteeing them. And typically, in an acquihire, you would have some sort of minimum employment period, in addition to whatever compensation you’re doing, but essentially, in an acquihire, it should be either 100% or almost 100% earn out as far as how the actual transaction compensation is paid. And so that way, you’re, you’re de risking that, but you sell it to the person that you’re buying because they get all the upside because that you know, they would get a good chunk of whatever it is that they brought over and whatever new stuff they bring in, they should also get a piece of as well. continued to be incentive to grow the business.

GINI: So let’s give listeners an example. Let’s say that you were going to buy my agency and my book of business, how would you structure that deal?

CHIP: I would never ever buy your business. No.

GINI: And I would never sell.

CHIP: Because then I’d have to work with you. You know,

GINI: I had to talk to you once a week. Exactly,

CHIP: exactly. So, you know, I could that could be problematic, but no, so Okay, so So typically, the way first of all, you need to go into it and make sure that you’re really understanding that individual and their business because this is more than just a straight hire. So, you know, you have to think to yourself, okay, as exciting as this opportunity seems, and they all seem exciting from the get go. You need to make sure that you’re you start with a baseline of putting in the same level of effort that you would have if you were hiring a senior employee. So you start there, and then you build up on top of that. So whatever you would do for a normal interview or conversation Process who they need to meet on the team, you want to make sure that all of that is still taking place. So you have the appropriate synergies once that person comes on. But then you also need to do the diligence on the business itself. And so, you know, just as you would if you were buying a real agency, you know, and I’m not saying that if it’s an acquire, it’s not a real agency, but you understand that typical transaction, you would still want to look at, you know, the standard three years of previous financials at a minimum, you know, you want to look and understand, you know, is the business growing, you know, what are they showing for clients? Obviously, it can be challenging when you’ve got a situation where someone is cooking the books, particularly in small businesses, it’s often difficult to uncover that usually they’re on audited financial statements, and it frankly doesn’t make financial sense for anyone to, to pay to have them audited, right. They’re that small. So there is an element of trust that takes place here. So you want to take a look and make sure that you understand the business it may be worth looking at bank statements and things like that to verify that you know what they’re saying for payments are actually coming particularly if you have any, any even slight whiff of lack of trustworthiness, and certainly anything more than a whip, and you shouldn’t do the deal, but you know, if there’s just that disquieting feeling a look at the bank statements can often resolve that. And so that’s that’s all the sort of the preparatory work and then it gets to the paperwork, which we can talk about as well. But

GINI: so in the due diligence piece of it, do you think asking to see big statements should just be part of the process? Or is that only if you feel like there’s something missing?

CHIP: So I mean, it typically should be it’s it is best practice in a transaction to look at bank statements, because they are while they’re not the same as having truly audited financial statements. It is a good way to just as, as President Reagan would have said, trust but verify. I’m picking a president who’s less controversial even to

GINI: Well, today Anyway,

CHIP: today. Amazing what history does

yeah, so you know, so so looking at those kinds of things, you know, is important. You want to make sure that you’re looking at the contracts that that individual has with clients a because it proves that they actually exist. Yeah, you know it. My general experiences people who will cook books and do unethical things that there’s a limit to how much effort they’re willing to put in. Because usually one of the reasons why they do things like that is because they’re lazy. And so you know, if they’re asked to produce contracts and can’t that’s a bad sign, it’s unlikely that they’re going to take the time to actually forge contracts, if they’re lazy, so, but you want to take a look at the contracts for two reasons. One is to confirm that they actually exist and see what the general terms are. But the second piece that you really want to be looking at is whether the contracts are assignable or not. And this is this is one of my pet peeves with agency contracts is that they often are written such that they are not assignable. Right in the event of a transaction, you want to make sure that they are assignable in the event of a transaction because otherwise the client has extraordinary leverage over you. And this is This isn’t leverage that I’ve exercised myself. When I’ve been on that end, where I’ve had a contract that’s not assignable, that the vendor whatever goes through a transaction, and I go and get to say, Well, I’m renegotiating terms at this point, because you’re forced to sign this in the next 24 hours, they’re going to be on my terms, not yours, right. And it’s, you know, that’s just how business is, you know, you, you have an opportunity, and there’s a reason to change it, you might as well at that point. So make sure they’re assignable to you, because that then means that you don’t have to go beg every client to sign a new contract with you, doesn’t mean you won’t do that over time anyway, but you want to minimize that risk. And then, you know, the other piece of, of the diligence that you really want to make sure that you’re doing is if they’ve got contractors, and the contractors are part of the actual client service. You need to understand what they’re going to do are they are they willing to come with you and and either be a contractor or an employee for you, whatever you’re looking for, you really need to make sure you’re understanding that piece of the puzzle. Because that makes a huge difference in the client experience for that book of businesses coming over.

GINI: So when would you look for an apple hire? In my case, the first one was because I needed an office in a different part of the country. And this was back when it was very important to clients that you had offices. And then the second it was to have senior senior level talent in a certain industry. So in both those cases, so when when else would you look for an acquihire?

CHIP: Yeah, so I mean, typically, when I’ve used an acquihire in the past is when I was looking for a particular talent, that for whatever reason, I couldn’t get through a normal hiring process, you know, either I had already looked and hadn’t been able to find it. Or I just I knew based on how particular I was being on what I was looking for that, you know, that that person wasn’t available otherwise. But you know, to me, I’ve always approached it from the hiring standpoint, you know, what am I looking for, from a talent standpoint and then whatever client stuff that would come along with it was it was gravy, and it was something that would make the investment more affordable for me in the near term. But you know, it’s it. The other way that you can come at it is if you’re if you are a larger agency and you’re looking to do an acquisition, generally you find out that whoever you’re interested in acquiring the agency just isn’t big enough to do a traditional transaction. And then that sort of becomes an acquihire by default. And one of the challenges that we all have these days is figuring out, you know, what a business is like from the outside. So, you know, we know what it looks like, you know, you can even see people involved, but you know, maybe they’re contractors, maybe they’re only working a couple hours a week, lot of agencies list tons of people on their About Us page, none of whom were employees. And in some cases, they may only work an hour or two a month if that for the agency. So you know, it’s very difficult until you actually get inside and start having candid conversations to know you know what that business is really like and so it could be that it turns into an acquihire after the fact

GINI: So why would you do an acquihire versus just contracting with that smaller agency?

CHIP: Well, so, a couple of reasons. You know, a lot of times the the agency that selling just they want to get out of the day to day running of the business, so they’re not, they’re not looking at setting up a partnership with you or something like that. They just, they want to get out of it. They’re, you know, typically they’re, they’re folks who don’t like the ins and outs of managing a business. Typically, they’re people who aren’t really thrilled about business development, right. I mean, that’s, that tends to be the biggest thing that drives people out of agency land is if, as an owner, they don’t want to be selling, you want to be selling, it’s you’re going to have a tough road ahead of you. And you’re probably going to fit better in a larger organization, because particularly a small agency, you can’t really outsource that sales process. And so that’s that’s but it’s important for you to understand that because I see acquihires where they go wrong because someone says oh, well this person built a business, you know, so they can absolutely go out and, you know, they generated you know, 500,000 or a million dollars in revenue. for themselves, they can do more than that for me, because I’ve got a bigger brand and all that. And typically, it’s actually the opposite, they’ll actually generate less Yes. Because a the, you know that the, you’ve taken away some of the fear factor because now they have a salary. But the second piece is a lot of times that that business that they got, in the early stages of a small agency are, I don’t want to call them favors, but they’re, you know, they’re there because someone had a personal relationship with that individual. And so, you know, someone may be more likely to do business with them directly than with a larger agency that they just happened to be part of.

GINI: Well, I think there’s a lot to think about. In both cases, I have not had good luck with either one of them. And mostly because I think I was naive and young and not as wise as I am today. But you definitely have to look at all of those aspects for sure.

CHIP: Oh, absolutely. And it’s, you know, you really have to understand that anytime you’re going into One of these things that it’s a real business transaction. This is not. This is not a, you know, hey, you know, we had a great time chatting over martinis, let’s jump right into it. I mean, it’s the, at some point, we can have a show where we talk about, you know, having partners within your agency and how to do that. I mean that, but there’s, you know, there’s even more challenges with that. And that’s, that’s another thing, frankly, to look out for an acquihires, you know, a lot of times, whoever you’re acquiring may want to get equity in your agency. that complicates things substantially. So my general advice is, don’t give equity in an acquihire. If someone is if you’re not that much bigger than whoever you’re hiring, you probably want to look at a different structure than an acquihire, you may want to look at actually becoming partners or you know, or something. So typically, these work best if there’s, you know, one is disproportionately large compared to the other and then it’s it. Frankly, that reduces the risk for everybody and also makes it easier to complete the transaction.

GINI: Lots to think about

CHIP: lots to think about. But also it’s and these, you know, these transactions are increasingly happening. It’s a good reminder that no matter what kind of agency you have, it is possible to sell it. You know that I talked to people all the time and say, you know, How big does my agency have to be before I can sell it? And the answer is really, technically, I mean, you can sell it, you know, two months in Yeah, you know, if you’re willing to go work for whoever wants to buy it, and you’ve got a little bit of business to bring along yet you can call that a sale and be done with it. It’s really as you get bigger, you just are able to build a more stable business that hopefully get you better multiples, on your revenue and on your profitability.

GINI: And also be prepared if you’re selling to go have a workout because you’re not just going to sell it and walk away.

CHIP: That is correct. That is probably the biggest misconception amongst business owners generally, but particularly agency owners who think that oh, I sold my agency now I go get to go sit on the beach. Nope, nope. No, you know, almost every single one of these transact is going to require that you, you work for several years. And frankly, it’s one of the things that you have to include in your calculation as to whether you want to sell because, you know, if you’re, if you’re getting, you know, on the low end, a low end multiple, so say, you know, three or four times your profits, and you’re being required to work for three or four years, hey, guess what, all you’ve really done is guaranteed that you would get the same as if you held this business steady for the next three or four years. Right? And so, is you know, yes, you’re accelerating some of those payments. So that may be useful and you are de risking a little bit but you know, is that really worth it to you and so, you know, as you’re looking to sell, you really want to think about, you know, what kind of additional multiples you can get but that’s that really is a topic we can dive deeper into another day and not quite as relevant to an acquihire. We’re, you know, it really the, the sales price, if you will, really is just the employment contract plus whatever percentage of the revenue that that you win, that’s typically how those deals are done.

GINI: Yeah, and I like about I like that. Thinking about it as salary plus commission. I like that. Yeah. And and,

CHIP: and perhaps a signing bonus, although I would from the buyer side, if you’re doing a signing bonus, I would encourage you to probably not be an immediate signing bonus, but a signing bonus contingent upon every you know, all of those clients coming over or a certain percentage coming over. Yeah, I mean it Yeah. And that’s definitely how I’ve structured them. Unfortunately, I haven’t had that same situation as you did, but a good cautionary tale. You just got to be careful about jumping into any of these things. And we all get more experienced over the years. You know, I certainly did some transactions and in my early businesses, including my first agency that I would never do today, and you live and learn and I’m still learning there’s still deals that I got done with the last year or two and say, Nope, nope, won’t try that approach.

GINI: Not doing that again.

CHIP: No, nope, not gonna do it. Got another

GINI: residence in one podcast.

CHIP: So, on that note, that will bring to And this episode of the Agency Leadership podcast. I’m Chip Griffin

GINI: and I’m Gini Dietrich

CHIP: and it depends

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