The Art of Valuing Your Telecom Agency
The telecom agency business is one of those “boutique” industries where successful agency owners who have been in the business for a while have likely built up an admirable stream of monthly residual income. But many owners are at a crossroads today – some are fully embracing the need to invest heavily to transform their legacy businesses into next generation, trusted telecom and technology advisors. Others aren’t sure how to do that, or aren’t interested in making the significant investments necessary to position their agencies as leading-edge digital resources for their customers. And then there are other owners that are searching for a way to monetize their years of success in the channel as they plan to sell and eventually exit the business.
Regardless of where they are in their agency’s lifecycle, every owner has a need to understand the value of their business. But determining an accurate value of a telecommunications consulting and service agency is tricky. Unlike many other businesses, an agency’s assets are fundamentally limited to future cash flow of a residual commission stream. And that cash flow can be severely impacted by a number of factors outside the control of the owner. So, how can an owner determine a fair price for his/her company, and how can potential purchasers know that they are paying the right amount for a telecom agency?
Before we go farther, there are two important points that we need to make. First, there are entirely different dynamics at play when valuing a master agency vs. a direct selling agency. With that said, this article focuses on direct selling agency valuations. Look for a future article with information on the valuation approach for masters.
Second, there are generally two different types of buyers: those who operate existing telecom agencies and who have interest in growth by acquisition, and those who are outside the telecom channel. This second category of buyers includes companies in related spaces, like MSPs and VARs, but it also includes professional buyers like private equity firms who see a way of profiting through “roll-up” or other aggregation strategies. In this article, we’re looking at valuations for transactions within the telecom agency channel, not for professional or external players. Now, let’s look at some business valuation basics, and you’ll see that determining an agency’s worth is more of an art than a science.
How Buyers and Sellers Determine Value
What is any business, parcel of land, or item of property worth? The most fundamental determinant of value is the figure that a buyer and seller agree upon through a “meeting of the minds.” In other words, value is based on what a buyer is willing to pay, and a seller is willing to accept. This may seem overly simplistic, but more sophisticated valuation methods follow from this basic premise. Also, while it is true that a negotiated price is a function of economics, there are some general valuation guidelines and tools to help buyers and sellers arrive at some starting figures.
Using Formulas to Arrive at a Baseline Multiple
Depending on the type of business, a go-to figure as a starting point for determining a valuation multiple is either top-line revenue or bottom-line profit. These approaches are referred to as the Times Revenue Method and the Multiples of Earning Method respectively.
For a telecom agency buyer, top-line revenue, generally the same as total commission revenue, is important, as it adds clout to the buyer’s relationships with providers. But top-line revenue alone usually has little value without good bottom-line net income. So top-line revenue is a good starting point for agency valuations, but only in the context of net income. Here’s a general guideline of how revenue may impact multiples:
Unfortunately, agencies with total annual revenue of under $1 million are not viewed as attractive prospects by buyers. In addition, the multiples applicable to those agencies are so small that owners generally opt to continue to operate their business in some fashion to sustain the residual commission stream.
Direct selling agencies at the other end of the revenue spectrum are more commonly the target for a “strategic” buyer – a buyer, perhaps from another industry or even an institutional buyer (like a private equity firm), that sees a very strategic fit driven by the uniqueness or simply the size of the larger agency.
As you think about net income in the context of these multiples, it’s important to focus on what the net income would be post-transaction. There are myriad of add-backs and subtractions from an agency’s current P&L that have to be factored in, including owner’s compensation, the expenses the owner runs through the business, key employee replacement costs and any potential changes to the cost to run the business post transaction.
Remember, these multiples are simply a starting point, or baseline. Adjustments to the baseline multiplier are essential as a valuation process moves from the general to the more specific. We’ve developed an easy to understand matrix HERE of factors that work to either increase the final multiple or decrease it.
Other Telecom-Appropriate Valuation Methodologies
While the Multiple of Earnings Method is the most commonly employed valuation approach in the agency channel, there are some different methods for arriving at a valuation for a telecom agency — each of which may be appropriate based on a variety of factors unique to a particular business. These methods look at comparable companies, the value of assets, and investment-based perspectives.
Determining Market Value
A Market Value Approach to business valuation compares the subject business to other similar companies. This is the method often used in residential real estate sales and other transactions where comparable sales information is plentiful.
Of course, finding public information about recent sales is the foundation of this valuation methodology. Commercially brokered agency deals may make their way to a database, but since agencies are typically privately held, many sales comparables are just not available.
Counting Assets
For some agencies, value is a function of what the company owns. Inventory, equipment, proprietary systems/software and other assets can give a business inherent value that can be more easily determined. Most agencies have little inventory or equipment, but what about other assets aside from their future commission stream? An agency that has developed a unique managed services offering, where long-term contracts exist between the customer and the agency, has a real asset (the customer contracts) that has tangible value. Supplier contracts can also be an asset, if they are considered ‘best in class’. But keep in mind that those same supplier agreements may be a liability if they are not strong contracts that pay out high commission rates and protect revenue for the long term.
Unlike other businesses that are primarily asset-based, an agency with some hard assets (like the customer contracts in the example above) likely still has the majority of its revenue tied to traditional residual commissions. So, instead of utilizing a pure asset-based valuation, it’s more likely that assets would result in a positive uptick, and liabilities in a reduction, in a Multiple of Earnings valuation calculation.
Assigning a Value to the Future
Given that telecom agencies generally have few hard assets, and comparable sales just aren’t available to use in a valuation process, future earnings can become a more relevant factor in a valuation. The discounted cash flow method projects sales into the future, such as for a period of five years, to determine cash flow. It’s crucial for the projections to be grounded in reality, and anticipate how cash flow would naturally progress based on the company as it exists today. In other words, the value should not reflect any goodwill or efficiencies that would be gained or lost through new ownership. Then, this projected cash flow should be discounted back to the present as a net present value (NPV.) Determining the correct discount rate adds a layer of complexity to the process. Considerations in arriving at an accurate discount rate include market rates of return for similar investments, capital costs, and projected inflation rates over the five year period.
Considering Intangibles in the Valuation Picture
Goodwill is a factor in valuing many agencies. Current owners may have a position of respect in the industry and/or in their local market, and the value of the agency should reflect any potential leadership change. Goodwill is the value that is above and beyond things that can be counted or projected, such as assets or future sales. Factors that comprise goodwill include, but are certainly not limited to:
Brand value
Market recognition
Customer relationships
Employee relationships
Management and leadership
Reputation and relationship with vendors
Proprietary technology
But not all intangibles add to the valuation; some can detract. The agency business is very risky, with many company specific and general industry risks that can negatively impact the business, including:
Not holding a contractual relationship with the customer
Customer relationship management
Providers’ behavior
Provider bankruptcy
Technology changes and staying relevant
Click HERE to see how these, and other intangibles impact an agency’s valuation.
It’s easy to see how telecom agency valuation is far from straightforward, especially considering the many positive and negative intangibles, the profitability of the business, and little in the way of assets. The most often employed valuation approach starts with top-line revenue to determine a baseline multiple of net income. From there, the value will be significantly impacted by other tangible and intangible factors.
Interested in learning more about how to determine the value of a telecom business? Contact us for more information or to schedule a consultation.