In rececent months we've seen a wave of small search marketing firms selling to larger buyers. How much are search engine marketing companies worth? If you own a firm, when is the right time to sell?
A special report from the Search Engine Strategies 2004 Conference, March 1-4, New York City.
The value of an search engine marketing (SEM) firm might come from experienced staff and a strong client list, but the company might need to have value beyond the dedication of team and loyal customers. In this session, both SEM firms and buyers explained how they valued the companies and what life was like after the sale.
How SEO firms are valued
"If you can satisfy the engines and the advertisers, you create interest for the investor," said David Hills, President of 24/7 Real Media. "An SEM [firm” must understand the playing field they are operating under in order how to add value, and how an outside investor might be interested."
Jeffrey Dearth, Partner at DeSilva & Phillips, Inc., shared his experience on how to value companies and what some of the metrics are:
- Industry EBITDA (earnings before interest, taxes, depreciation and amortization) and revenue multiples
- Comparable transactions
- Discounted cash flow
- Public valuations
"Professional service firms traditionally sell for lower revenue multiples than media firms due to customer volatility and concentration, "said Dearth. "Just like an ad agency that loses a big account, a shop can be decimated by losing a client."
Professional service firms often have lesser value due to lack of proprietary tools and technology. Some SEO firms offer submission tools, ROI tracking software, and training materials. The number of patents and blue-chip clients is attractive to investors.
"Any company that has solid technology is obviously going to add to its valuation vs. solely the personal services end," said Hills. "Two things are important: what is your tool set, and can you actually do something with your tool set that's valuable?"
SEO companies also need to have a durable business model. "There is pressure on SEO companies to be competitive, creating an environment that is conducive to all kinds of acquisitions and mergers," Hills explained. "Acquisitions have to be forward-looking. If all they do is fill a hole, if the only value of an SEO company is today and no discernable focus on tomorrow, that is going to impact the valuation of it."
Currently, Dearth does not believe that discounted cash flow applies to SEO firms too much due to uncertainty. "Perhaps if SEO firms had cash flow that they could trot out over four to five years, or if you could determine was absolutely certain was in the bank, this could work," he explained. "But now, SEO firms are dealing with volatile clients. People come and go. Companies can be bought. Therefore, it is unlikely that this method of valuation that will be applied to SEO firms."
An SEO company's staff also carries considerable weight. "Having a strong management team with a proven track record obviously increases the value of the company," said Hills. "Something that can bring real fruit in coming years are a smart, engaged, and highly-focused management team. The difficulty with burgeoning markets is that they tend to develop generalists before they develop specialists."
"People want cash flow and size," Dearth added. "Multiples won't matter if SEO firms do not have that."
Knowing when to sell
"A small company has a startup phase and a growth phase," said Dearth. "When the operations become so overwhelming that the company finds that they cannot do it all, entrepreneurs bring in a larger group to take away the headaches." Once an SEM firms has strong business model, a steady cash flow, long-term contracts with clients, proprietary technical tools, and a large staff of experts, the SEM firm can look to sell.
"You're never going to be able to figure out the optimum time to sell your company," Dearth continued, "but you can see what other deals are going around you. Keep your eyes and ears open, and get some sense of who is doing what and what kinds of companies might be interested. Rather than approaching them, you might want to stand back. If possible, let people know that you are interested in discussions."
"Ad agencies are not afraid to purchase things at an early stage," said Hills. "So they'll bring in small groups of people, and I think that's how you wind up with small agencies inside this beehive that are highly productive. They have a core need. They find a small company to bring in and incubate that need. And then they get a broader customer base than that small company could have done on their own."
"If you think about historically what has been the base of an ad agency's strength," Dearth added, "it has mostly been on people alone. Most of their [the agency's” business models were built around getting a lot of people and building a creative marketing campaign or ad campaign. SEM is a lot harder than that. It is not just about hiring creative or smart people. It's about leveraging technology, understanding search engines and relationships and databases."
"I think you will see a lot of ad agencies have a harder time organically growing this capability than a larger interactive agency with some technological capabilities that they could start to leverage," Dearth concluded.
Grant Crowell is the CEO and Creative Director at Grantastic Designs, Inc.. He has 15 combined years of experience in the fields of print and online design, newspaper journalism, public relations, and publications.
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