Intro
Did you know that in 2020, 51% of businesses increased their online interactions with customers?
Brick-and-mortar businesses are great. But it pays to have some sort of presence in the digital world, especially since the pandemic.
It’s like we always preach here at Contrarian Thinking: ‘Layer new tech on top of antiquated industries and boom… you have magic.’
But even with millions of businesses coming out of the digital dark age every year, guess who doesn’t have a hang of the internet?
It’s certainly not the 68-year-old boomer owner who puts ‘The’ in front of Google.
From TikTok to SEO and Pay-Per-Click ads… digital marketing is vast, complex, and ever-changing.
Even billion-dollar companies with dedicated in-house marketing teams don’t have a handle on it all.
Enter – digital agencies – how to cashflow by starting or buying, growing, and potentially exiting your own agency for passive income.
Performance marketing agencies have never been in greater demand. Nearly two-thirds of B2B companies outsource their digital marketing. That’s two in three!
And it’s not just corporate firms. Even 34% of small businesses are actively on the lookout for external parties to handle their marketing.
This practice may seem odd at first but in truth, it’s actually more prudent.
For example, hiring an SEO agency to design and maintain a website for a $5k project fee + $1k retainer is more cost-effective for a bakery than employing a full-time web developer for $69k+.
There’s also the experience factor to consider. A newly VC-funded SaaS company with a budget for earned media is sure to get its money’s worth with a veteran PPC agency. Whereas, trying to figure out Google Ads on its own is a surefire way to burn $200k literally overnight.
When you weigh the asymmetry in demand and supply, incorporating digital agencies into your portfolio of businesses makes a ton of sense – especially since they are heavy on cash flow and low on overhead. And hey…most older boring biz’s need them. Can someone say…vertical acquisition?
Playbook
Your step-by-step on passively cashflowing or growing your current business with a vertical acquisition of a marketing agency.
Step 1: Where do you find digital marketing agencies for sale?
Everybody knows the best place to find fish is water. And since most digital agencies do their business online, that’s always a great place to start.
Online marketplaces like MicroAcquire and Flippa are great places to find verifiable listings. A simple ‘agency’ search on either of these platforms will bring up dozens of agencies for sale.
Small ones tend to do $1k-$5k in MRR while medium and large-sized agencies generate $5k-$50k and >$50k MRR respectively.
Social media is also a great source for off-market deals.
If you’ve never heard of #moneytwitter, now might be a good time to start searching.
Agency owners are mostly vocal about their business on Twitter. It’s not uncommon to find one publicly sharing their MRR, offer, and customer acquisition strategies.
With a cold DM, you can reach out to these owners, find out if they’re open to selling, and verify their numbers before making an offer.
Also, if you belong to Contrarian Community, the smart move would be to ask other members for agency recommendations. This gives you tried-and-true knowledge on where to narrow your search for off-market deals and also which agencies to avoid.
But the best hack for finding deals is one you’ve heard a dozen times: Build relationships with people.
Already own an agency? Or started one from scratch? Scale by rolling up. Six years after he started 3Q Digital, David bought his second agency to merge with the first. How did he find his deal? He didn’t. It found him…over dinner.
As someone who believed that there was plenty of business to go around in digital marketing, David made friends with other agency founders, even those that were his direct competition.
So in 2014, when one of those agencies had reached its limit capacity-wise, David got first dibs on an asset that bumped his revenue from $12M to $16M.
Step 2: What are the different types of digital marketing agencies?
We’re not normally in favor of building over buying. But if your expertise is so unique that you’re literally one of a kind, it’s a great idea to start an agency and eventually sell or add to your next vertical acquisition.
There’s no shortage of business models that agencies can use or niches in which they can operate. But for the sake of this resource, we’ll outline the most popular and profitable agency types.
Lead Gen
This may come as a surprise but 61% of businesses struggle with finding new leads, which prompts them to always be on the lookout for someone who can.
This type of agency is often niched down to a T. Whether it’s home service businesses, realtors, or other agencies, successful lead gen agencies often narrow down their scope to one subset of any industry. This allows them to focus exclusively on getting appointments for those business types.
Since the majority of lead gen involves sending cold emails and DMs, the process can easily be automated with SaaS tools for a fraction of a single employee’s salary. However, most lead generation agencies work on a performance-based model, which means the owners don’t get paid until they hit their quota.
Web Design
What if we told you ~126 websites are created every minute? That’s 252,000 new websites every day!
In truth, those numbers are no surprise at all. Running a business without a website in 2022 is like shooting yourself in the foot.
Since websites are often a one-time investment, most web design agencies will have a great deal of churn. But despite the low recurring clientele, a decent one can still make $10k+ every month.
Content writing
Nothing nurtures leads better than good content, which makes content-writing agencies an ever-pressing need for businesses. In B2B industries alone, 64% of marketers revealed that they outsourced their content writing. This much demand explains why there are millions of freelance writers in supply, many of whom are stuck in dead-end content mills being paid pennies for their work.
A six-figure content writing agency with 2-3 writers, who focus solely on creative and not drumming up new business, can easily operate at a 50-60% profit margin.
E-commerce email marketing
The average DTC brand generates 25-35% of its revenue from its email lists. This makes email a vital marketing channel for ecom brands, and they are often willing to pay top dollar for it.
Since competent email marketing agencies also charge up to 10% of the revenue they generate, this model provides extra income streams aside from the monthly retainers most agencies charge.
Social Media Marketing
Most agencies in this category tend to focus on one social media platform alone. But it’s not uncommon to find full-suite outfits that deliver across the board.
But keep in mind that an agency’s platform of choice greatly influences its operating margins. For example, a Twitter-centric agency can spend up to 40% of its gross revenue on its ghostwriters. While a Youtube/Tiktok/Instagram agency can chalk up as much as 70% to editors, camera equipment, and other video-related overhead.
Public Relations
PR may seem like an obsolete space in 2022 but believe us when we say startups are still reliant on them. This is mostly because getting funding requires buzz. And to get buzz, your name needs to be placed in front of the right eyes, which is PR in a nutshell.
A PR agency typically drafts and submits press releases on behalf of its clients to news outlets and also creates thought leadership articles for its execs to be distributed in industry publications.
This agency type is heavily dependent on professional contacts in media but an optimized PR agency with 2 writers, 1 admin, and 5 clients can operate at a 40% EBITDA margin.
Copywriting/Ghostwriting
Ghostwriting agencies are similar to their PR counterparts, except they don’t deal with the formal, buttoned-up nature of publications.
The content these businesses create is primarily for personal newsletters, Twitter, and LinkedIn accounts. Their best clients are usually C-suite execs who are looking to build their personal brand/authority online but are too busy to tweet.
Monthly retainers are the prevalent model with ghostwriting agencies and they range anywhere from $2,500 to $25,000 per client. But because of their skill and niche knowledge, hiring capable ghostwriters can be pricey. Expect to chalk up 60%-70% of gross revenue to labor costs.
SEO
SEO is one of the more prominent niches in digital marketing…and rightly so. If you’ve ever tried to rank on page 1 of Google, then you’ll know it’s back-breaking work. The tedious nature of the job description also makes it one of the highest-paid roles in the space. Between link-building, site optimization, and traffic building via blog posts, a mid-range SEO agency can charge anywhere between $3000 – $10,000 in monthly retainers per client. Profit margins on that usually stand at 20-30% EBITDA.
Paid Advertising
Since small businesses earn an average of $3 for every $1.60 they spent on Google Ads, it’s no wonder why companies always make provisions for Pay-Per-Click (PPC) ads in their marketing budgets.
PPC agencies can specialize in Facebook ads for home service businesses, Instagram ads for info products, Google Ads for e-commerce businesses, or more recently, Tiktok ads.
Step 3: How to perform due diligence for digital marketing agencies?
Just because most agencies have no physical assets doesn’t mean you should skimp on DD. If anything, that’s a valid reason to doubly vet the deal before forking anything over.
Here’s a 82-item checklist you can use to kick things off…
Data
During due diligence, you’ll get a full understanding of the data of that company. This will not only open up a deeper understanding of the company but also the maturity level of data management and how the company is using data to drive sales forward.
- How is the company collecting data?
- Which feeds are they taking data from – digital marketing, direct, POS, sales funnels, etc.?
- Where is the data stored?
- Security and legalities (GDPR) – how have they managed this and systems in place?
- Do they have a single customer view of a customer – with all touchpoints attached?
- How is the company querying the data to answer questions?
- Reporting and analysis – what reports are they producing regularly?
- How is the company using data to make decisions?
- Is the data leading the decision-making – if so, how and when?
- What are the companies’ critical KPIs – why?
- How is the data being fed back into acquisition marketing?
- How is the data being fed into retention marketing?
- Are they using real-time AI analysis of the data to make decisions on the platform or across marketing channels (personalized content)?
Competitors
Understand the competition in the vertical, who are the most significant threats and what are they doing well. How will the target company compete and accelerate?
And here’s a list of financial documents your seller must absolutely provide…
- Audited financial statements
- Balance sheets
- Tax returns
- Monthly Cash flow statements
- Credit reports
- Profit/loss statements
However, due diligence isn’t only applicable to numbers. You’ll also need to evaluate the company culture. That’s why it’s important to meet with the creative team to get a read on them, especially the second-in-command if they’ll be staying on.
Most sellers will never agree to this when asked, which in most cases is usually a red flag. That’s why we recommend you don’t ask at all. A light-hearted DM to employees of the business saying you’ll be in their city for a few days and want to grab a few drinks should do the trick.
It might seem like an underhanded tactic at first but it’s really not. You’re simply making sure your money isn’t being pumped into a burned-out asset.
For David, a thorough due diligence process is centered on examining financials. That involves:
- Ensuring the net margin percentage of the business is healthy
- Checking if its Compound Annual Growth Rate (CAGR) is positive (we’ll explain this a little later)
- Confirming revenue is evenly distributed i.e. no more than 40% of the agency’s revenue is tied to a client.
We don’t have to point out why having a centralized revenue stream is bad for business.
While having a whale client feels great, you don’t want all of your agency’s bandwidth to be focused only on them. Because if they decide to leave, you might be left unable to pay your operating expenses until you fill their spot.
On average, viable digital agencies have a 15-20% net margin (or operating margin) before tax. Meanwhile, gross or delivery margins sit at 50-60%.
Here’s how you crunch the numbers for each margin:
Delivery Margin (%) = Delivery Costs/Adjusted Gross Income
Operating Margin (%) = EBITDA/ Adjusted Gross Income
Other vital signs David looks out for in his deals include
- Good client references
- Good tenure among employees
- Consistent vision among the leadership team about the agency’s future
You might find some agencies come with in-house SaaS tools built for customer fulfillment. If you want to get lower valuations, don’t be afraid to splinter those off.
Let’s talk about CAGR.
CAGR is an important metric for online agencies because it measures the rate at which an agency’s revenues and profits are growing over time. CAGR is a useful metric for comparing the performance of different agencies, as well as for understanding the trajectory of an agency’s growth.
CAGR also helps to identify areas of improvement for an agency and to make informed decisions about how to allocate resources to maximize growth.
CAGR = (Ending Value Rev/ Beginning Value Rev)^(1/n) – 1, where n is the number of years.
While there’s no standard CAGR in the industry, keeping this metric between 10-15% can help ensure a high ROI on your investment.
Step 4: How to perform financial planning for digital agencies
Figuring out margins with digital agencies can be tricky.
So we found this nifty modeling tool that helps you verify P&Ls and thoroughly vet the margins of online agencies.
Here’s the instruction manual on how to get the most out of it.
On the other hand, your business plan doesn’t have to include precise numbers. Here’s the business plan of an email marketing agency you can use as a guide and another template you can build off.
Also, keep an eye out for recurring expenses to get a sense of operating costs. The costs of monthly expenses for digital agencies vary from niche to niche but they can all be summed up with this formula:
Total Costs = Fixed Costs + (Variable Costs * Units Sold)
Agency fixed costs typically include domain name, hosting, etc. While variable costs include Customer Acquisition Cost (paid ads, content creation), salaries, SaaS subscriptions etc.
Step 5: How to get financing for purchasing a digital agency
Personal Funds
30% of the agency listings on page 1 of MicroAcquire go for $1k – $250k. When a potential acquisition falls into this price range, it’s easier to provide the capital out of your pocket. Or to raise from the oldest VC firm in history: friends and family.
However, if you don’t have enough in the bank to fund the buy, or if putting your money on the line doesn’t interest you altogether, there are multiple financing options you can explore.
Debt Financing
SBA Loans – While their online-only, remote nature makes it trickier to obtain SBA loans, digital agencies still qualify for loans less than $5M under the SBA 7(A) and 504. Here’s a guide that outlines what you’ll need to pull it off. When you’re ready, here’s a list of SBA lenders.
Traditional Bank Financing
This process is quite similar to the SBA loan route. It requires the same business financials for approval and a 10-20% down payment. The only major distinction is the SBA doesn’t back these loans but they are instead financed by banks.
Seller Financing
Seller financing is another way to mitigate some of the risk on your part. Typically, you can negotiate to pay 15% – 60% of the purchase price out of the agency’s future revenue over time instead of upfront.
Equity Buyout
David’s first acquisition involved no cash at all. Yet, he retained all four founders of the $4M agency by offering them equity.
Always explore the possibility of offering partial ownership to the seller. It never hurts to ask.
While all these options are perfectly capable of financing your acquisition, there are a few other unconventional methods you can try.
Step 6: How to prepare a digital agency for an exist?
Since most digital agencies are remote and have no specialized equipment, the most important factors when analyzing their price tag are optimization and MRR.
Optimization can easily be measured in terms of documented SOPs and how easily operations can be carried out on auto-pilot. The degree to which you structure your agency to function without you will directly influence the multiple at which you can sell during an exit.
On the other hand, MRR is a foolproof way for the buyer to forecast future revenue and cashflow. Assuming all economic factors are equal, an agency that’s made $50k in MRR for the last 12 months proves there’s a minimum of $600k to be made within the next year. That’s an important factor to consider when setting your selling price.
In a typical digital agency sale, standard multiples range from 2-3x of gross revenue from the preceding 12 months. But as you climb higher into 8-figure EBITDA territory, multiples can easily soar to 10-12x.
This is largely due to EBITDA being an accurate indicator of risk. Small agencies (under $1M in revenue) tend to be overly reliant on human capital. When these assets are bought, the buyer is essentially ‘buying’ a ton of people, which translates into a higher risk factor considering people can up and leave at any time.
That’s not to say larger agencies ($5M+ in revenue) don’t have employees. But with the detailed documentation, automation, and SOPs they typically have, large agencies can function to some extent without humans.
Less risk = Higher Multiples.
That said, you also have to keep your books tidy. Organize your financials in the same way you’d want them if you were the buyer.
It’s like David told us, “Great companies are bought, not sold.”
Keep your agency in tip-top shape and buyers will come knocking on your door. That’s been David’s experience so far.
To learn more about agency exits, you can read more on selling the asset class here.
What are Buyers Looking For?
1. Healthy Margins and Growth
- 20/20 rule: EBIT margins and 20% annual revenue growth are ideal
2. Track Record of Customer Success, Ideally Shared via Clients
3. Opportunity to increase Market Share
- Consolidation within a market
- Expansion to a new market
- Biostering of functional capabilities
If you decide you’re not interested in selling, digital agencies are rife with opportunities for mergers and acquisitions…especially in 2022.
Here’s a report by Hubspot explaining why P.E firms are scrambling for performance marketing agencies and what they look out for. It’s a framework you should copy.
David’s own agency, 3Q Digital, is one of many that were scooped up by private equity in the last six months. And this was only a few short months after 3Q Digital acquired another SEO agency.
Step 7: How to run a digital marketing agency?
- The riches are in the niches – The most profitable agencies aren’t those that do everything for everyone. It’s those that deliver one service to one set of people. For example, an agency that handles SEO for only realtors. It’s tempting to be a jack of all trades when you’re starting. But it’s always better to start small and expand from there.
- Focus on service-market fit – The best hack for scaling agencies from $0 to $1M quickly is to polish your service-market fit. That means you should determine which customers have the most need for your service. For example, it makes more sense for a Google Ads agency to go after e-commerce businesses than law firms.
- Optimize your SOPs – While going from $0 – $1M is all about the service, scaling from $1M – $5M is all about processes. Since most 7-figure agencies have teams of 5+ employees, it pays to record your SOPs and have them uploaded to a platform like Notion. This eliminates the need for constant supervision and ensures the quality of your agency’s output stays consistent.
- Retain former owners – The smaller the agency, the more important it is to have its founders stick around after the acquisition. This is because founders in small agencies usually hold all the relationships with clients and handle all the sales. If they walk out the door, so does your revenue. Don’t be afraid to keep the former owners on to help with the transition. Have them hang around in exchange for 20-23% in phantom equity.
- Use project management solutions – Use tools like Atlassian and ClickUp to track your hours and communicate internally and with your clients. This way, you’ll quickly figure out where you’re spending too much time vs where you aren’t & which clients are profitable vs which aren’t. What gets measured gets managed.
- Work for free upfront – One of Codie’s agency owner friends has an interesting process for getting consistent deal flow. First, he goes on Crunchbase and searches for companies that recently got funding. After identifying his ideal clients among them, he scrapes the emails of their key decision-makers and sends them a proposal detailing what’s wrong with their current SEO and the precise steps he can take to fix them—and it works! Adopting this strategy not only builds goodwill with the lead but also demonstrates your agency’s expertise.
- Keep your clients in the loop – Clients who are constantly kept abreast of progress on their campaigns are more likely to stick around longer than those who aren’t. That’s why invoices should never be the only emails you send to a client. Create concise weekly reports that highlight key changes over a fixed time frame.
- Use pricing tiers – SaaS companies aren’t the only businesses that can benefit from staggered pricing. For example, instead of offering one package at a flat $10k rate, your agency can offer DIY, DWY, and DFY services at $5k, $15k, and $60k respectively. The psychology behind this is that people always want the best of what’s available, which often leads them to pick the most expensive item on the menu.
- Understand the role of location – The majority of the agency listings you’ll find will be remote assets, which leaves you with essentially no hassles on the real estate front. However, this is counterbalanced by the new challenge of managing virtual employees, especially when said agency uses overseas labor. When your payroll employs people from multiple countries, it becomes near-impossible to be legal and HR-compliant in every one of them. This is why it’s essential to use an all-in-one tool like Deel for contracting, payroll, etc. Not only does it ensure the agency stays on the right side of international law but also keeps financials tidy ahead of tax season and exits.
- Create content – Cold emails are great but nothing beats the feeling of a $15k deal falling into your lap because of a blog post you wrote four years ago. That’s why you should create content. Whether it’s blog posts, threads, or Tiktoks, craft content around your service and post them on platforms where your customers usually hang around. When you present your agency as a thought leader, you’ll drastically reduce your overhead costs and reliance on sales reps.
- Maintain relationships with clients – Contrary to popular belief, the most successful agencies don’t scale through marketing. They grow through word-of-mouth and client referrals. David revealed that agencies are in the business of people. By doing great work and keeping your clients happy, they will naturally bring in new customers.
- Always test your new hires – The quality of your agency’s work is only as good as the people in it. Never make an employment offer until after a candidate has completed their paid trial period. This selection process weeds out people who excel at interviews but are actually terrible at the job.
Ready to jump into our more advanced content? We’ll meet you where you’re at.
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