(Excerpt from Selling Your Marketing Agency)
A multiple of LTM EBITDA is the standard method of valuation for agencies, but that’s not the formula used to value technology companies. Indeed, it’s not uncommon for tech companies that are losing tons of money (negative EBITDA) to be valued in the billions of dollars. Often, tech companies are valued on a multiple of revenue instead of EBITDA. And these valuations can be as much as 100 times revenue!
To put that in perspective, if you have an agency with $10 million revenue and $2 million EBITDA, you might be worth $10 million, but a tech company with $10 million of revenue might be worth $1 billion!
Given the vast difference between these two valuations, it’s not surprising that some agencies try to sell themselves as technology companies rather than as agencies. Can this strategy work to achieve a higher valuation?
The answer, like everything when it comes to valuation is . . . it depends! First, to call yourself a tech company you have to build actual tech. Buying off-the-shelf software programs or having an IT staff that helps you get all of your data into the Cloud does not qualify you for tech company valuations. To be considered a tech company, you need to build proprietary software or hardware (for marketing agencies, it’s almost always software).
Second, the technology needs to enable exponential growth for your business. Tech companies get sky-high valuations—even when they’re losing tons of money—on the assumption that their tech will someday enable them to make massive profit. The tech may cost a lot to build, and during the building phase the company doesn’t make money, but at some point, the company can bring on new customers at virtually no incremental cost per new customer. At that point, profits grow dramatically. That investment is reflected in a reduced EBITDA for the investment periods. Therefore, a seller will need to make the case that a buyer should look at a normalized level of EBITDA that accounts for the investment. This is often a challenging give-and-take discussion in the M&A context.
Thus, an agency will only get a tech valuation if the agency can demonstrate to acquirers that the tech it has built is going to someday create exponential growth, both in revenue and profit. That said, in these cases, the improvement in valuation is not exponential in comparison to the aforementioned SaaS valuations, but can add a premium.
Non-scalable tech can still benefit an agency’s valuation. If an agency has tech that improves the EBITDA of the business, that increases valuation.
