Its over thirty one years ago since weatherman Michael Fish made his fateful broadcast. During his lunchtime TV slot he confidently reassured viewers that no hurricane was on its way. How (spectacularly) wrong he was became obvious just a matter of hours later, when the country was battered by the greatest storm witnessed in three centuries.
As forecasts go, Michael’s was pretty lame. As was the then CEO of Microsoft, Steve Ballmer’s prediction about the first iPhone in 2007: “There’s no chance that the iPhone is going to get any significant market share” he said, “No chance.” Nice one Steve.
Finally, spare a thought for the executive at Decca records who rejected the Beatles in 1962 telling the band’s manager Brian Epstein, “the Beatles have no future in Showbusiness.”
What none of these otherwise perfectly sensible people were able to see was what the future looked like. Nor can we – which is why we don’t like forecasts. Not because we’re prejudiced but because, well, they’re pretty flaky things on which to base important business decisions; like valuing an agency.
Rubbish in, rubbish out
Forecasts are projections. Or worse, they’re calculated conjectures. So when people talk about getting their forecast ‘wrong’, it’s not the forecast that’s wrong, it’s the assumptions that were made at the time that the forecast was put together. (Rubbish in, rubbish out, you could say)
To make matters even worse for our would be agency sellers, one of our partners, Edward Goodchild has had a lifetime spent in the financial services industry where the mantra is, “past performance is no guarantee of future results”.
Mm. If we don’t like forecasts and we don’t like taking the results achieved in previous years as the basis for projecting them forwards into the future, then what do we like? Well, the good news is that we do like something even more ephemeral; goodwill.
Why we won’t use forecasts as part of the valuation process
Agency owners often optimistically present us with their forecasts for the years ahead and ask us to factor them in to our valuations. (Which as they’ll only sell their agency once is fair enough!) However, putting a value on the future is a bad idea. Not because we don’t believe growth isn’t possible or measurable to within an acceptable degree of accuracy, or because we don’t appreciate that a growing company is more valuable than a flat lining one. We don’t like incorporating a value based on the future into our assessment for three reasons.
Firstly, agencies are normally goodwill businesses only. By that I mean we buy no assets. We buy customers, people, processes and a track record of performance (Even Ed begrudgingly agrees with this). We make a judgement that we can manage an ownership transition through and achieve similar results after we’ve bought the agency. We pay owners a multiple of their profits to recognise the goodwill they’ve built up in their businesses and to help them release the value they’ve created. That multiple is based on past performance because it’s goodwill.
Secondly, valuing on the future usually means the C word. Contingency. While our standard purchase agreements ask owners to warrant revenues to historic levels, asking them to warrant future revenues is a lot more difficult. Future valuations are contingent on growth and if growth doesn’t materialise, things get messy. We can work with contingency. But, in every offer letter where we’ve proposed it, it’s been rejected by the agency owner. No-one like betting on the future. Why should we?
Thirdly, our agency owners typically want to slow down once they’ve sold up. A payment deferment schedule is standard practice, so post-sale we’ll normally have at least a two-year involvement from vendors. But their time-on-task typically tapers pretty quickly. Throwing in stretch targets with contingency-based payments over three or four years does exactly the opposite of what most vendors want. Just when they’re looking to reduce their golf handicap, they find they’re working harder than ever. Instead of being their own boss, they’re slaves to their forecasts. It just isn’t why most owners sell their agencies to us.
We’re backing our own judgement
I’m not saying that forecasting isn’t an important part of the business planning process, clearly it is. We use forecasting ourselves. In fact, when we’re valuing your agency prior to making an offer, we’ll be creating our own forecasts of your future performance. The critical difference is this. We’ll build in a significant margin of error (or confidence) so we won’t later claim we got the forecast ‘wrong’. Essentially we’re backing our own judgement here.
We’ll also pay you for what you bring to the table. If you bring a well-balanced profitable and specialist agency with balanced pillars, we’ll pay well. But, the future is our risk and our risk alone. Not yours. We’re prepared to back ourselves and take that risk. But if you think the future is so bright that we simply must put a value on it, then I’d say you’re not ready to sell – at least not to us. Deliver the growth, take the value that you have worked hard to create and then come back and we can talk again.
Dom has spent nearly thirty years as a marketer. He started his marketing career in creative communications agencies before starting a business which he built from the ground up, exiting in 2009. He then consulted to tech and service companies before putting Selbey Anderson on the launch pad. Today, he leads development of the group strategy, M&A and performance.