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May 16, 2008

Huge Growth + Talent Shortage = Increased M & A Activity

Last week I wrote about how the SEO industry is growing up. Tremendous growth and low barriers to entry are / will attract many new entrants to the market.

But with formal SEO training not yet available on mass (i.e. taught in colleges), this growth is going to leave us with a talent shortage.

Essentially, large companies who want to get into this business are going to be forced to buy their way in.

In order to prepare your shop to possibly benefit from this increased M&A activity, it is helpful to have a sense of what factors will make you attractive to a perspective purchaser.

But one size does not fit all.

The evaluation of a one man shop is entirely different from that of a large Agency .

There are many one man shops that are hugely successful. In fact many of our most authoritative industry experts are sole proprietors.

Like it or not, YOU ARE the business. Your business has little value unless you come with it.

Potential buyers – Your potential buyers are likely those looking to “buy talent” and/or credibility. A new entrant to the SEO Industry can say that they’ve been “doing SEO” for as long as you have.

What makes a one man shop desirable?

1) Reputation / Brand – To be attractive to a potential buyer in this scenario, you MUST have a well known name in the industry. Ideally, you will have case studies from recognizable brands. Further, active participation in the industry increases your credibility as an authority.

2) Re-occurring Revenue Stream – A re-occurring revenue stream will also be important to your valuation as it is likely that your price will be a multiple of your revenue. Moreover, your established business (re-occurrent revenue) should be sufficient to pay for your future salary.

3) Top Line Revenues – An EBITDA (earnings before interest, taxes, depreciation and amortization) calculation doesn’t make a lot of sense to a one man firm as sole proprietors typically realize their profits as they are earned vs reinvesting.

In this case, a calculation should be made based on a multiple of top line revenues.

SMALL TO MID SIZED SEO FIRM (2 – 30 people*)
If a new entrant is looking to fast track it’s success by”buying the talent” that it requires then considerations around the size and strength of your team will be important.

1) Team Attributes – How many years of experience does your team have? Do you have high turnover? Do you have senior people filling key roles in your business?

2 Process – Process is also an important consideration. A new entrant doesn’t want to just buy talent, they want to buy the secret recipe……

  • How do you sell SEO?
  • How do you manage the work flow process?
  • Who is accountable for what aspects of the process?
  • Do you have checks and balances in place?
  • What does your reporting look like?
  • And to what degree is it automated?

3) Cash Flow – Cash flow will be an important consideration (nobody wants to buy a sinking ship) however if you’re having trouble collecting on your receivables, many companies will assume that once they take over, they can do a better job than you are (rightly or wrongfully so).

For a large SEO Agency, factors that make you attractive to acquisition focus much more on hard calculations than the softer considerations of small to mid sized firms.

*Note: There are lots of web design firms who claim to be in this category when in fact only a handful of their 30 person shop actually do SEO. This article differentiates between firms with an SEO component versus a dedicated shop of 30+ people who only do SEO.

1) Scalability – The strong team you were proud of as a small to mid sized SEO firm is expected of in a large firm. For a large SEO agency to be attractive for acquisition, organizational structure is critical.

Can the structure be replicated easily for growth? Are there established training programs in place?

2) Cross Sell Opportunity – New entrants will be looking for “fit” with their existing markets.

  • Is there an opportunity to cross sell between the acquiring company’s existing clients and your products?
  • Is there an opportunity to sell between your clients and the acquiring company’s products?
  • What about clients? Do you predominately service mom and pop shops while your perspective buyer mainly targets enterprise sized clients? Your firm will be less attractive if the purchaser is discounting too large a proportion of your business due to “lack of fit”.

3) Technology – Have you invested in proprietary technology that would benefit the buyer either by providing them with a competitive advantage or reducing costs?

Not only does an investment in technology give you an edge against the competition but it also shows long term strategic thinking.

The actual calculation
Keep in mind that there is a difference between book value and market value. A traditional “by the book” valuation will typically end up being a multiple of your EBITDA. Six times EBITDA on the low end and twelve times EBITDA at the higher end.

But EBITDA isn’t always the most fair way to measure value. When companies are growing really quickly, profits tend to be lower or non-existent. This does not mean that your company’s value is non-existent.

This is why in a pressurized environment like SEO, a calculation based on a multiple of your top line revenue may be the more appropriate measure even for large SEO Shops.

At the end of the day, what you’re worth really boils down to how much you’re willing to sell for. And with the industry booming, algorithms changing, new markets emerging – it’s still very much the wild west out there.

so, how do you put a price on fun?

Jennifer Osborne writer and marketer for Search Engine People.