Cashflowing with Digital Agencies - Acquire or Vertically Integrate

The Ultimate Guide to Making Wifi Money

Welcome to another edition of a Cashflow playbook!

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 CT: ‘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.

Summary

Intro:

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?

Interview

David has been running digital agencies long before they were cool.

He launched his first agency, 3Q Digital, in 2008 after working at a different agency for 8 years.

3Q Digital started with Search Engine Marketing (SEM) as its sole service. But now, it’s a full-service digital marketing company that offers it all—paid media, conversion optimization, performance marketing…you name it. Much of that was added on with M&A.

Within six years, 3Q Digital scaled from a one-man operation to an agency generating $10M in annual revenue. And after a few rollups, that number quickly crossed $15M+.

Since 2008, David has bought two 7-figure agencies and sold one. And while he’s no longer involved in the day-to-day operations at 3Q Digital, he sits as an advisor on its management team.

David successfully started and scaled a digital agency through one of the worst times in the US economy. So we figured if anyone had sage advice on how to buy and run a 7-figure agency, it was him.

That’s why we sat with him to get the scoop.

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Playbook

Your step by step on passively cashflowing or growing your current business with a vertical acquisition of a marketing agency.

Step 1: Where to Buy An Agency

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 masterminds, 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: Understanding the Types of 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. Which 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 ecommerce businesses, or more recently, Tiktok ads.

Step 3: Doing Due Diligence

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 100-item checklist you can use to kick things off…

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 Codie recommends 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.

The importance of CAGR in online agencies - this 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 in order 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.

**To view the rest of the playbook and access your resources, visit the vault!**

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