You've found what appears to be a good opportunity to purchase another agency. You've done your homework: completed due diligence, carefully considered the risks and formulated pro forma income and balance sheet statements based on realistic assumptions. But even after all this, how can you be sure it's really a good deal? How do you judge whether it will be successful?

Here are some tips to help with seeing clearly through the fog of acquisitions. In short, a deal is good if you know what you want and you get what you want. Sounds simple, but it's not.
Know your goal
The first step is determining the goal of an acquisition. What do you want an acquisition to do for your agency–and will it actually accomplish that goal? Far too often, consultants and investment bankers tell clients a deal is good or bad based on their own standards–not on whatever the client is trying to accomplish. To use a sports analogy, think of acquisitions in terms of the NFL draft: If the best player available is a running back, but your team really needs a defensive end, which player do you choose? Not the “best” one, but the one that's best for you.
Even if a deal is never profitable, it may still meet an agency's needs. In his book “The Black Swan,” author Nassim Nicholas Taleb observes that a key reason so many M&A deals lose money for the buyer is that the alternative is worse. In other words, an acquisition may lose a company $5 per share, but the buyer estimates that without the deal the loss would be $10 per share. The better choice for the buyer, then, is doing the deal.
Define the parameters
When developing your acquisition goal, carefully consider the parameters necessary to define that goal, such as profit, growth, risk and time horizon. As an example, consider two buyers and two deals:
Deal One: No significant risks, 45 percent earnings before interest, taxes, depreciation and amortization (EBITDA), 5 percent growth in a very soft market, and a price of 2.3 times revenue.
Buyer One is looking for quick growth, so he turns this deal down because it doesn't pay for itself in three years and the profit, including amortization, depreciation, interest and taxes, is only 15 percent.
Deal Two: No significant risks, 40 percent EBITDA, -3 percent growth in a soft market, and a 2.8 times revenue price.
Buyer Two is looking to expand the agency's sales force and believes this deal is a steal because EBITDA is 40 percent and the deal pays for itself in eight years.
These two buyers have very different goals and parameters. The investment time horizon is one obvious example. One buyer is extremely patient and the other is not. However, neither is right or wrong (regardless of what MBAs may declare). The key is whether the deals are profitable within the chosen time horizons.
Who made the better decision? They both did. Both buyers set their goals, knew their parameters, made their decisions accordingly and are happy with the results. You or I may have chosen to go a different direction if they'd been our agencies, but so what?
Match your goal to your situation
Problems develop when buyers do not clearly understand their own goals, which is often the case. Let's twist one of the examples above. If Buyer Two doesn't mind waiting eight years to break even, are acquisitions really the best strategy? After eight years, a very large percentage of the accounts purchased will no longer be with the agency. At an annual 90 percent retention rate, only 43 percent of the original accounts will remain after eight years. With that much time and business lost before turning a profit, could the buyer do better by building a strategic organic sales platform instead?
The answer depends on the buyer. Many agency owners cannot build a strategic organic sales platform. They may not have the culture or the expertise to do so. Whatever the reason, even if all they gain in an acquisition is a sales platform with a few customers thrown in, at least they understand their goals, weaknesses and strengths. They're not fooling themselves into believing they're purchasing a strong book of business whose customers will stay with them forever.
That's the benefit of making an honest assessment of the situation and knowing what you're after. The buyer can build upon the true value of the acquisition, which for him is the sales platform. An acquisition need not be ideal by some lofty impartial standard to benefit an agency. It just needs to benefit your agency and your needs.
By contrast, the buyer who does fool himself will not take action to support the sales platform and will soon be wondering where all the customers went. This buyer will fail to recognize that what he wants and what he's buying are two different things.
Use the correct measurements
Beware of using EBITDA to measure profit. Many buyers (and some sellers) who do not really understand EBITDA believe that it's the coolest measure of profit margin known to mankind and name-drop the term as if it were the secret key to acquisition success. Remember, the Securities and Exchange Commission has advised investors not to use EBITDA to make investment decisions.
The problem is that EBITDA excludes the amortization cost of acquisitions, and for an acquisition amortization is the price of growth. As a result, EBITDA falsely gives the impression that acquisition growth is free. But growth always costs money. The cost of organic growth shows up on the income statement as compensation, benefits, advertising, marketing, entertainment and training. Acquisition growth shows up almost entirely as amortization, but EBITDA erases virtually the entire expense. EBITDA provides instant growth for free! Except free growth is fictional.
Investment bankers love EBITDA because it makes firms doing acquisitions appear vastly more profitable than those growing organically–and investment bankers make money on acquisitions, not organic growth in the service industry. When comparing organic versus acquisition growth, net post-tax profit is the best measure for privately held agencies and brokers.
So, how does your acquisition look now? Does it meet your goal? Does it fit your parameters? Does your goal support your true situation? Once you're keeping score using the appropriate methods, your success should be very easy to measure.
Chris Burand is president of Burand & Associates LLC, an agency consulting firm. Readers may contact Chris at 719-485-3868 or by e-mail at [email protected].