Art Stevens Managing Partner StevensGouldPincus

"For example, there was a firm purchase today that will be released soon, and Ohio-based Edward Howard also recently merged with another regional firm (Fahlgren Mortine Public Relations). We are seeing more action and there certainly seems to be a stirring." While many of these may be smaller deals, they may also be an indicator of growth—and clearly underscore that PR is a hot new growth area for companies looking to expand again.

In addition, larger holding companies have not closed the door to acquisitions this year, and are looking selectively at specific niches, geographies and capabilities, according to Stevens. "Generally speaking, the number one hot practice area is interactive digital and social media. Healthcare is still very hot, and public affairs is becoming increasingly important. While it will be tough for an agency to acquire a PR firm in D.C., a lot of buyers will want to add public affairs expertise in state capitals this year. That will be a hot area where we'll see a lot of movement."

Other emerging acquisition areas, according Stevens: "IR will be hot, as well, given the catch-up that public companies have to do in 2010. They really need IR help to do that." Similarly, he says, "Geography will become a bigger factor in 2010. General agencies in certain geographies may become wanted targets. The Edward Howard deal last week is an example of that [two regional Ohio firms joining]. The ‘A' markets will stay strong, with a New York City firm wanting a Chicago firm, a Chicago firm wanting a Los Angeles firm and a Los Angles firm wanting a Seattle firm," he explains, adding that secondary markets from Des Moines to Oklahoma City will also be interesting to watch as medium sized firms look to add to their bulk in these and similar areas.

So how can you get in on the bullish action moving forward? How can a firm best prep itself to be acquired? What elements do acquiring companies look for in a firm? What should a firm or owner not do if you are hoping to be acquired? Stevens and others share these tips:

Brad Schwartzberg Davis & Gilbert

Margaret Booth President M Booth & Associates

Abby Gouverneur Carr Managing Director Bliss PR

"It's important for sellers not to go on autopilot," he cautions. "Instead, take a step outside and ask what you want for yourself and your company. Go through that drill fairly regularly. It takes time to implement deals based on those goals—and they may change.

Abby Gouverneur Carr, managing director of Bliss PR, agrees. In 2006, she helped sell Bliss Gouverneur & Associates in a four year deal to CommCor (renamed The Dudnyk Exchange). "If you aren't in negotiations already by now, then you're frankly not selling this year. But you should lay the groundwork now. Use this article to get you where you need to be, because few deals get initiated and consummated quickly."

Schwartzberg elaborates: "The most important thing that a PR firm can do is to engage in the process of preparing for a sale before it's even on their radar. These things are time intensive. PR firms are bought and sold for the most part pursuant to an earn-out transaction. Even on the day you close, you will only realize between 20 and 50 percent of the purchase price, and the balance will likely be paid out over the next three to five years after closing."

His point: "If you ignore how your company would look to an acquirer and wait until the day you're ready to sell, you'll be sorely disappointed. There are a number of things you need to implant early on, and you can't get started on those things soon enough."

3. Show you are financially sound. "Most important is to get profit margins to 20% or better," says Booth. "The higher the margins, the more valuable your agency." Stevens elaborates: "Last year's margins averaged around 11%. PR firms will do better in 2010 and should be able to get ratios back as near 20% as possible. That will enable a buyer to come to conclusion that you're reasonably well run."

"If you are under 15%, you're not ready for sale," Schwartzberg asserts. "Focus instead on growing revenue topline or cutting expenses. This allows you to evaluate your company before you're under the microscope of a buyer."

Then prepare accrual-based financial statements in accordance with GAAP, advises Schwartzberg. "That's what a buyer will demand to see as soon as you exchange confidentiality agreements. Consider working with a respectable accounting firm on ‘compilation' or ‘review' level financials. An ‘audit' level won't likely be necessary."

"PR firms tend to be acquired and priced on multiples of pre-tax [EBIDA] profit in accordance with GAAP. If you don't have these financials ready to go now, then you have no idea what you're worth in the open market. So engage an accounting firm now and start the process," suggests Schwartzberg.

4. Build a solid second-tier management team. Without your client base and second tier management locked in, you have nothing to sell, according to our sources. "You must grow and keep your clients—long standing client relationships are key," says Booth. But equally important is to, "Nurture your senior team. Buyers want to see possible succession. It's important that your senior leadership is being groomed to take over after the earn-out is complete."

Otherwise, Schwartzberg, says, "A buyer will just move on. Buyers know all the purchase price goes out the door if your key staff walk."

Daniel Lemin Director PainePR

Carr adds this perspective: "Focus 125 percent on your biggest clients and serve them like crazy. But also, don't wring the last drop out of your people. They and their client relationships really are what you're selling. If you end up with bitter, disloyal employees—well, you have nothing to sell." Her tips:

• Practice greater transparency. "Be completely transparent with employees about firm profits and losses, as well as your search or goal to find a buyer."

• Compensate competitively and offer equity. "First, consider tying half of your bonuses to how the firm does and half to how they do as employees. In addition, open up to offering equity. At the time we sold, there were two full partners and two junior partners—and they all had a piece of equity. Junior partners had about four percent—and they were the most critical to keep. As a result, we didn't lose anybody in the transition."

• Create a culture of retention. "We offered ample vacation time and stress busters in terms of events and parties," recalls Carr. "The point here is to create a culture of retention. If you can't improve retention rates before a potential sale, then there's something wrong with your leadership."

Stevens puts a finer point on it: "Buyers really are buying people on accounts. They want to make sure there is strong management that will stay in place if and when the owner who sells decides to leave. So be sure to retain key managers. Don't let them get away during any acquisition. The managers are the ones who got you where you are. Make sure they stay with you so they can help take the new firm into the future. If the firm has conversations about being acquired," he adds, "then make sure your secondary management tier is locked in and retained. You can do that with phantom stock, actual stock, incentives and other equity in the firm."

Schwartzberg also suggests tying your key managers to the deal by setting it up so they share in the purchase price proceeds. "This motivates the person not to leave."

The big point, however, is to "Create some form of compensation matrix that ensures these people are motivated to stay with you and continue to grow the company now, through the sale and after," Schwartzberg concludes. "If you don't build good incentive equity and appealing non-equity based compensation levels, it will be tough to sell."

5. Know what acquiring firms are looking for. "A big thing firms look for is compatibility," stresses Booth. "Does the client mix work? Can the firms' cultures get along? Will leadership of the acquired firm see eye-to-eye with their new owners (how hard will they be to manage)?" Next on this list is growth, she says: "What is the growth potential of the agency? Is it poised to increase its revenue? Does it have an effective profit model?"

Kathryn Morrison, President and CEO, SunStar

• Deep expertise. "As buyers, we are looking for true expertise and knowledge of the players in your sector. We are looking at your book of business. Do you know all the companies in wind, solar panels or energy cells? Can you call the players and get us in the door? That's what a buyer wants," assures Morrison.

• Audited books. "This makes a big difference and is better than non-audited," she says, echoing Schwartzberg's earlier comments regarding financial strength.

• Culture match. "It needs to be a match," she says. "For example, we are entrepreneurial, so we're looking for an entrepreneurially minded firm. We want a PR firm whose book of business is not the GE's of the world, but whose clients are the smaller entrepreneurial firms."

• Tax friendly corporate structure. "The kind of corporate structure must also be match," says Morrison. "For example, your taxes should probably be set up like an S corporation's. Otherwise, the taxes on the transaction can become a bigger liability."

• Commitment. "Buyers want to work with someone committed to the business. For example, you could put part of the purchase price into a work-out, where you get paid X amount up front and the rest will be worked out by reaching Y and Z targets over a certain time frame. Deal points can be negotiated that support this. If someone is committed, they will embrace these approaches."

• Integrity. "Referrals count," assures Morrison. "They help get to the integrity of the principals, which is a definite checkpoint on my list of criteria."

• Payout flexibility. "A buyer will also look for flexibility in how you're going to be paid for the acquisition. For example, let's say yours is a small firm and you think your business is worth $4-5 million. If you say the buyer has to pay that all out in two years, then they may come back and agree—but only if the buyout is $4 million. If it's $5 million, then they might offer to pay it out over five years."

6. Avoid these cardinal sins and common mistakes. Middleberg says the biggest mistake a seller can make is not being realistic with expectations. "I've honestly never heard of a deal working out where there's 100 percent real synergy," he explains.

Morrison adds these no-no's to the list:

• Hoarding cash. "Companies hoard cash and try to increase their free cash flow as much as possible," says Morrison. "But as a buyer right now, I would rather see a company investing in learning where the new winners are. Invest in growth, that's my advice."

• Not diversifying. "If too much of the business is coming from too few clients—that's a red flag. Forty percent of your business coming from one or two clients is a problem. That would scare me away," Morrison says. "Instead, broaden client base within your specialties."

• Allowing churn. "Turnover of staff or clients is a big warning sign. Is the average employee staying a year or five or ten? The secret to keeping clients a long time is having happy employees. Churn in staff means churn in clients—and that will turn buyers away in droves," cautions Morrison.

Stevens puts it this way: "Business has been off these past two years, but the worst thing you can do is continue to spiral downward as everybody else starts to increase in 2010. Don't sit on your laurels—or your hands. Keep generating new business and clients while shopping yourself around. Show you're a magnet to new clients."

But Booth stresses the foremost mistake agency owners make is to get too anxious. "Wait till they come looking for you, if you can," she advises. "It is always better to sell when you don't have to or really need some convincing to make the deal."

Carr concludes with this similar perspective: "Know what you want and don't be afraid to walk away if you're not getting it. Don't be impatient. You can't engineer the outcome or time frame like you'd want," she stresses. "From the time we met CommCor to the close of the deal was over two years. We got what we wanted, but it took a long, long time. It's easy to get anxious. Take a deep breath. Don't make a stupid decision because you're trying to rush through it."

—By Brian Pittman