Your IP is worth more than Billable Hours
So, which are you going to choose?
You have a choice. You can either continue to charge your time out (and that of your employees) on a billable basis, or you can use your resources instead to productize what you do. You might think that the choice of one or the other is just down to personal preference. But it has a potentially massive impact on the enterprise value you are creating in the long run.
What’s more, most agencies are already sitting on potentially valuable IP. They just don’t know it.
The problem with billable hours
The biggest problem is that it’s hard to scale billable hours. Any of us who has run an agency knows that it’s very hard to spin up and down billable hours. Maybe it’s easier if you use an outsourced company, but even then it’s not totally straightforward. At the SaaS business that I co-founded we had a couple of years where we were growing at a rate of 3x year on year. If you’re selling software, tripling in size in a year has its challenges, but it’s not going to be as difficult as tripling an agency in the same period. Hiring is expensive, onboarding is expensive, dealing with hires who don’t work out is expensive.
At the same time, there may be repeatable code or systems that you’ve developed are just sat there being used to help you do your job better, when they could be sold as a product instead.
But, perhaps even more concerning than the fact your own IP isn’t working for you, is that you are working hard building a business that could be worth a fraction of what it could be if you changed your focus.
Valuations
Let’s have a look at how businesses are valued. Obviously goes without saying that market sentiment changes over time and these numbers are indicative of what I think companies are getting valued at now from a little research. But you should do your own and see if you agree.
Let’s look at three business models:
1. Agencies with billable hours
Most service businesses are valued using EBITDA multiples.
For small to mid-sized agencies, valuations tend to fall in the 3x–5x EBITDA range (although could be higher if there were exceptional aspects to the business’ client base or growth).
If your agency generates $2.5M in Revenues and $500K EBITDA, it might sell for $1.5M–@2.5M.
The reason for these relatively low multiples is because agencies are people-driven, not asset-driven. Buyers see them as risky because revenue depends on keeping key employees and clients happy. If a few key people leave, the agency’s ability to generate revenue can take a huge hit.
2. Agencies with Productized Services
Still probably valued on a multiple of EBITDA, but a higher multiple. Maybe 4x - 6x. This is because a productized service is more sticky and may be less reliant on people, or at least there is less of a direct correlation between project size and people costs.
An agency with Productized Services doing $2.5M in Revenues and $500k EBITA, might sell for $2M - $3M.
3. SaaS Businesses
SaaS Businesses are normally valued on a multiple of Annual Recurring Revenues (ARR), rather than EBITDA. Although good or bad EBITDA numbers can also influence the valuation. Here, the multiples at the moment are in the 5x - 10x range.
This means a SaaS Business doing $2.5M in ARR, could be worth between $12.5M and $25M.
Whether my multiples are a bit out, you can see that the difference between the value of an agency and the value of a SaaS doing the same revenues, are pretty significant.
Is your IP that valuable?
You might be thinking, ‘great, but do we really have any IP that we could turn into a product?’ Which is a fair point. Many agency owners assume their IP isn’t worth selling because they think:
"Every client is different - there is nothing repeatable we can turn into a product.”
"Our work is too customized. It would be impractical to create a generic version of what we do"
"No one would pay for our internal tools. There’s nothing particularly clever about them."
But if you step back, you might see that your clients are asking for the same types of solutions again and again. You may think the value comes from your unique creativity - and that may be the case. BUT… some of the value you provide might come from just knowing how to make something work well. We tend to think things that are second nature to us are second nature to others, too. But that often isn’t the case.
I’ve no idea how to change the oil on my car. Maybe it’s easy. maybe it’s not. But I’m happy to pay an expert to do it for me in case I get it wrong.
If your agency has developed a process, framework, or tool that makes delivering results more efficient, that’s a valuable product in disguise—and your clients already see the value in it. I would ask myself a few simple questions just to see if there isn’t something sat in plain sight.
What problems do you solve repeatedly?
What frameworks, templates, or tools have you built to make servicing clients quicker/easier?
Could any of these be packaged into a standalone product or SaaS?
An example of where it’s worked
I generally like to illustrate my points with hypothetical examples, but here’s a real one:
Pixl8, an agency worked for many years for Membership Organisations building them websites. They realised that they could productize much of what they did for their clients since there was a lot overlap between clients’ needs for these projects.
They created a platform called Ready Membership that productizes a lot of what they were doing for their clients on a project-by-project basis. They also have a healthy degree of agency services that go on top of that since given the types of engagement they have.
But they are also looking at what IP they have within their stable that could be turned into a pure SaaS offering. And there is a lot of choice. At some point in the near future I hope I’ll be able to come back and tell you more about those.
In summary
I just wanted to do a bit of a rallying call to service business owners who are still on the fence about this. The more you delay things, the more you are ploughing your blood, sweat and tears into something that won’t deliver you the same financial value for you and your family that you could get if you created a product business delivering the same revenues.
Maybe you don’t start with a fully-fledged reimagining of your agency as a SaaS business on day 1, but if you can start nudging your way in that direction, it could be the best financial decision you take over the long term.
