Buying a new capability: should you acquire, build or partner?

In short: Start with the evidence of demand, because all three routes fail without it. Then judge the routes on speed, investment and what is at risk, who owns the clients, IP and data, how quality is controlled, key person exposure and how easily you can change direction. A partnership can test demand before capital is committed. Building keeps control and takes time. Acquiring is fastest to a credible capability and carries the most capital, integration and key person risk. The answer depends on how certain the demand is, how central the capability is and how much management capacity you have.

Start with demand

The question usually arrives as “should we buy an agency that does X?”. The better first question is whether clients will pay for X from you, at a margin, for long enough to justify any of the routes. Evidence looks like: named clients who have asked and what they said; work you have referred out or subcontracted in the last year, and its value; briefs you have lost because you could not offer it; and what competitors who do offer it charge. Where the evidence is thin, the route that tests demand cheaply is more attractive, whatever the strategic logic.

Then ask how central the capability is. A capability that becomes part of how you are positioned, that clients will judge you on and that you want to own the IP and data for, argues for building or acquiring. A capability clients want available but will not choose you for argues for partnering.

A sector scenario

Suppose an experiential group with net revenue of £6 million finds that clients increasingly want content captured at live events and turned into social and campaign assets. Today the group refers that work to two production studios and keeps nothing. The founders are considering three routes, with the hypothetical figures below. Every number is an assumption for illustration.

• Build. Hire a content lead and a team of five, with kit, at a cost of about £500,000 in year one rising with the team. Credibility with clients takes time: an assumed £300,000 of revenue in year one, £900,000 in year two and £1.4 million in year three.
• Acquire. Buy a production studio with £1.2 million of revenue and £300,000 of profit for an assumed enterprise value of £1.5 million, paid £1.0 million at completion and £0.5 million deferred over two years, plus £100,000 of fees. Cross selling into the group’s clients is assumed to add £100,000, £200,000 and £300,000 of contribution in years one to three on top of the studio’s own profit of £300,000, £450,000 and £500,000.
• Partner. Agree a referral and white label arrangement with one studio: the group sells and manages the work, the studio delivers it, and the group keeps a 20 per cent margin on assumed billings of £400,000, £800,000 and £1.2 million.

The worked comparison

Contribution is before group overhead, tax and the working capital tied up in delivering the work, and the acquisition figures exclude the deferred consideration and any earnout from the contribution lines because they are payments for the business and do not form part of the cost of running it. The cumulative figures are nominal and ignore timing. On these assumptions acquiring produces the most contribution, and it also puts £1.6 million of capital and obligations at risk against demand the group has not yet proved, which is the trade the table is there to make visible.

Decision criteria

• Certainty of demand. Proven and recurring favours acquiring or building; plausible but unproven favours partnering first.
• Centrality. Part of your positioning favours owning it; a convenience for clients favours partnering.
• Speed. A client or pitch deadline that cannot wait favours partnering now, with a decision on ownership later.
• Capital and funding. Acquiring commits capital and future obligations; funding an agency acquisition sets out the full requirement.
• Talent and key person risk. Whether the capability lives in a few people you can hire, in a team you would have to acquire whole, or in a partner you cannot control.
• Control of quality, IP and data. Clients who will judge you on the work argue for ownership; regulated or sensitive client data argues against sharing it with a partner.
• Exclusivity and conflict. Whether a partner will serve your competitors, and whether you would accept being tied to one partner.
• Margin. Partnering typically earns a referral or management margin; owning earns the full margin and carries the full cost.
• Management capacity. The route the leadership team can run alongside the existing business.
• Reversibility. What it costs to stop if the demand is not there.

What would change the preferred route

In the scenario, the group might reasonably start with the partnership, because the demand is reported by clients but not yet contracted, the capability is adjacent to its positioning without being central, and the leadership team is already stretched. Three things would change that.

• If referred billings pass, say, £1 million a year within the first year and clients say they would prefer the work in house, the demand is proven and the margin being given away argues for acquiring or building.
• If a client makes content capability a condition of a major programme, speed and ownership matter more than testing, and acquiring moves ahead of partnering.
• If the partner serves direct competitors, or will not agree to the group owning the client relationship and the assets produced, the partnership is testing demand for someone else’s benefit and should end early.

Build becomes the preferred route where the capability is central to how the group wants to be known, where the people can be hired, and where the founders would rather absorb eighteen months of investment than integrate a business with its own culture.

A decision process and the evidence to gather

1. Write down the capability, the clients who have asked for it and the value of work referred out or lost in the last twelve months.
2. Decide whether the capability is central to positioning or adjacent to it.
3. Build the three route comparison with your own assumptions, including management time and reversibility as well as contribution.
4. Identify the conditions that would change the route, and the evidence that would show them.
5. If partnering first, set the test: duration, the billings threshold, the client ownership and IP terms, and the exit.
6. If acquiring, move to planning an acquisition: criteria, origination, underwriting and the funding case.

What to do next

Gather the demand evidence first; the route often becomes obvious once it is on paper. If an acquisition is the likely answer, our buy an agency page describes how we support buyers from strategy and origination through to completion, and building value covers what a new capability does to the value of the group itself.

Written by Rick Palmer and Rob Reid, founding partners of Motion Advisory Partners. General guidance, not advice on any specific business or transaction. Legal and tax points vary by jurisdiction and should be checked with appropriate advisors.