Martin Sorrell has resigned from WPP, the marketing group that he founded in 1985, leaving behind many wealthy executives. His largesse is reflected in the 400 companies that WPP lists as subsidiaries, the 43 small agencies that it bought last year alone, and the £13bn of goodwill on WPP’s balance sheet.
Wire and Plastic Products, the company he used for the longest acquisition spree in advertising, was not in the business itself. Sir Martin used it to buy everything from J Walter Thompson to Young & Rubicam and to defy the broader trend against holding companies. WPP held any agency going, apart from those acquired by Publicis, Omnicom and other rivals.
Many people in advertising regard themselves as creative — there are “creative data analysts, creative media buyers, creative media planners,” Sir Martin explained recently. But they are most creative at rewarding themselves by founding boutique agencies, selling to WPP and others, waiting a few years until their acquisition earn-outs expire, and then starting again.
The creative carousel paid for a lot of houses, boats and divorces; Sir Martin did well himself, taking home £48m in 2016 and owning about 2 per cent of WPP. His resignation places the process in peril. WPP is not alone in suffering from the industry downturn; the carousel is slowing and may grind to a halt.
That drags on the entire “creative economy” — the ecosystem of little marketing, media, design, public relations and technology companies that have flourished in service sector economies. Ninety per cent of creative businesses in the UK employ five or fewer people — the partners and a couple of others — and many would like to be taken out by an acquirer.
It worked like this. Imagine that you and a partner founded an advertising and public relations business that did well and made annual profits of £3m. You could persevere, counting on continued growth and paying yourselves well in cash and dividends, or you could sell to a company such as WPP. You were entrepreneurial by nature but even risk-takers crave some security.
The holding group offered £20m for the business, a third of it immediately and the rest paid over four years for hitting targets. Each partner’s £10m capital gain was taxed at 10 per cent in the UK under the entrepreneurs’ relief scheme. This meant two post-tax payouts of £9m, compared with remaining independent and paying 40 per cent or more on income.
You gained tax-efficient wealth by selling the business at seven times its earnings, and the holding company raised its value by more than the acquisition price because it traded at double that multiple until recently. When the earn-outs expired, you could demand more money to stay, or leave and start another boutique.
It hardly made you into Mark Zuckerberg but it made you comfortable and one can see from the sheer number of companies that WPP and the rest acquired that it appealed. “A lot of this is basically tax arbitrage,” observes one beneficiary of the carousel. The financial details differ by country, but lower capital gains tax rates and incentives for entrepreneurs are common.
I do not begrudge them their liquidity events. Being an entrepreneur is harder and riskier than those watching from the sidelines tend to imagine, and houses are expensive in cities where marketing types cluster. The process has driven economic activity in London, New York, Paris and the like.
But it requires there to be enough money to finance an ecosystem of high margin businesses, all contributing a small slice of innovation to the whole. That means a lot of intermediaries to support. It is now threatened, both by internet companies led by Google and Facebook controlling the bulk of digital advertising and by big clients cutting their marketing budgets.
Sorrell’s departure makes it harder for founders of advertising agencies to become rich
Sir Martin insisted before his departure that WPP’s woes were due more to the latter than the former: it faced a cyclical, not a secular squeeze. In the end, it comes to the same thing. When Marc Pritchard, Procter & Gamble’s chief brand officer, complained recently that creativity was “surrounded by excess management, buildings and overhead,” he described the carousel.
This recalls the go-go years of the music industry, before a wave of piracy crimped the high life for hundreds of labels and the tastemakers who wielded influence over bands. Working in “artists and repertoire” was a secondary form of creativity but a primary source of wealth creation.
A & R has flatlined — the industry estimates that the sum it invests in discovering and developing bands grew only marginally to $2.8bn between 2011 and 2015. There lies the future of marketing agencies: a prolonged squeeze on the fixers in the middle.
Advertising’s entrepreneurs will no doubt apply their creative minds to finding other acquirers. Consulting firms such as Accenture are flocking into the business and Sir Martin noted last month that some US digital agencies were on sale for prices that even he would not pay. But his departure after three decades at WPP removes the biggest media buyer of all.
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