How to Grow and Sell a Consulting Firm

A QUICK GUIDE How to Grow and Sell a Consulting Firm Growing & realising equity value in consulting firms

1 of 10 Introduction This guide is aimed at owners of small to medium sized businesses in the broad consulting or professional services sector. These are people businesses where the sale of time is the overriding objective of the company. Its purpose is to persuade you that there is a proven process to build a consulting business with strong cashflow and sustained profit growth. This creates a valuable asset and a wealthy future for you through the realisation of your equity using one of the exit options available. The reality is that most consulting firm owners are conditioned to believe that it s all about fee income, that there s no equity value in a people business, and you work until you drop, content (or discontent!) with an annual income. In this guide we are going to dispel that myth and show you how to maximise the value of your firm and make it attractive to investors. So read on if you want to earn a healthy salary, achieve cash flow growth, AND capitalise on the equity value of your firm by selling up one day. First, let s whet your appetite by highlighting the deal values for consulting firms in the M&A market, identify where your buyer may be coming from and introduce the most important equity value driver to focus on. Later in the paper you ll learn about the 8 levers of equity value, and the factors used in the valuation of a consulting business, all of which will help you build your equity growth plan and enable the sale of your firm for its maximum value. So what s my firm worth? It s probably the question on the tip of your tongue, so let s deal with it first! There are many factors involved in a valuation, however in simple terms your firm is worth a multiple of the last twelve months profits or revenue. Based on our own market research and direct experience of selling consulting firms, the average pre-tax profit (EBIT) multiple over the last 5 years has been 10 and the average revenue multiple has been 1.1. Furthermore, many people believe that mergers and acquisitions are only for the big players. This is not true as about 75% of all deals in the consulting sector are valued at less than 30m. In fact 4m is the most popular deal size, so good quality small firms are always in demand. Don t run away and put down a deposit on your Ferrari yet! There are big variations in the numbers, for example the average EBIT multiple may be 10, but the range goes from 2 or 3 to 40 and there are many other factors to consider for the particular circumstances of your firm and the market conditions at the time of sale. The recession in 2009 will inevitably reduce the market premiums we ve seen in the past few years, however it all comes down to how hungry a buyer is for your firm and what they re willing to pay for it! As we will go on to explain, the real value of your firm is in your ability to reliably predict profits into the future. If you have an ambition to sell, then the ideal approach is to benchmark your current value, assess the profit risks in the business (using the 8 levers of equity value below) and systematically work on strengthening each lever to build value over time.

2 of 10 Who would want to buy my firm? There are two main types of investor that could be interested in you; other consulting firms or service businesses (trade buyers) looking to bridge a gap in their growth strategy and those coming at it purely from a financial perspective, such as Private Equity. A trade buyer could be interested in you for a number of reasons: You re a competitor that will give them scale You occupy an adjacent competency space they want to fill You operate in a geography that they need to cover You have sector expertise where they don t You have client relationships they can leverage. Financial investors, like Private Equity houses, are always looking for a better return on their capital and larger mid market firms are being targeted because well run consulting businesses have a reputation for healthy profits and good cash-flow. Compared to other sectors, consulting service businesses don t suffer from the same kind of working capital demands, so there s plenty of free flowing cash to play with. This means they can use debt as part of the purchase structure, the so-called leveraged deal, and provide great returns to their fund providers. You may be surprised to know that in 2006 Investment Houses overtook Trade Buyers as the largest buyer type of consulting firms, however the recession is causing the pendulum to swing back the other way. Where s the equity value in a people business like consulting? OK, so we hope you ve bought in to the fact that the consulting industry M&A market is very active and quality firms sell for good prices. If you re investment ready there s a real possibility that you could sell your firm in the next twelve months, and if you re not, now s the time to put your equity growth plan in place and prepare for exit in the next few years. So how do you build equity value in a consulting firm and maximise your multiple? At first sight, a casual observer would place very little value on a people business as it would appear that all the assets of a consulting firm reside in very mobile people and laptops! However, as we said, in simple terms your firm is worth a multiple of the last twelve months profits and if you can convince an investor that those profits will continue, or indeed grow over time, then you have equity value in your firm. If you can t, then the value may indeed be low. So the key to equity value and the multiple applied to your firm is in your ability to reliably predict your future sales and profits AND show that the risk of you failing to achieve them is low. Therefore the most important equity growth factor by far is the creation of a sales and marketing process that delivers a healthy business pipeline and de-risks the traditional feast and famine issues often found in consulting firms. Sales and Marketing Process is crucial, but on its own it s not enough. There are seven other factors, each of which will either increase or decrease the probability of your firm delivering robust profit growth and impact your value multiple.

3 of 10 We will cover the Eight Levers of Equity Value next and this will give you a framework for an equity growth plan for your firm. Meanwhile let s just summarise what we have said so far: The consulting M&A market is very active and quality firms are in demand Trade buyers and investment houses are the most active buyers The 5 year average profit (EBIT) multiple at the time of writing is 10 Your equity value is based on a multiple of your last 12 months profits This assumes you can reliably predict profits into the future And finally You can increase your value and personal wealth using the eight levers of equity value. The Eight Levers of Equity Value So let s look in more detail at the factors that create equity in a consulting firm using a model we call the Eight Levers of Equity Value. We use this model to help value a business, but we also use it as a planning tool to drive the growth in profits and equity value of your firm in the right direction. It does this by focussing on the factors that drive consistency in profits and reducing the risk in your business. Even if you re a small firm with entrepreneurial flare, this is an opportunity to build for the future and start as you mean to go on! Let s just recap in simple terms your firm is worth a multiple of the last twelve months profit and when someone invests in your firm they re gambling that profits will continue, or indeed grow over time. Therefore if the risk assessment is high, then the multiple will go down, if it s low it will go up. The Eight Levers of Equity Value model is used to assess the risk, so if you get them right you ll drive up your multiple and build a real pension fund. Get them wrong and you may have to live off your annual income for a long time! Each lever is an area of opportunity to either increase or decrease the probability of your firm delivering predictable and robust profit growth. By assessing your performance in each lever and giving it a weighted score (some levers are more important to buyers than others), an overall risk factor can be developed. This is then applied to the current multiple for the prevailing market conditions to determine an equity value for your firm. Also, by benchmarking your performance in each, you can create an improvement plan to fuel growth and therefore increase equity value relative to profits over time.

4 of 10 So what would a buyer be looking for in a quality firm and what should you be striving for in each lever to grow your equity value? 1. Sales and Profit Growth Can you show a consistent growth in revenue and profits? This is the primary driver of equity value and a firm with a track record of erratic revenues and profits sends a concerning message to buyers and investors, so if you can show sustained revenue and profit growth AND high margins, you have an attractive proposition. Before you take you firm to market, you want to be able to demonstrate consistent growth over the last three years. Sales and profit growth is a reflection, or an output of your performance in the other seven levers and as we said, the most important factor is your Sales and Marketing Process. 2. Sales and Marketing Process Can you predict top-line sales revenue with accuracy? If you can then there s a high probability that you can forecast profits, which is why a quality sales and marketing machine is vital in the valuation equation, because it delivers a healthy business pipeline and derisks the traditional feast and famine issues often found in consulting firms. If you leave all your sales and marketing activity to a small number of rainmakers, or serendipitous sales opportunities, then you re hostage to a group of very mobile assets and your sales pipeline will be vulnerable and unpredictable. Investors want lead generation to be independent of any individual, with automation embedded into the sales and marketing process. A marketing-led firm, where prospects are attracted through a balance of pull marketing and push sales is more likely to deliver a robust sales pipeline. Overall they want a culture where sales and marketing is seen as an investment and not a cost, and by cranking the marketing handle faster you can drive more sales and cash into the business. 3. Market Positioning Does your value proposition provoke a WOW or a so what? The more unique, compelling and targeted your value proposition, the better you can demonstrate that your firm can command market attention with greater ease than its competitors and the higher you can push up your fees. If you re in the me too zone, then the risk of future profits is higher because competition risks are higher and you have to fight harder for business. Quality firms with a strong unique value proposition tend to have robust processes around such things as market research, competitor analysis and win/loss reviews. Notwithstanding your magnetism to the market, a clear value proposition helps you stand out in the crowd when a buyer is hunting for a firm like yours! 4. Management Quality Does you leadership team work on or in the business? An investor wants to see a balanced, experienced leadership team with a track record of delivering results, working in an environment where they spend more time working on the business rather than in it! If this is happening then the firm is likely to be innovative, focused, and tightly managed with good KPI measurement and financial control. If the management style in the firm is right then not only will your buyer see effective processes, but they will also see people willing to go the extra mile when they interview key personnel in the delivery team.

5 of 10 5. Client Relationships Do you have a well managed contact base and low client attrition? Quality of client relationship management extends from your account planning methods to the way you nurture influencers, decision makers, dormant clients and old contacts. Good firms employ methodologies like Miller Heiman s Large Account Management Process (LAMP) to protect and grow strategic accounts; they use a CRM or contact management system to assist in relationship development with individual contacts. Quality processes such as these enhance your ability to acquire, retain and build a client base, increase the revenue per client and improve the quality of your fee income. 7. Intellectual Property How much IP is in your very mobile people and laptops? A systematic approach to innovation, knowledge management and IP building will make your firm more valuable because it de-risks the acquisition from the buyer s perspective. Their vulnerability to losing people post-acquisition is less a threat and it makes the firm more scaleable if IP can be ported to other resources. Also, effective IP development and management improves your market position by raising the height of the bar for competitors. 8. Consultant Loyalty Can you stop your equity from walking out the door? 6. Quality of Fee Income Do you have long term contracts and no bad debt? If a good percentage of your future fee income is locked in through long term contracts (12 months or more) with a number of clients, then you re in the right place. Investors like to see a diverse client portfolio (not too many eggs in one basket) with fee income growth balanced across existing clients and new business. Add to that a quality approach to billing and debt collection, resulting in zero bad debt and low to zero working capital requirement, then you have a very strong card to play with investors! There s no point in winning all those new deals if you can t provide the skills and manpower to deliver, so you need an environment people want to work in, where they get recognition, reward, personal development and have fun. If you create this environment, then you ll be more likely to hire the best people to keep your business growing and reduce their desire to take the next head-hunter call! Also, if you ve locked your key staff into the future of your firm through profit-sharing and share options, then you ll have a team where all are focused on the equity growth of your firm and its future acquisition. This is probably one of the harder issues for an owner to grapple with the thought of giving up equity in return for a bigger pie at the end of the line!

6 of 10 OK so far? If you need to, stop for breath and have a cup of coffee! Now we re going to complete the picture by looking at the most important qualitative factors influencing an investor s perceived value of your business and discuss the key considerations in taking your firm to market. What does a well run firm look like to an investor? As you now know, consistent and reliable growth in profits is the main driver of equity value, so if you can forecast top-line sales revenue with accuracy then there s a high probability that you can forecast profits. That s why the quality of the sales and marketing machine is vital in the valuation equation. The most important factor in maximising the value of your consulting firm is your ability to forecast sales revenues. Firms without a good quality sales and marketing process cannot reliably predict sales revenue, in fact some don t have a sales and marketing process at all. In the typical small consulting firm, sales happen serendipitously through a process that can best be described as 'network selling'. This is good, but it s not enough on its own. There s too much of a reliance on people and referrals, which increases the risk of feast and famine and saw-tooth sales revenues. Firms with this approach to sales and marketing present a very risky profile for an investor because of their complete reliance on erratic and unreliable sources for their sales pipeline. On the other hand, a marketing led firm with a well-oiled machine independent of any individual can usually show a healthy, growing pipeline because of the mechanised, multi-channel, campaign orientated and measured approach to lead generation. Companies like this would be able to attract a premium price from an investor and if they are at the top end of the scale, they will be able to demonstrate the following: Qualitative factors attracting premium valuations There are four main key performance indicators (KPIs) that would be taken into account in a valuation: Pipeline A premium value would be placed on a firm with 75% of its pipeline as business booked over the next 3 months and 50% booked over the next 6 months Sales Growth 15% consistent year on year growth would be viewed as strong, but 25% would win a premium valuation Repeat Business A firm with 80% repeat business would be seen as strong and 90% would win a premium value Client Relationships - a valuation would increase where long term client relationships are prominent and a discount would be applied if too many eggs are in one basket in terms of client concentration. It s important to understand that valuation is not a science, and other factors such as synergy with the buyer have a major influence, so the figures above should be taken as guidelines. However, a firm s ability to demonstrate numerically the growth and repeatability of sales is always going to attract higher multiples. Conversely, those that can t demonstrate robust processes in sales and marketing may never achieve a sale or investment!

7 of 10 So let s assume you are able to present a positive picture and well placed to take your firm to market. How do I find out if my firm is attractive to buyers? Talk to advisors like Equiteq who have experience in mergers and acquisitions and people who have bought and sold consulting firms. They will know the market, and how to evaluate the attractiveness of a firm of your size, market and services. They will not only take into account how similar companies have sold in recent times and the current demand for companies with your services/niche/geographic markets, buyers will also be willing to pay a premium for firms with a high degree of synergy to themselves. If a buyer really wants what you are selling and you are the perfect strategic fit, then you can achieve an even higher price for your firm. clients are singing your praises, then you stand a very good chance of getting a premium value for your firm. However to achieve a confluence of all three peaking areas at the same time is not always realistic, and there are many personal factors to take into account on the timing of an exit. Sometimes it is better to do a deal now, rather than work hard for another 3 years. You may well be able to push up your valuation, but does that trade well against the uncertainty of what may happen in the elapsed time and would you be better off with cash in the bank now? What are the various exit options and how do I choose the right one? There s a wide range of options to sell your company or release equity value, but there are five main routes available to you. Remember to be calculated and cautious in the early stages, you can t take every positive conversation too seriously. You may hear a lot of flattery when you put your firm on the market but the most important thought to keep in mind is the golden rule of selling your firm - one buyer - no buyer! and aim to achieve a bidding contest for your firm. When is the best time to sell? In an ideal world, the best time to sell is when the following three areas are in line and on the increase: A peak in market activity A peak in your own profits A peak in your market sector. If these three things coincide and you go to market at a time when you have an excellent sales track record and 1. Trade Buyer Usually a strategic acquisition by another consulting firm, or services business who believes that your firm can further its growth ambitions, possibly by extending their geographic footprint, widening their service portfolio, or increasing capacity. 2. Investment House This is usually a purely financially motivated investment. There are a growing number of Private Equity houses who now see consulting as a good market to invest in because of its reputation for high profit margins and low capital requirements, thus delivering a good return to its investors. 3. Debt re-structuring This is where bank debt is used to re-structure the shareholding, resulting in cash available to founder shareholders and a larger shareholding being distributed to smaller shareholders.

8 of 10 4. Management Buy-Out (MBO) - This is when some of your senior team raises capital from third-party investors or banks to buy out the founder or other larger shareholders. 5. Stock Market Floatation An option for bigger companies is to float the business on the stock market. This would require a fairly large sales turnover figure to qualify and it varies by stock market, but would probably require at least 50m sales turnover as an entry point. So, how do you choose? Size will rule out some of the options but you need to consider if want to sell out completely or be involved at the next stage of growth? If you want to sell out completely and move on, then selling to a trade buyer who will take on your firm lock, stock and barrel could be the option for you. If you only want to relinquish part of the business, then perhaps look at a private equity investor or a bank. If this is the case, ensure you redistribute your shareholding so that your Management Team is motivated to continue to work hard and do their best for the business during any changes. How do I prepare for a sale? Preparation is the key because if a buyer s due diligence discovers nasty surprises then the deal could be jeopardized or your firm could be devalued. It will normally take about 3 to 6 months to get your firm prepared for sale and it will be a big distraction to normal business. So it s a great opportunity to make use of Chairmen, Finance Directors etc. Get them to go through things with a fine toothcomb whilst the management team stays focused on growing the business. Clearly this is also when you should be making use of external experts in the Consulting M&A field in order to both maximize price and increase the chance of a successful outcome. Our Equity Growth Accelerator valuation and profit growth model is designed to simulate the scrutiny of a buyer in fine detail and has proven to be an excellent tool for assessing the risk before taking your firm to market. There are two main areas to focus on to reduce the risk of nasty surprises, Operations and Finance: Scrutinize and clean up all your operations by removing any negative issues, or implementing quality changes that will reinforce future profits. This may include removing errant shareholders or employees, dealing with impending litigation, streamlining teams, or ensuring that client, supplier and employee contracts are sound and in place. It s vital to clear out any dubious assets or expenses, such as private yachts, or odd payments to people who aren t strictly employees! Keep it legal and make sure your accounts are squeaky clean. Finally, and this is most important, whilst sharpening the act, clearing skeletons out of cupboards and making things nice and transparent, make sure you have a strong sales pipeline to back up your profit forecast otherwise you won t be going anywhere! However if you follow the path we ve recommended in this guide, you could be looking at a very wealthy future along with the other shareholders in the business.

9 of 10 Summary: The main points we ve discussed in How to Grow and Sell a Consulting Firm: In simple terms your firm is worth a multiple of your last 12 months profits Valuations of 7 to 10 X EBIT is a realistic expectation for a well-prepared firm The lower the risk of profit growth the higher the valuation Use The Eight Levers of Equity Value to grow your firm and reduce risk The most important factor by far is a robust sales and marketing machine There are a range of exit options, choose the best one for your circumstances Good preparation is the key to ensure a smooth route to a successful sale How to obtain a valuation and create an equity growth plan If after reading this guide you want to explore your growth and exit options, please contact: Tony Rice on +44 (0)1252 724264 or tony.rice@equiteq.com to arrange a confidential discussion with one of the Equiteq partners. If we decide to work together, we would start with a 2 day workshop with you and your team where we: a. Performance benchmark your firm across the 8 levers of equity value and 80 best practice metrics b. Produce a valuation and explore future equity realisation options c. Identify profit risks, strengths, weaknesses and opportunities d. Identify short term wins for sales and profit growth e. Prioritise the most important actions for highest financial gain in the shortest period of time f. Agree how we would support your growth through to a future exit

9 of 10 Further Information Download Equiteq s free research report, The Consulting Industry M&A Report. This is available on our website at, it shows trends in the market and provides other useful information to owners of consulting firms anywhere in the world. Find out more about the Equity Growth Accelerator valuation and profit growth model by downloading the briefing pack at /ega About Equiteq Equiteq LLP provides merger, acquisition and growth services exclusively to the consulting and IT services industries. We help investors to find and acquire their ideal company and SME consulting firm owners to grow profits, equity value and successfully sell their firms. We are different to most M&A or corporate finance organisations because we have: An exclusive, in depth focus on the professional services sector Ourselves built and sold a firm to 63m with 350 consulting staff A proprietary database enabling us to match buyers and sellers together A proven methodology for sustained profit and equity value growth A track record in selling people businesses