Paul Collins
In Part 1 of this series, we looked briefly at the mergers and acquisitions market for consulting firms and highlighted typical deal values. We also introduced the topic of how you actually value a people business with few, if any, fixed assets.
Now, using a model we call the ‘Eight Levers of Equity Value,’ we’re going to look in more detail at the factors that create equity in a consulting firm. You can use this model not only to value a business, but also as a planning tool to drive the equity value of your firm in the right direction. 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.
The Eight Levers of Equity Value
To recap from Part 1, in simple terms, your firm is worth a multiple of the last 12 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, and if it’s low, it will go up. The Eight Levers of Equity Value are 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 increase growth and therefore increase equity value relative to profits over time.
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. 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 your firm to market, you want to be able to demonstrate consistent growth over the last 3 years. Sales and profit growth is a reflection, or an output of your performance in the other 7 levers.
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. It delivers a healthy business pipeline and de-risks 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 your 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 buyers 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. Client Relationships
Do you have a well-managed contact base and low client attrition?
The 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 your client base, increase your revenue per client and improve the quality of your fee income.
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.
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. The vulnerability to losing people post-acquisition is less a threat and that 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?
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.
So in Summary…
If you have a firm with a solid track record of profit growth over the last three years that has: a lead generating ‘machine’ independent of any individual; a proposition that WOWs your market; a management structure with breadth and depth; effective client relationship management and long term relationships with blue-chip clients; mined and built its IP; locked in its staff to the future of the firm—then you have some real value to talk about!
Next month in the final part of How to Grow and Sell a Consulting Firm, we’ll look at some of the quantitative factors used in equity valuation and give you some pointers on how and when to take your firm to market.
Author Bio: Paul Collins is the founder and Managing Partner of Equiteq LLP, a UK based business advisory firm on M&A to the consulting Industry. Formerly he was the founder and CEO of the consulting firm WCI Group plc, which he built from scratch to $130m before selling his stake to private equity. He is now Europe’s pre-eminent authority on M&A in the consulting industry. Find out more at www.equiteq.com.
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