The eventual price that a buyer agrees to pay for your firm is based on many factors. But ultimately it boils down to how hungry they are to get the benefits of future profits they see being generated from the merging of the two companies and their mutual strengths. A significant difference between consulting firms compared to most non-services businesses is that the assets are not physical plant or machinery, but people, client relationships and intellectual property. On the face of it, these assets are risky. If someone buys your firm today, could all the value in it evaporate tomorrow?
Achieving a valuation that financially exceeds what you could earn by continuing to run your business independently is predicated on a number of factors, but convincing the buyer that future profit growth is sustainable is critical. If you provide a credible, robust profit forecast three years into the future, and are then able to also show the additional profits that will come from synergies over the same period of time, then premium valuations are achievable.
So having said that most of the value of a consulting firm is based on future profit streams, why are the three years leading up to a sale critical to securing a rewarding valuation and deal structure?
Take a look at these four profit growth profiles leading up to a buyer negotiation. Imagine you are the buyer of your firm and ask which case generates the most belief in the future in the mind of the buyer?
It’s interesting to note that nearly every firm we talk to forecasts that they have a great three years ahead, no matter what the past looks like! This is why buyers look at forecasts of potential acquisitions initially with extreme skepticism. What the seller wants to do is quickly eliminate any negative thoughts about financial instability and move the focus onto the future profits that will come from the synergies of the two companies. But the weaker the past performance is, the more difficult this is to achieve.
So let’s put this into real world context. For argument’s sake, let’s assume your firm is a good fit for a buyer, it is generating, say, $7.5m EBITDA (net profit) and for illustrative purposes we assume a mid-point valuation of five times EBITDA (the average multiple in the consulting sector). It doesn’t matter whether your EBITDA is $5m or $20m, the scenarios below illustrate the possible impact of buyer confidence in the future. Don’t read into the actual multiple figures or percentages as absolute or accurate at all, they are just there to show the dramatic variations that can occur.
Scenario 1 may get you 5 x $7.5m = $37.5m with 40% up front and the rest in a 3 year earn-out based on performance
Scenario 2 may get you 1 x $7.5m = $7.5m with nothing up front and all in a 3 year earn-out based on performance
Scenario 3 may get you 3 x $7.5m = $22.5m with 30% up front the rest in a 3 year earn-out based on performance
Scenario 4 may get you 8 x $7.5m = $60m with 60% up front and the rest in a 2 year earn-out based on just remaining in the business
As these examples illustrate, there is a lot to play for. If planning to sell your business in the future, significant value enhancement is possible if you build in the operational characteristics that will assure growth in revenue, profits and equity value. And by showing a potential buyer steady growth in the business over the past three years, it gives them much more confidence that they will realize value from synergies if they were to buy your business.
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