M&A trends amongst buyers indicate the potential for premium valuations in 2017

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By
 Ramone Param, Buyer Coverage Associate, Equiteq.

We’re pleased to be launching our third global research report from our annual survey amongst buyers of knowledge-intensive services businesses. The report delivers current, actionable intelligence that isn’t available from any other source and covers each of the five consulting segments that Equiteq specializes in: Management consulting, IT consulting, Media & Marketing, Engineering consulting and HR consulting.

Demand for acquisitions remains as strong as last year, with respondents expecting to make nearly 4 acquisitions in the next 2-3 years. However, buyers are seeing a slowdown in the growth of new opportunities coming to market. This may be a momentary slowdown, or it might suggest the start of a period of increasing competition for assets, supporting stronger pricing power for selling shareholders of unique knowledge-intensive services businesses.

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Should you sell to a private equity buyer?

Eight mistakes when building a sale-ready business

Private equity (PE) – or financial – buyers differ from trade buyers in that the former acquire strictly to make a return on their invested equity. Trade buyers (also referred to as strategic buyers) acquire to realize long-term strategic value by combining the two firms. Because of this, PE buyers will look for specific traits in a target and selling to a PE buyer will have different implications for a consultancy than selling to a trade buyer.

To make a return on their invested equity, PE buyers look for a company that has value enhancement potential and acquire it at a favorable price with financing. With consultancies, they are attracted by the relatively high profit margins compared to other industries, high levels of profit to cash conversion, the potential for high growth if a consultancy is in a hot sector, and the barriers to entry that can be maintained if proprietary expertise is retained and leveraged through intellectual property.

Conversely, returns can be risky since the company’s core assets (people) can walk out the door. And since most consulting work is project based, future forecasts are difficult to predict. Nevertheless, PE firms that focus on knowledge-based businesses know what to look for and will carefully consider investing in consulting firms to complement one of their existing businesses or as a standalone investment.

Once acquired, they enhance the value of the firm during the ownership period through a variety of ways such as: providing the capital to fund investment in the business for organic or acquisitive growth; strategic advice through board membership; and providing market access through relationships and potentially through other businesses in their portfolios that can help smooth entry into new markets or geographies.

PE owners then exit their investment after a period of growth (typically 3–5 years) at a higher price than their entry point. Sometimes this is through an initial public offering, but far more commonly it is through selling the firm to a trade buyer.

The advantages of being acquired by a PE buyer as opposed to a trade buyer is that your firm remains independent, your identity and brand will continue unaffected and you retain more operational control than if you had been bought by a corporate buyer. PE buyers can also offer more flexible deal structures, which provide greater options for sellers in terms of liquidity and taking money off the table. Although in their initial acquisition consideration PE buyers do not have synergies that enable a higher purchase price, they often have a more rapid value creation plan than most strategic buyers, which can enable them to be competitive on pricing.

However, there are also some important considerations that may not be as favorable. PE ownership typically involves majority control of your firm and a seat at the board. So although your firm will remain independent, the PE owner typically has significant influence on the direction of growth and key strategic decisions. As your firm is expected to grow rapidly, the pace of change will need to be managed carefully to avoid attrition of your staff and to retain the culture, which remains an important element of people-based firms. Furthermore, your payout as an owner staying with the firm may be staggered: one at the point of initial investment and a bigger payout after the PE firm exits its investment, since the focus in the interim will be on growing significant value in your firm. So you effectively have a bigger second bite of the apple in payout terms.

In a competitive sale process, PE buyers will be quicker to act and meet with you than other strategic buyers, as they are constantly sourcing firms in the market. Strategic buyers will take longer to consider the potential fit and only selectively meet with the right acquisition target firms. Sellers should take this into consideration when in a competitive process.

As future potential owners, you will need to see PE buyers as a growth partner. All parties will have skin in the game, so if your strategy is realized all will remain happy, but if growth stagnates or starts to decline, be prepared to be put under a microscope.

NB: The term ‘trade buyer’ refers to those who acquire for strategic purposes and includes in it our definition of consulting and corporate buyers.

This blog is condensed from a more in-depth article that you access here.

If you are preparing to sell your consulting firm and would like to discuss your plans, please get in touch.

Are you a member of Equiteq Edge? It’s full of content to help consulting firm owners prepare for sale and sell their business. Register here to gain full access.

The year in review: Equiteq Edge’s most popular blogs of 2015

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As 2015 draws to a close we thought it worthwhile to take a look back at the most popular blogs of the year. If there’s a topic you’d like covered in 2016 we’re always interested in hearing from our community, so please contact us here.

We’ll be taking a break from our blogs now until the New Year, when we’ll be back on the 7th of January. Until then, have a great festive season and we look forward to welcoming you back to Equiteq Edge in 2016.

1. Profile of a healthy consulting business: We’ve analyzed thousands of consulting and professional services firms over the past decade and have a unique perspective on the financial metrics of consulting firms.

2. Why branding for professional services consultancies matters. Part one: The sales and marketing process is one of our 8 Levers of Equity Value and branding is a key component of this. Part two can be read here.

3. Why do consulting firms with capable leaders get stuck?: Growing a consultancy is not easy; there is a reason only 1% ever break the $20m barrier. As a rule there are three different mindsets which lead to consultancies failing to scale as they should.

4. How best to manage utilization in a professional services business: Utilization can have a big impact on the bottom line and should be monitored carefully as, in our experience, firms that measure utilization regularly end up outperforming those who do not.

5. Six key principles for a value-driving compensation structure: By structuring compensation in the right way, it’s possible to accelerate growth by having everyone pulling in the same direction. It will also help the business retain its best people and ultimately will make the company more attractive to acquirers because of the culture and drive within the business.

6. Buyers’ view: Hot sectors update March 2015: Our analysis found that the first quarter of 2015 saw big demand from buyers in IT consulting, engineering/environment/energy and the media/marketing sectors.

7. Consulting firm M&A intelligence on cloud-based consulting: Cloud computing has become one of the world’s leading transformational technologies and consultancies operating in this sector are in hot demand.

8. Consulting firm M&A market intelligence on cyber security: As we all become more reliant on technologies such as smartphones and social media, businesses must be very careful with data security.

9. What deters the buyers of consulting firms?: Our research has identified that there are three top factors which dissuade buyers when it comes to making an acquisition.

10. Why do human capital consultancies plateau? Part one: You’d think that HR consultancies, with their focus on people, would have superior leadership abilities. However, they often fall victim to the same ‘Do as I say, not as I do,” as other consultancies. Part two can be read here.

Are you a member of Equiteq Edge? It’s full of content to help consulting firm owners grow and realize equity value in their business. Register here to gain full access. 

Demand for acquisitions in the consulting sector? What buyers say.

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We’re pleased to bring you the results of our second annual Buyers Research. We commissioned an independent researcher to speak to over 100 consulting firm buyers across North America and Europe. The results provide valuable intelligence for both consulting firm owners with an eye on selling their firms at some point in the future, and consulting firm acquirers wishing to understand buying trends in the current market.

The research found that buyers’ acquisition expectations have more than doubled in the past year and there are huge amounts of capital set aside to enable these acquisitions. Within those spoken to for the research, there are over $7.7bn of funds available for the acquisition of over 400 firms in the next two to three years. This is an 11% increase from last year’s budgets and is encouraging given the continuing economic uncertainty we have seen over the past year.

When it comes to the size of consultancies most in demand, buyers are looking for larger firms than they were last year. On average the target acquisition size for the next two to three years ranges between $18m and $45m in revenues, with an optimum size of $31m. This reflects a 20% increase in size preference at the lower end and a 15% increase at the upper end. However, if you’re looking to sell your firm, it is important to recognize that the vast majority of consulting sector deals are consistently done at the smaller end of the market. Because of this, knowing the right buyers to approach can make the difference between success and failure when selling your firm.

Buyers are polarized in their use of qualitative and quantitative measures when evaluating acquisition opportunities in consulting. Quantitatively, buyers prioritize margins and growth above all other metrics. Qualitatively, buyers focus in on your client base and quality of your intellectual property (IP). A deep understanding of what buyers are looking for will allow you to tailor your approach accordingly.

IP continues to be of paramount importance for buyers, as 68% of all buyers cited IP as being extremely or very important as a factor when assessing potential acquisition targets. When considering the different types of IP, buyers prefer IP that directly generates revenue, or that supports the delivery or standardization of a target firm’s consulting services. While IP plays a key role in buyers’ consideration of consulting firms, consulting firm owners need to draw a clear line between their IP and the real value it creates for the firm.  Forty-five per cent of all buyers found it difficult to understand how the IP in the target firm contributes to the success of those. If you’d like to learn more about this, please view our webinar on how to build IP which will grab a buyers’ attention here.

Earn-outs continue to be a reality for the majority of consulting sector transactions. The ‘average’ deal will include 45% in up-front cash, with the rest over a period of 2.7 years; 83% of buyers measure earn out performance on gross margin, but measures range from partner retention to net profit performance. There is a wide range of ways that deals can be structured and a lot at stake, so the need for good negotiation skills is critical to get the best deal for you and your business.

Finally, once the champagne cork is popped and the focus turns to integrating an acquired consulting firm, the survey found that buyers tend most often to focus on the integration of people above all else in the first 90 days post deal. This is due to the fact that human capital is the real asset of a consulting firm. As any acquisition is a disruptive time for a seller, buyers are keen to ensure their assets don’t walk out the door during or immediately after an acquisition. Following the integration of people, clients are the next highly prioritized area and the more mechanical integration of technology and systems follows on from these. How long do integrations typically last? On average, as a seller of a consulting firm you can expect to be involved in an integration period for just under two years following an acquisition. Buyers start thinking about how a seller’s services will integrate with their own early on, although it is also critical for sellers to consider how integration into a buyer’s firm will impact the firms culture and its ability to retain the attributes that make it successful.

When selling your firm, knowledge of buyers in the market is critical. The more informed you are about buying behaviour and preferences in the market, the better equipped you will be to navigate through to a successful sale.

To read more detail about the findings from the research you can access the full report here.

Are you a member of Equiteq Edge? It’s full of content to help consulting firm owners grow and realize equity value in their business.  Register here to gain full access. 

What to expect from consulting firm buyers

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Different buyers look for different things when acquiring consultancies. Broadly, there are three different kinds of buyers: consulting buyers, corporate buyers and investment buyers. Each will see different aspects of your business as valuable and understanding their motivations is important. This week, we’re taking an in depth look at consulting buyers and will examine corporate and investment buyers in future pieces.

There are four key areas of consideration for consulting buyers which we will explore in turn.

  1. Build vs buy: Why consulting firms choose to acquire rather than grow a capability.

Growth is always on the agenda for most large and mid-market consulting firms. It typically comes down to balancing organic and acquisitive growth. Organic growth takes time and the careful management of demand and supply in the new area. There is the potential risk that the payoff takes longer than expected or does not happen at all. The upside is that the firm is in control of its own growth and the pace is incremental. Acquisitive growth, if successful, is immediately additive. However there are well known statistics on the failures of M&As which are often the result of poor post-merger integration.

In practice, consulting buyers use a combination of organic and acquisitive growth. Sellers of consulting firms need to understand that buyers will always consider whether your business could be built internally for less money than it would cost to acquire your firm. It is worth asking yourself, “What am I actually selling?” as the buyer will be asking “What am I buying?” Therefore, you need to demonstrate that what you have is additive to them, rare in the market with valuable intellectual property (IP).

  1. Acquiring capabilities: What is the landscape of capabilities, services and expertise that consulting buyers typically consider?

Large, multi-disciplinary consultancies that are likely to acquire other firms tend to be organized by both capability and industry. The reality is that strategy firms have historically organized themselves by industry expertise and most others have done so by functional or disciplinary capabilities. The reason for this is that in order to provide sound strategic advice, strategy consultancies look holistically at business issues across functional disciplines and consider market dynamics within an industry.

The trick is to understand which consulting buyers will be more attracted by your focus areas (capability or industry) and less deterred by areas where you may be more generic. Ultimately, buyers are looking to pay fair market value for your firm, but gain above average returns from their investment. The way to do this is by making acquisitions that have a high degree of synergy potential with the existing business.

  1. Intellectual property: What is it and what value does it represent?

IP has always been a key consideration for consulting buyers, but is becoming increasingly important as the landscape changes. IP is difficult to define and even more difficult to value. So sellers often want to understand how to define IP, whether what they have developed as IP is valuable to buyers, and if so, what is it worth?

IP comes in many different forms. The most understood forms of IP are software or IT products/solutions that are directly revenue generating as a standalone asset. The most abstract forms tend to be methodologies or best practices that do not generate revenue, but better enable a consulting firm to sell their expertise in a repeatable and consistent fashion.

Ultimately, consulting buyers are looking to acquire IP that allows them to sell more, or higher value, consulting work.

  1. Post merger: What to expect from consulting buyers following an acquisition

It is well known that the main reason for most M&A failures is poor integration, including pre deal integration planning and post deal integration execution. The situation where a consulting firm is acquired by a buyer is even more sensitive to integration failure, as integrating people is both the most difficult aspect and also the key to its success.

Time and time again, the critical factor of integration has proven to be the alignment of leadership objectives and defining successful integration as accurately as possible. However, as the acquisition of consulting firms by buyers involves people based risks, such as attrition, most buyers mitigate this through a deferred payment or earn out in the deal structure, with upfront payment typically in the form of cash and shares (partnership with some consulting firms). However, there is an ongoing dilemma for most buyers – how to measure the performance of an earn-out to ensure the acquired firm continues to grow, while trying to take advantage of the synergies between the two firms that often make standalone earn-out metrics difficult to measure. Some firms get around this by using top line earn-out metrics such as revenue or gross profit, while others stick to earn-out metrics for an initial period until the growth and integration is proven, then work collectively with the target to adjust objectives and take advantage of the synergy opportunities.

Ultimately, the integration of consulting offerings and cross selling opportunities with clients commands most of the air time in integration discussions, as this is where the money is made and where the opportunity lies. However, consulting buyers more than others understand that a better than average alignment of people is required to make this happen.

Understanding the motivations of consulting buyers can help you position your business in a more attractive way. If you’d like to read more about what consultancy buyers look for please read the full article here.

Are you a member of Equiteq Edge? It’s full of content to help consulting firm owners grow and realize equity value in their business. Register here to gain full access.

What deters the buyers of consulting firms?

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During a sell-side process, it is natural to focus on the factors that most attract buyers and attributes that make your firm a good strategic or financial investment. However, it is also important to understand the often pessimistic perspective from the other side of the table – the buyers.

Why? Active acquirers look at hundreds of acquisition opportunities every year. The first time a potential buyer looks at your firm as an acquisition opportunity, they are likely to try to justify a quick “no” to move quickly though their pipeline of potential deals.

Our research and experience has identified the three top factors which deter buyers of consulting firms. Some of them can take years to address, so early identification is key.

1. Poor cultural fit

A poor cultural fit is most likely to deter buyers from making an acquisition. Prolific buyers (those who buy more than one firm a year) in particular recognize the wide variety of integration challenges that most acquisitions present and that stand in the way of the expected benefits.

Cultural fit is a critical factor in realizing the full synergy value of an acquisition, as this is not simply a mechanical integration task. It always involves people from different firms working together toward a common purpose. This is especially true of acquisitions in the consulting sector, where people are the bulk of the assets and in which cultural synergy is highly sensitized.

Unlike other red flags mentioned in this blog, culture is not something that should be tampered with as part of a transaction. Culture is often inherent in a firm. It is significantly influenced by a firm’s leadership and typically lies at the heart of the firm’s success or failure.

2. Diversity of service offerings

For a consulting firm, a strategy of building and maintaining a wide spectrum of services can be a strategy of responding to and profiting from a variety of client issues. However, if you are looking to sell your firm, buyers may not view this positively. From a buyer’s point of view, a broad set of services may dilute their perception of value, as they may see less focus and domain expertise in any one service area, which is an aspect that buyers are in fact most attracted to.

3. Good profits, but no growth

There are often different choices made when operating your firm for sale versus operating for growth. For instance, a growth-focused firm may have the appetite and flexibility to make investments today that consume capital and impact revenue and profits, with the expectation of payoff in improved revenue and/or profits in the future. In contrast, a firm looking to sell will want to show a historic track record of growth and, at the time of going to market, be in a steady growth state with good profit margins. This sets a historic precedent for the forecast future revenues and profits, on which buyers base a value. As such, a firm should ideally sell when prior investments have begun to pay off, as opposed to making new significant investments just before a sale that may temporarily impact revenue and/or profits. Doing this will break the track record of growth that sets the precedent for its future trajectory.

This is important as buyers effectively acquire ownership of a firm’s future profits or cash flows. However, even if a firm is profitable today, buyers will be deterred if there is no precedent for and/or planned future growth.

By identifying the areas that may deter buyers early on, you will be in a position to address these prior to any future sale process. And by addressing these key issues early on, you will maximize the chance of gaining full value should you one day want to sell your consultancy.

If you’d like to find out what deters buyers in more detail, please read the full article here. You need to be a member of Equiteq Edge, but signing up is free and takes only moments here.

Buyers’ view: Hot sectors update March 2015

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We spend a lot of time talking with buyers of consultancies and listening to their strategic growth needs. We also track several markets in consulting and monitor acquisition activity across the world. In doing so, we develop a good sense of hot spots for consultancy M&As. So as we head towards the end of the first quarter of 2015, what are the areas that buyers are the most interested in?

IT consulting

IT consulting continues to make up the largest proportion of deals in the management consulting space, as it has done for many years now. IT consulting covers a large and disparate set of firms, horizontally across technologies and vertically along a ‘value stack’ in IT. From IT strategists to system integrators, SAP to Workday consultants, business intelligence and data analytics specialists to IT transformation advisors; this space is broad and continues to evolve at a rapid pace.

The fact that IT is driving change in so many other industries, such as media/marketing (digital), telecoms, healthcare and financial services, amongst others, means that this section of the consulting market will, somewhat unsurprisingly, continue to evolve and change in line with demands from various different industries. As this happens, not only does it drive the need for increased IT services and advisory, it also begins to drive acquisition demand from the industries becoming increasingly dependent on IT.

Subsectors in this category where we are seeing particular acquisition interest include the so-called ‘SMAC’ areas (Social, Mobile, Analytics and Cloud), as well as cyber security. For IT consulting firms, these areas have become a necessary focus, given the new IT deployment models and the heightened threats that come with them. Our next sector insight will be on cloud computing and the various areas of consulting within it, so check back next week for a more detailed analysis on this area.

Engineering / environmental / energy

Engineering has long been a popular area for M&A activity and is seeing a particular demand for firms that deal with infrastructure change. As well as this, demand is also being driven by the general developments occurring in emerging markets.

Environment and energy are becoming more topical as concern about global warming moves up the business agenda and the demand, supply and price of oil continues to have significant economic and political influence. These issues mean businesses seek advisors in this space, hence the uptick in demand in this sector. There is also the constant flow of civil design and architectural firms acquired each year.

As this part of the market is constantly being replenished with new engineering consulting firms coming to market and a fair bit of consolidation across the board, in addition to a growing global population, significant environmental factors and changing energy needs, we expect engineering consulting to remain as one of our hot areas.

Media and marketing

Media and marketing has always had a strong advisory component and the move from print to digital has seen this sector transformed, particularly in the past two years. While print is still represented, the new digital channels are where all of the change and activity is happening. The amount of customer data generated – and the opportunities afforded by effective analysis and monetization of this – make consultancies in this space hot property. We are seeing particular demand for analytics, mobile and social media marketing, which as mentioned earlier is driving change in both the media and IT markets.

To ensure they remain competitive, big media firms need to have the right skills or access to customer channels. As these areas can take time to develop organically, media firms continue to look for acquisitions in these areas to quickly gain access to new skills and intellectual property. Otherwise, they will continue to see their market share eroded as innovative and agile companies take bites from their customer base.

Technology companies are also buying into this space as it is very IT reliant. Customer analytics for example is critically important for predicting future customer behavior and therefore how best to reach them. As this is mostly about analyzing data, IT plays a key role and large IT firms with these skills are increasingly important to the media sector.

These three areas have seen a lot of activity in the past couple of years and we expect them to continue to be hot in 2015. We regularly produce market intelligence reports on these and many other sectors. If you would like to find out more about what reports we have available, please contact us at info@equiteq.com.

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