Keeping your service portfolio profitable: how ‘scraping the barnacles’ can make your boat go faster

By Jason Parks, Director, Equiteq and Pat Webb, Director, Equiteq

Clients give knowledge-intensive services firms such as consulting, IT services and media agencies difficult and constantly evolving problems to solve. Markets change, competitors emerge and macroeconomics shift, all of which have an impact on what’s hot and what’s not when it comes to M&A.

That means buyers are attracted to firms with a clear value proposition that transcends service offerings and the capability to respond and deliver a relevant service portfolio in a changing environment. Simply put, a firm is worth more when it is bought for its strategic capability rather than just offering the buyer additional service capacity.

Achieving a relevant and effective service portfolio means more than investing in new service lines, because it’s also important for consulting firms to phase out what is no longer working for the future value of the business.

David Ogilvy explained in his “principles of management” (which took his firm from a start-up to generating billions) that dropping services that have become unprofitable must be driven by management:

“To keep your ship moving through the water at maximum efficiency, you have to keep scraping the barnacles off its bottom. It is rare for a department head to recommend the abolition of a job, or even the elimination of a man; the pressure from below is always adding. If the initiative for barnacle-scraping does not come from management, barnacles will never be scraped.”

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How aligned are the shareholders as you prepare for sale?

Alignment

By David Jorgenson, CEO, Equiteq.

Some may think that once the shareholders agree they’d like to sell the business, then this means that everyone is on the same page and it’s now a matter of finding a buyer. However there are a wide-range of issues that need to be agreed on in order to present a united – and attractive – front to prospective buyers.

Timelines and value are two of the most immediately evident points to agree on. If one shareholder wants to sell now for $1m, the second shareholder wants to sell in 2 years for $5m and the third wants to receive $10m for their share no matter how far in the future, then there needs to be some discussion about how to get the best outcome for all involved.

There is then the practicality of what actually gets paid. A deal can be structured in a variety of combinations with cash, shares and earn out lengths all in play and of differing appeal to shareholders involved. Shareholders will receive a payment which is proportionate to the terms of their agreement and a good deal adviser will keep all parties apprised of changes and what they will be taking out of the business at all times. Before embarking on a sales process, consultancies should ensure they have a well-drafted shareholder agreement to avoid problems down the line when a sale is well advanced.

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Why phantom shares may grease the wheels when selling your firm

Cogs of people cropped

When selling, or planning to sell, a professional services firm, it is important that the key personnel who are crucial to the on-going performance of the company are aligned to the majority shareholders’ exit goals. Without this alignment, they could be a less potent force in making those goals happen. Consider phantom shares as an alternative to employee share plans, in order to get that alignment in place.

What are phantom shares?

In simple terms, phantom stock does not include any real stock, it is like a cash bonus plan linked to the success of the company, where the timing, magnitude and phasing of the payout is determined by the deal terms you get in a liquidity event, such as your firm being acquired. Just like other forms of stock-based compensation plans, phantom stock serves to align the interests of recipients and shareholders, but without the same level of cost, complexity, and risks associated with a share scheme.

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