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 to put margins at the center of your business

There’s perhaps no topic more important for consulting firms than improving profits. Because of this, we recently ran two 30-minute webinars on improving margins. This week, we’re looking at questions asked during the first of these, which explored how to put margins at the center of your business.

If 20% EBIT is a good target for a consulting firm, would a firm achieving 40% EBIT be viewed as considerably more valuable?

At face value, a 40% margin business might appear more valuable, but it depends on whether the buyer considers this sustainable.

Some will interpret a margin of this size as indication that the firm has under invested in itself and will discount this. Because of this, we typically recommend that 50% of revenue be spent on the delivery of your services and 30% should be allocated for overheads – such as selling or marketing the business, admin costs or recruitment or IT fees – leaving the remaining 20% for EBIT.

Firm owners might be wise to consider investing any EBIT above 20-25% into growing the top-line instead.

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How IP can make your profits fly

By Adam Blatchford, Associate, Equiteq.

Smart Scaling is all about growing revenues and profits while also building your equity value, as opposed to doing one at the expense of the other. Intellectual Property is central to that, it is a ‘win-win’ because buyers want it and it drives profitable growth in your firm.

Whether your firm generates revenues of $20m or $100m, IP differentiates you. It ensures clients buy your services, means you can deliver profitably, and makes investors love you. This blog will focus on how to achieve that in your firm.

What is IP?

In simple terms, intellectual property is any knowledge recorded and maintained as a usable business asset. In most consulting firms, this means ‘trade secrets’, such as process maps, methodologies, training systems and software tools, rather than just copyrights and trademarks.

There are three main types of IP:

  • IP to market the business
  • IP to deliver business
  • IP to run the business

All three are important, but in the context of Smart Scaling we will focus on delivery IP. See here for a deeper discussion of the three types.

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Kick-starting margin improvement in your consulting firm

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By Jason Parks, Director – Strategic Advisory Services, Equiteq.

Gross margin is an important metric in consulting organizations. It can be the difference between steady growth, and running to keep the lights on. It’s also one of the key metrics potential consulting firm buyers focus on as they look to acquire firms with strong profitability.

We recommend that gross margin should represent 50% of a firm’s revenue. If it’s less than that then you’re unlikely to be generating the funds needed for growth or delivering a net margin that will drive equity value.

The challenge with improving gross margins lies in the fact that they rarely have a singular root cause.

There are three main areas to focus on to improve profitability in a consulting or professional services firm, and they are all intertwined:

  • Increase revenues generated by the business by selling higher value work
  • Improve the leverage structure of the delivery organization (i.e., people, IP, QA)
  • Optimize overheads

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Case study: Strengthening and leading Blue Sky to a premium sale

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Background

Blue Sky Performance Improvement, a boutique performance improvement consultancy, create a different approach to training and developing people to improve business results. Blue Sky leadership engaged with Equiteq to help build value over several years with the aim of finding and securing a deal with an acquirer who would buy at a premium price.

We worked closely with Blue Sky to grow their equity value, improving and strengthening key areas of the business such as market propositions and intellectual property that proved vital in demonstrating their synergy to the eventual buyer. At the end of a three-year process, Capita approached Blue Sky. Equiteq led the sale of the firm to Capita, who offered £12m, equivalent to a revenue multiple of 1.7.

The client’s situation

Because Blue Sky had sound business propositions and a steady client base in the performance improvement area of consultancy, the ambitious management team wanted to sell to de-risk the value they had built and sell whilst the business was performing well. To begin with, we conducted an Equity Growth Accelerator, and a quarterly review of progress continued over 36 months.

Although Blue Sky later decided to switch to another advisor to try and clinch a sale deal, it fell through, and they found themselves back at square one. Once we were re-engaged, we set about building growth and securing a buyer prepared to pay a premium price for its assets in 2014.

Our approach

Over three years Blue Sky used Equiteq’s 8 lever ‘Equity Growth Wheel’ with on-going consulting support to set up a best practice operating model and grow revenue, profits, and equity value.

Selling a ‘people’ business, where your strongest assets and intellectual property could walk out of the door, requires a unique approach to sale.  We helped Blue Sky build stronger market propositions, put rigour and process around capturing their intellectual property and strengthen the management structure.

Three years into the process and with profits growing healthily, Capita approached Blue Sky. Capita had recently won a large government contract and Blue Sky were seen as a key part of the delivery solution. We managed the sale process throughout, and negotiated a premium price.

How did this deliver value to the client?

  • Using our Equity Growth Wheel, Blue Sky made fast progress over four years towards best practice in key areas
  • Equiteq helped grow Blue Sky’s sales from £4.2m to £7m
  • Blue Sky were offered £12m, negotiated up by Equiteq from an initial offer of £10m, with 60% payable cash up front
  • Earn out period was reduced from 33 to 27 months
  • Equity value increased from 5 x profit to multiple of 7.6 x profit
  • The revenue multiple increased to 1.7

Equiteq took Blue Sky from being an attractive sounding business and transformed them into a robust business asset that sold at a premium.

To read some of our other case studies, please click 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. 

How to build intellectual property to drive more profits and equity value in your consulting firm

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Quality intellectual property (IP) enables any consultant in your company to deliver superior results to clients, compared to what they could deliver by working for a competitor. So the question to ask yourself is this:

How much more valuable to a client is one of my expensive consultants, compared to an independent contractor who has no overheads to worry about?

My consultant – independent consultant = ∆ added client value

What’s the delta difference in your firm? If it’s zero you are selling bodies with no IP added value and no differentiation. And this is a dangerous position for a company to be in, especially one that is interested in driving more profits and equity value.

When we talk about IP we are not talking about patents, copyrights, or trademarks, although they may feature. In a consulting firm, value is created by reducing risk, increasing differentiation and showing sustainable growth performance. IP is about having a professional process for codifying, organizing, storing, securing and centrally leveraging the assets that enable your company to perform well and make it stand out in the crowd, independently of any individual in your firm.

There are three main areas of IP:

Sales

These are assets that enable you to sell more at lower cost and shorter sales cycle times; material such as marketing campaign models, case studies, thought leadership content, sales and marketing collateral, pitches and proposal templates.

Delivery

This IP area is fundamental to scalability and value. It’s where profitability hits the road through leverage, because we can sell services at premium fees using less expensive resources. Here we have our training systems and content, client facing tools and templates, assessment models, benchmarks, datasets, technology enablement of delivery and more.

Performance

These are the tools that keep the boat going in the right direction with continuously improving performance. It includes your CRM system, KPI tracking system, resource planning, pipeline management, finances, client contracts and pricing models, human capital training and management etc.

There is a symbiotic relationship between all three areas and a well-run IP building program yields faster and better results as it progresses.

A firm will have these assets across the board but how much is at risk and not being centrally leveraged as it’s in consultant’s head and on their laptops? Without an IP building program all of your assets are portable, you are unlikely to grow and your firm will not be an attractive proposition in the consulting M&A market.

When in serious discussions to acquire a firm, buyers of consultancies are principally concerned with three things, all of which are improved with a strong IP program:

  • Is this business financially stable?: A track record of growth will mean a higher value for your company as the buyer will see little risk in your continued growth. The track record of growth to date will speak for itself and belief in the future will come out of the performance systems IP you’ve built for the running of your business. It will provide demonstrable evidence to support your continued growth story.
  • Is there fast leverage in the synergy factors?: Your potential acquirer may see compelling synergies, but can they be monetized, how hard will it be to integrate them and how long will it take before benefit realization begins? If you’ve built great service delivery IP that has de-risked your business and provided you with leverage, then it should be transferable to your buyer. What you are doing with 50 consultants in 20 clients, they can do in six months by porting that IP over the ether to their 500 consultants in 200 clients.
  • What’s left if the owners leave the day after the transaction has closed?: Your eventual buyer will be paranoid about this last point! They know that the moment their millions are in your pockets, no matter what the earn-out terms (assuming you get money up front in the transaction), your motivation and drive may change, or you may just decide to leave. From their point of view, everyone in your firm is vulnerable. However the more solid your IP, the better you will be de-risking the deal for your buyer.

IP is an essential tool in growing the value of a consulting firm. By having a strong IP program in place and working together, value and equity will grow more quickly. If you’d like to read more about building IP, 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.