Training isn’t just for athletes

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This week we have a guest blog from Patrick Chapman, Business Development Partner at Elevation Learning.

Everyone agrees that most of the value of a professional consulting firm comes from the people within the organization. In fact, staff in a consulting business are so important that ‘consultant loyalty’ is one of Equiteq’s 8 levers of equity value. So if you want to grow your firm with a view to selling it one day, then nurturing and developing your staff has to be one of your priorities. Unfortunately, when looking to improve financials prior to sale, training is one of the first budgets to be cut. However, this strategy is undertaken at your peril and will end up doing more harm than good.

To build value, your staff team needs to have a shared language and consistent ways of working. This will allow different groups of consultants to come together quickly to form a cohesive unit for each client engagement, meaning truly chargeable work starts more quickly. This ultimately protects your margins and when the value of the whole exceeds the sum of its parts, your bottom line performance will benefit, meaning you’ll be more appealing to buyers.

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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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Eight mistakes to avoid when building a sale-ready business

Eight mistakes when building a sale-ready business

Over the years, Equiteq has worked with many entrepreneurial owners of consulting firms to help them grow value and sell their businesses. However, from experience we see that only a fraction of consultancies grow to a saleable scale. In this blog, we’ll explore some of the mistakes leaders make that affect their success.

  1. Working IN, not ON the business – Particularly for early stage firms below $5m revenue size, this is a common reason why businesses fail to scale. Business owners should recognize whether they are spending too much time delivering for clients, as opposed to delegating and working to lead the growth of the business.
  1. Innovation distractions – Ultra-entrepreneurial leaders can get into the habit of spotting new ideas and innovations that promise to bring in millions to their firms, but often just suck resources out of the core business. Think: Will this new idea add leverage to the core service? Will potential buyers be interested in these assets together or is it worth considering launching a separate venture that does not distract?
  1. Value negative diversification – It is important to scale up while also remaining attractive to potential buyers. Diversifying and growing into different markets or verticals can dilute the focus of the company and its niche. Because buyers are often interested in specialized firms, business leaders should contemplate whether the company’s focus is spread too thinly and if a buyer will be interested in all of their business – if not, the business may be growing in a value negative way.

For more on the equity value risks in international office expansion, click here.

  1. Failing to professionalize the business – A business made up of very smart people who generate work by network selling may make a lot of money, but may have very little value and be hard to scale. Unfortunately, many owners can be slow to introduce the necessary cogs in the machine needed to guarantee future growth. Buyers are only interested in organizations with high potential to grow, but there isn’t any value in a company that relies too heavily on a small set of highly skilled individuals. When you come to sell the business, it is the demonstrable evidence of these disciplines and business constructs that will enable the buyer to place a value on your company.
  1. Misunderstandings of valuation – Consultancy owners sometimes mistakenly assume that their business is both valuable and sellable when buyers approach them speculatively. In the real world, poor knowledge on value often results in premature, bad, or failed deals. If you don’t know the realistic current value of your company, how do you know what good or bad looks like when decisions are to be made?
  1. Lack of a plan to become ‘sale ready’ – Sale readiness has two meanings: firstly, that the business is at a stage where it has reached the desired value and, secondly, that it is well prepared for a transaction. If the plan is to grow to $20m and exit in three years, then it is important to bear in mind that, though, the target of $20m might have been met, there might still be a high risk in completing a successful transaction. A lot can go wrong in the six-to-nine month transaction period.
  1. Inadequate shareholder alignment on exit strategy – If you are not the sole shareholder, then other shareholders will have their unique needs and goals. If these goals are too diverse, then growth may be held back, or a potential sale may be hindered.
  1. The Johari Window mistake – Supreme confidence is a valuable thing. While entrepreneurial achievements deserve all the hard-won kudos and respect earned, does this mean you don’t need to take advice on value growth and selling your company? Savvy owners that avoid this mistake build into their plans that they ‘don’t know what they don’t know’. They build a support structure around them to ensure that hazards are foreseen during value growth and that there is a high probability of a successful transaction when the company sells. So hire an advisor; if not Equiteq, then someone else.

If you’d like to read more about entrepreneurs’ eight biggest mistakes in building a sale ready consulting business, please read the full article here.

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Does your consultancy have a real value proposition?

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A consultancy’s value proposition is a crucial component of its success. Are you selling only on the basis of your technical expertise or on the value you drive for your clients? The proposition describes the services you offer, such as IT implementation, strategy development or engineering design, for example. The value describes the results and benefits which clients obtain from using the services.

During our Equity Growth Accelerator (EGA) diagnostic we identify where a consultancy lies on the value-based proposition scale. At the lower end, there are resource-based propositions. These are offered and priced on the basis of the number of consultants deployed on the project. So called ‘time and materials’ projects are resource-based.

In the middle are value-based propositions, which are offered and priced on the basis of the predicted benefit to the client: the greater the value to the client, the higher the fee. Normally these propositions are fixed price and are not hard-wired to actual consulting effort.

At the upper end of the scale are gain-share propositions. These put some or all of the fees at risk, depending upon the delivery of agreed outcomes, and are structured in order to generate higher levels of fees than either resource-based or value-based. The element of risk associated with these propositions increases the unpredictability of the fees as well as the potential fee level. A typical gain share would see a proportion of savings, delivered by the project, being taken in fees by the consultancy.

Consider a supply chain consultancy working for a client to design and implement a new inventory management system. A resource-based approach would simply provide a number of consultants on an agreed day rate (or rates) and the fees would equate to the total number of days billed multiplied by the rates per day. A value-based approach would charge a fixed fee which the consultancy would price in proportion to the benefits they believed they would deliver which, in this case, could be the reduction in inventory costs that their client would enjoy at the end of the project. A gain-share approach would charge a lower fixed fee than the resource-based approach, plus a proportion of, say, the inventory savings that the project would deliver. Overall, the total fee for gain-share should be the highest of the three options.

There are benefits and drawbacks for each approach. When charging based on resource the consultancy is never ‘out of pocket’ as all days spent on the project will be billed. But its offering is more likely to be seen as a commodity and fees will consequently be lower and can come under even more pressure if rates can be readily compared with competitors. Furthermore, engagements may be easier to terminate by the client as the service is seen as paid for by the day (or hour). A resource-based approach may incur additional administrative costs if the client wishes to track – and possibly challenge – the time spent on the project.

Value-based charging can attract higher overall fees than resource-based and is light on administration. It enhances the status of the consultancy in the client’s view and provides longer term certainty of fees compared with both resource-based and gain-share. However, margins can be eroded if projects consume more consulting resource than estimated

Charging using the gain-share approach provides the opportunity for earning the highest possible fees and is easier to sell as the engagement represents a very low risk to the client. It also aligns the client and consulting goals. However, gain-share propositions carry with them the highest level of risk that the consultancy might lose money on programmes of work. Unless the benefits are very strongly linked to quantifiable metrics, and unless the criteria for benefit calculations are completely transparent, disputes over payments can easily arise.

If you can mitigate the risks of gain-share programmes then you will have the strongest propositions of all and the opportunity to really drive up revenues.

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. 

Case study: Focus on profit and leadership brought buyers to Easton

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Background

Founded in 2000, Easton Associates provided product and business strategy consulting services to companies in the life science industries. In 2009 they approached us asking for a business valuation and market risk assessment and we valued them at $5m. By helping them restructure the leadership and to improve sales and marketing over the following two years we helped them grow their profit and the value of the business increased to between $12-$15m. In 2012 Easton sold to Navigant for $15m.

The client’s situation

Easton was a consultancy on the up, but it was struggling to convert sales into revenue and profit. The ambitious leadership team was keen to rectify this and turn the business into a thriving consultancy that had a true handle on its bottom line and was worth something on the M&A market. They asked Equiteq to help.

Our approach

When we first came on board, Easton had five partners. To improve decision making Equiteq helped the team re-structure and Easton appointed a chief executive officer. She was charged with, and given a bonus for, delivering a new profit target. Easton used Equiteq’s 8 lever Equity Growth Wheel to help them introduce best practice in driving sales and profit growth, improving intellectual property, and formalizing sales and marketing processes. Turning sales into revenue and profit was a key priority, and Easton needed to put consistency around their sales and business development processes and to make staff more accountable for delivering targets. Gross margin targets were set in line with capabilities and incentive bonuses offered on delivery. Elsewhere, building value into a ‘people’ business, where, in theory, your intellectual property is in people’s heads and on laptops, requires a unique approach. We helped Easton build detailed market propositions and put rigour and process around how they captured and recorded their valuable intellectual property.

How did this deliver value to the client?

Easton made rapid progress over a two year period using the Equity Growth Wheel, with a specific focus on sales and profit growth, market proposition, intellectual property and management quality

Equiteq supported Easton in:

  • re-structuring their leadership team to provide better clarity and focus
  • growing revenue by 37% – from $9.5m to $13m in two years
  • growing profits from $650k to $2.5m – an increase of 280%
  • Easton’s valuation grew by $10m in two years

The EBIT value of the firm started at four but reached a multiple of 7.5 at the end of the engagement

Three years to multiply the value of your firm

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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?

Past and future forecast scenarios

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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Which of your revenue streams are the most valuable to a buyer?

revenue streams croppedRevenue may seem like a straightforward topic; what could be easier than adding up revenue? But the truth is that not all revenue is created equal. In the first blog in this series looking at consultancy financials, we outlined the profile of a healthy consulting business. In this blog we’re taking a closer look at the different components of the revenue line.

On the topic of scale: while buyers of consulting firms have told us that size is important, it can be trumped by other factors. Above a certain size, what scale indicates to a buyer is that you’ve found a valuable service offering and a method of selling it. Furthermore, a strong growth trajectory will trump revenue scale in most situations. Most buyers would prefer a high-growth $9,000,000 business over a flat $19,000,000 one because they would assume the faster growing business has a more valuable offering in the market. It will probably be easier to scale within their operation too.

So now to revenue. We said that it’s not all created equal, but what did we mean by this? Let’s take a look at the different characteristics of revenue:

  • Recurring revenue: this is revenue that repeats each year in a very predictable way. This is extremely valuable as it reduces the need to sell each year to hit budget. Recurring revenue could come from a long-term contract or project, or it could be in the form of an outsourcing contract that lasts multiple years
  • New client service revenue: This is a critical component as it represents new market adoption of your offering. But it is by definition new selling every year and so viewed as higher risk and, if it is a significant part of the future forecast, it could potentially drive a higher earn-out
  • Existing client service revenue: This is easier to sell since a strong client relationship can support the sale of several projects over multiple years
  • Product revenue: These are things such as training materials, software etc. and are usually seen as a follow-on sale to the core offering
  • Reimbursed expenses: Expense reimbursements sometimes come with a small markup depending on the contract terms with the client, but are not normally seen as valuable revenue

So as you can see, some types of revenue are more important to a business and more appealing to a potential buyer. For an owner considering a sale, it’s important to clearly quantify the different kinds of revenue in your business and understand how they will be viewed by the buyer community. High growth businesses with significant recurring revenue can be more attractive than purely service consultancies that have to sell the entire revenue each year.

Fundamentally, buyers of your business will value two things about your revenue: How easy it will be to scale within their organization, and how much risk there is that it won’t work. Of course, other factors must also be taken into account, such as sector focus, geographic reach, business model and margin, so it’s never as simple as this! If you’re interested in finding out more about how to grow and sell your consulting firm you can download our quick guide here.

Our third blog in this series of consultancy financials will be looking at the different kinds of margins and how they affect value.

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