If you are hoping to sell your consulting firm, either now or in the future, it’s important to understand how the size of your firm can impact your ability to sell it.
This guest post by Tony Rice, founding Partner of Equiteq, shares his insight and research on why the size of a firm matters when an owner wants to sell it.
Equiteq, a leading Mergers and Acquisitions (M&A) advisor for consulting firms, helps firm owners grow profits, revenues, and equity value. They also guide firm owners through the process of selling their firms for maximum value.
Does Firm Size Matter?
How large or small should your firm be before you sell it? Mostly, that depends on the result you’re hoping to achieve with the sale.
Firm size does not equal value.
For example, you don’t want to grow your business to a level that could make your firm less attractive to buyers. Nor do you want to live with the false hope that your <$1m practice will sell easily.
Firm size does matter, and it is an important variable (among many) in preparing your firm for sale.
There isn’t one answer about the importance of firm size to a sale, but it is possible to consider the question from different market perspectives.
Does Consulting Firm Size Matter to the M&A Market?
As you can see from the chart below (from our 2014 Consulting Sector M&A Report), firms of all sizes sell. The chart is based on the value of the deal, not the annual revenue of the acquisition.
However, based on the way valuation multiples in the consulting sector work, it is a reasonable assumption to make that valuation roughly equals revenue.
If you consider firms smaller than $5m to be “very small,” about 40% of the market volume is in this size category.
If you consider firms bigger than $30m to be “mid-market to big,” then only about 20% of the market volume happens above that threshold.
However, there is a caveat. For small firms, it’s often the case that money doesn’t actually change hands.
The probability of selling a sub $5m to serious buyers with cash up front is low, unless your firm has significant assets a bigger buyer can leverage.
In the small-firm part of the market, it is more likely that a merger is taking place, not a sale for cash. In instances where cash is involved, buyers would be more likely to offer a relatively small proportion of the sale price up front.
Does Firm Size Matter to Buyers of Consulting Firms?
Regular buyers of firms are sensitive to size. These buyers are firms in the Big 4, or others who make one or more acquisitions a year.
These are the serious buyers who are willing to offer significant amounts of money for desirable acquisitions.
A ‘typical’ deal with one of these buyers could include 50% to 60% in up-front cash, The rest of the price is often paid in cash or shares over an earn-out period of 2 or 3 years.
These buyers are looking at acquiring firms in the size range of $10m to $50m revenue.
Gear firm size to your personal and financial objectives by planning ahead to be ‘sale ready.’
Firm size is important to these buyers because firms that are too small are generally high risk (financially unstable). Even if the acquiring firms have great assets, the value of those small-firm assets isn’t usually enough to make an impact on the growth objectives of the acquiring firm.
Of course, there are exceptions. Small firms that are rich in tangible intellectual property that a buyer can leverage rapidly through its organization are often seen as worthy acquisition opportunities.
Similarly, if there is a new market that the buyer wants to get into and the market is not mature enough to have yet created firms of scale, then smaller firms would be attractive.
Does Size Matter to You, the Seller?
It depends on why you are selling and what you want from the deal.
If there are vital reasons why you want to get your firm into a new home and money is not the main driver, then size may be less important.
However, if you are running a $5m firm and the shareholders want to realize $20m in value, then it is important to grow the firm to that target value before trying to sell it.
However, beware of scaling up just for the sake of getting bigger. A smaller, $10m firm may be more valuable to you, and more sellable, than a $50m firm.
Larger firms need buyers with deep pockets. Usually, these buyers are more interested in specialist firms than generalists. So, if you’ve grown your firm by diversifying your services, it’s possible your firm would be viewed as a generalist firm. That could make your business less attractive to potential buyers.
Also, beware of the law of diminishing shareholder returns. To continue to grow, there comes a point where the founders have to dilute their holdings to attract and compensate senior people to run an increasingly complex business.
It is possible to grow profitably and still make your firm unsellable, or less valuable to founder shareholders.
The unfortunate result is a dilution in owner equity for the founders and a corresponding reduction in the value they’ll receive for selling the business.
Key Takeaway Points
- The probability of selling a sub $5m to serious buyers with cash up front is low, unless your firm has significant assets a bigger buyer can leverage.
- As a rule of thumb, strive to reach $10m revenue or above (profitably of course!) to attract serious buyers willing to pay cash up front.
- Gear firm size to your personal and financial objectives by planning ahead to be ‘sale ready.’
- Firm size does not equal value. It is possible to grow profitably and still make your firm unsellable, or less valuable to founder shareholders.
Interested in growing and selling your consulting firm?
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