How to Grow and Sell a Consulting Firm – Part 1
by Paul Collins
 There’s never been a better time to sell your consulting firm. In fact, 2006 saw a 40 percent increase over 2005 in acquisitions of consulting firms, and the market is more active than it’s ever been. But the chances are the very notion of selling your firm has never entered your head.
Most consulting firm owners are conditioned to believe that it’s all about fee income, there’s no equity value in a people business, and you work until you drop, content (or discontent) with an annual income. In this three-article series, I’m going to dispel that myth and show you how to turn your firm into a valuable asset that’s attractive to investors. So read on if you want to learn how to grow the equity value of your firm.
In this first article, I’m going to highlight the values we’re currently experiencing in the market, identify where your buyer may be coming from, and introduce the most important equity value driver to focus on. In the remaining two articles you’ll learn about the “8 levers of equity value” and the factors used in the valuation of a consulting business, all of which will help you create your equity growth plan.
So What’s My Firm Worth?
That may be the question that popped into your head, so let’s deal with it first. There are many factors involved in a valuation, however, in simple terms your firm is worth a multiple of the last 12 months profits. Based on our market research, the average pre-tax profit (EBIT) multiple in 2006 was 10, this compares to an average of 7 over the previous five years.
Looking at it in sales revenue terms, we’re seeing average multiples of 1.6 compared to 1.1 over the previous five years. So the market is quite hot for sellers right now with lots of demand.
Of course, there are substantial variations in the numbers. For example, the average EBIT multiple may be 10, but the range goes from 4 to 40, and there are many other factors to consider for the particular circumstances of your firm. Also, as I’ll go on to explain, the real value of your firm is in your ability to reliably predict your profits into the future.
Who Would Want to Buy My Firm?
There are two main types of investor that could be interested in you: other consulting firms or service businesses (Trade Buyers) looking to bridge a gap in their growth strategy; and those coming at it purely from a financial perspective, such as Private Equity, a fast growing sector investing in our industry for reasons I’ll explain later.
Trade Buyers could be interested in you for a number of reasons:
- You’re a competitor that will give them scale
- You occupy an adjacent competency space they want to fill
- You operate in a geography that they need to cover
- You have sector expertise where they don’t
- You have client relationships they can leverage.
Financial investors, like Private Equity houses, are always looking for a better return on their capital. Larger mid-market firms are being targeted because well-run consulting businesses have a reputation for healthy profits and good cash flow. Compared to other sectors, consulting service businesses don’t suffer from the same kind of working capital demands, so there’s plenty of free flowing cash to work with.
This means they can use debt as part of the purchase structure—the so-called ‘leveraged deal’—and provide great returns to their fund providers. You may be surprised to know that in 2006, Investment houses overtook Trade Buyers as the largest buyer type of consulting firms.
Where’s the Equity Value in a People Business Like Consulting?
OK, so the consulting industry M&A market is active and prices are high. If you’re ‘investment ready’ there’s a real possibility that you could sell your firm in the next year, and if you’re not, now’s the time to put your equity growth plan in place and prepare for exit in the next few years. So how do you build equity value in a consulting firm and maximise your multiple?
A casual observer might place very little value on a ‘people business,’ as it would appear that all the assets of a consulting firm reside in very mobile people and laptops. However, if you can convince an investor that your profits over the past 12 months will continue, or grow over time, then you have equity value in your firm. If you can’t, then the value will indeed be low.
The key to equity value and the multiple applied to your firm is your ability to reliably predict your future sales and profits AND show that the risk of you failing to achieve them is low. Therefore, the most important equity growth factor by far is the creation of a sales and marketing process that delivers a healthy business pipeline and de-risks the traditional feast and famine issues often found in consulting firms.
You sales and marketing process is crucial but on its own, it’s not enough. There are seven other factors, each of which will either increase or decrease the probability of your firm delivering robust profit growth and impact your value multiple.
Let’s summarize what I’ve said so far:
- The consulting M&A market is very active and prices are high
- Trade buyers and investment houses are leading demand
- The average profit (EBIT) multiple in 2006 was 10
- Your equity value is based on a multiple of your last 12 months profits
- This assumes you can reliably predict profits into the future
- And finally…
You can increase your value and personal wealth using the ‘8 levers of equity value’ which I’ll cover in next month’s article. This will give you a framework for an equity growth plan for your firm.
Paul Collins is the founder and Managing Partner of Equiteq LLP, a UK based business advisory firm on M&A to the consulting Industry. Formerly he was the founder and CEO of the consulting firm WCI Group plc, which he built from scratch to $130m before selling his stake to private equity. He is now Europe’s pre-eminent authority on M&A in the consulting industry. Find out more at www.equiteq.com.
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