- What Acquirers Look for in a Consulting Firm
What Acquirers Look for in a Consulting Firm
Next up management consulting guru David Bailey, who founded and grew the consulting firm Impact Plus which was acquired by Hitachi. Later, he went on to acquire other businesses for a range of companies including KPMG. Bailey discusses what makes a business attractive to an acquisitive bigger firm.
For Bailey, the most important drivers of value for a consulting business are its strength and competence in a particular area of the market, its profitability and its probity. A ‘clean’ business with clear and referenceable financial data at its fingertips and which is not encumbered by too many areas of difficulty – such as legal disputes or non-profitable offices – will be more attractive to acquirers. “You don’t want anything hanging off the side,” he said.
David Bailey – What Acquirers look for in a Consulting Firm
Doug D’Argenio: Welcome to the PS Insights Podcast series, sponsored by Kimble Applications. Professional services organizations strive for efficiency, success, and growth. This series is intended to provide key insights on how to achieve this from industry leaders.
Steve Brooks: Hello. My name is Steve Brooks, and today, I’m talking to David Bailey about what acquirers look for in a consulting firm. David has worked in professional services for nearly 30 years. He founded, grew, and sold a consulting firm to Hitachi, where he then worked on several major acquisitions. He has also worked as an M&A advisor in KPMG and now works as a strategic advisor to CEOs in the industry.
David, you sold Impact Plus to Hitachi 10 years ago. How did that come about, and how do the larger firms now look for companies to buy?
David Bailey: They contacted out of the blue actually. They were looking to build a global consulting business. They had very little in Europe, and had done a start-up in the UK, realized very quickly that they needed framework agreements, access to major clients, and they weren’t on any professional listing, preferred supplier lists, and so realised they needed to buy market share in initially the two largest sectors for consulting at the time, being financial services and public sector, did a search with a corporate finance house, and there we were.
Steve Brooks: So, who are the likely buyers nowadays? Is it still going to be international companies looking to invest in UK and Europe?
David Bailey: No, it’s quite a varied mix of buyers at the moment. Some of them are local businesses, probably large UK listed, FTSE listed businesses looking for scale, and as long as it’s agreed to, they can do a bolt on. Some are the larger consulting or advisory firms that are looking to plug capability gaps or gain access to specific markets. So, for example, I did an acquisition a couple years ago where a large acquirer was looking to actually get access to the FTSE 250 market. They were already pretty well-positioned in the FTSE 100, and they wanted to drop down a tier, so the easiest way was buy a firm that already worked in that sector. And so, large firms, system integrators, and outsourcers, they’re having their margins eroded, so they’re looking to buy higher value front end services, gets them onto client boards quicker in a lifecycle, and then tries to protect margin down the line.
The overseas firms, yes, wanting a geographical footprint, the UK being a sort of stepping stone from Europe to the States, or from the States to Europe, or wherever else, and then increasingly, actually, the new buyers on the market are the private equity houses. They’re becoming increasingly comfortable with services businesses as part of their portfolio, which only five years ago, they were not.
Steve Brooks: And if you’re starting and building a consulting firm, you might not have an exit plan, but you should at least have some goals. Do you expect an offering from those larger organizations, if that’s your end goal? How do you prepare for it? Or what’s the way in which you might be acquired?
David Bailey: Well, first, you do need to decide what your end goal is, and a lot of the advice I provide to the smaller firms actually starts with what’s the objective of the key shareholders? Are they looking to build an asset and realize value? Or do they want to make good money along the way, and then stop? Or is it more of a lifestyle play? Assuming they are looking to realize value from an asset, then strangely, the first thing they need to understand is what are the drivers of value, and any decent advisor, like myself, has a set of value sliders, as I call them. 10 or 12 topic areas that drive value, and others will have the same.
So obvious things are scale of revenue and profits, or EBITDA as people call it. They’re clearly key, and in the three years or so before you sell, you want a nice upward trend on both of those, but that’s not enough. You obviously need to be positioned well in the market. You need to be recognized for something. A specific sector expertise, a specific topic competence, and then of course you also need a clean business. So, if you’re running your own business, and you want to sell it at some point, don’t put anything strange through the books. Try to keep away from legal disputes, and also try not to have things hanging off the side, and setting up a New York office because you’ve got one client in the UK that asked you to do a project in the US is not always helpful for an acquirer that gets saddled with the lease in New York, and the three members of staff.
Steve Brooks: You mentioned EBITDA, but how important is profitability in that kinda calculation?
David Bailey: Very important. There are four or five different ways of valuing a professional services firm. The most popular one at the moment is to use multiples of EBITDA, discounted cash flows are coming back as well also as a way of looking at value of business. They’re probably the two main drivers today. So, profitability, very important.
Steve Brooks: And you mentioned about important metrics, and EBITR, and profitability, and you talked about having a scale of that, but you also mentioned, this is important, those metrics change over a period, especially that three-year period. Are there any non-financial metrics that acquirers look at specifically?
David Bailey: Yes. Once you’ve got beyond the basics of minimum threshold of revenue and profit, then an acquirer, if they’re going about it the right way, will want lots of information, factual stuff that you should either have at your fingertips, or should be able to press a button on your systems and get the answers without effort, and if you can answer the questions quickly, then it’s most impressive. So, your budget and latest forecast for the current year, as a minimum, maybe couple of years, revenue gross margin and EBITR, that should be at your fingertips. Your current forward revenue and, ideally, gross margin profile coming from forward backlog of committed work, a weighted sales pipeline, maybe backed up by unweighted sales pipeline. All that should be available.
Gross margin figures, it amazes me the number of professional services firms that don’t actually know what their gross margin is or is projected to be, but you really do need that overall for the business, by sector, or by competence as appropriate, and then eventually, by project. You should be managing projects to gross margin, rather than just to revenue, and maybe even by person.
Steve Brooks: Producing those metrics sounds like a lot of work, do acquirers want that as a one off, or are they looking for a constant update of those metrics during the process of acquisition?
David Bailey: Again, it varies by type of acquirer. For example, I was involved in selling a business to one of the big outsourcers in 2012. The whole process was done in six weeks. The need to update things constantly just wasn’t required. An offer was put on the table, it was accepted, brief due diligence done, money in the bank, but I compare that to when I sold my own firm back in 2007, and that was a nine month process, and we needed to provide constant updates of forward pipelines, staff to associate ratios, gross margin numbers, at the time, we had to produce all of that manually because systems were not integrated back then.
These days, there are systems that just have all the information there, all the way from your sales forecast, all the way through to billing the client. The information should be there without having to have endless spreadsheets that you’re updating on a daily basis.
Steve Brooks: You haven’t mentioned customer satisfaction. Should companies look to introduce net promoter score, or a balanced scorecard? And acquirers looking for that kind of information about customer satisfaction?
David Bailey: Personally, not a great fan of using those sorts of metrics for more soft measures. Much better, I think, to be able to say, “Well, this client must be happy because we won an award with them, in their industry, let alone in ours.” Or, “Here’s some great case studies and testimonials that the client has signed off.” Having a whole host of those that you can have freely available for the acquirer is probably more interesting than the net promoter score or something like that.
Steve Brooks: And are there anything else that they look for in that target organization, when they look to buy someone?
David Bailey: It’s varying. When I’m working with an acquirer, one of the first things I ask for is what is it they’re looking for. Sometimes they’re clear. Often, they just have a rough idea. So, I find myself doing a strategy workshop to clarify things. The key variables are geography. I’ve had, “I’m looking for something in the UK and the US.” I’ve had, “I want something that’s UK-centric.” I’ve had, “I want something in the DACH region.” I’ve had, “Everything must be in the UK, and only in the UK.” So, it’s important to understand the geographical focus, and why.
Then obviously sectors and types of clients. You may decide you want to go and buy something that operates in a particular sector, but do you want them to deal with the multinationals in that sector, or the second tier, or third tier, or what? And then capabilities, scale, some acquirers have a minimum threshold for those things, revenues, profits, those sorts of things, and then business model. Employees versus associates.
Steve Brooks: So organizational structure?
David Bailey: Yeah. The type of structure that you’ve got in there, and whether you follow this sort of traditional partner type model of the people at the top both sell and do, or whether actually you follow more of an IT services model, and you have people that sell, and people that deliver.
Steve Brooks: So, it sounds like the contracts around the people, and the talent is very important. So, are there any gotchas that people should be doing, and making sure they’re sorted out?
David Bailey: If you’re looking to realize value from a business like this, then first of all, you need your employee/associate ratio to be in the right order. You need more employees than associates, ‘cause associates can walk away more easily than employees, and the assets are the people of course. So firstly that, and then the more senior people, either needs shares or some form of share option scheme, or other incentivization, that can be continued in some way into an acquirers organization. So, they get some value from their skin in the game, but also, they get hooked into the future as well. So important to think that through, well before an acquirer knocks on the door.
Steve Brooks: And alongside people is obviously culture. What kind of culture should organizations create, that’s attractive? And are there any cultures that are less attractive?
David Bailey: I don’t think so much about a particular type of culture. The important thing is to have one. People always talk about they need to move away from a certain type of culture, but they never really talk about what type of culture they should move towards. So, I think the important thing is to have one. The important thing then from an acquiring standpoint is the cultural fit. So you will know very quickly, when an acquirer has knocked on your door, and you’re having meetings with them, you will know whether you fit as an organization or not, because you will find yourself opening up more, and they will find themselves opening up more, and more quickly, if that cultural fit is there. If it isn’t there, equally, you’ll know that pretty quickly, and that’s when to stop the conversations, unless you’re only in it for the cheque.
Steve Brooks: If your exit plan is to be acquired, how do you go about finding someone to purchase you?
David Bailey: You could run your own exercise for a start. That can be done, and I’ve packaged businesses up and sold them, as to corporate finance houses. So yes, you could do your own process, but if you just want to appear attractive, then you’ve got to become known. So, as I was talking earlier about specific competencies, specific sectors, those sorts of things, get focused in on them, but then, get people to shout from the rooftops, enter reward programmes, get onto lists of fast-growing companies, fast track 100 whatever, get listed as a good company to work for, join your industry trade associations. So, in the UK, The Management Consultancies Association would be key there. Get column inches in relevant online and physical press.
Try and get all those sorts of things. It all creates an environment within which you can then be found, not only by acquirers of course, because you can then also get found by prospective clients, which helps you grow your business. And as long you don’t spend a fortune on those things, then you should be doing those things anyway.
Steve Brooks: Does that depend on scale of consultancy though? Because if you’re a high volume, low value consultancy, doing a lot of work, would the net promoter score be more important to that point? You may still have the instances, but if you’ve got a lot of customers.
David Bailey: I don’t think so. There are very few types of consultancy that are purely transactional. If it is a purely transactional thing, then it will be done in a very low-cost way, probably offshore. And yes, you might want to have some metrics like that, but most professional services firms are trying to demonstrate higher value, and they’re demonstrating more of a client relationship rather than something like a score.
Steve Brooks: And you’ve had an approach from an acquirer, who should you involve on your side of the table, and who’s important to make friends with?
David Bailey: At the beginning, nobody, because this could be a massive distraction, send your business off in all sorts of strange directions, and start costing you money. So if they’ve approached you, and you are a major shareholder, or the managing partner, or whatever, and it looks interesting, go and see them yourself, form your own view, and then you might extend it to a small group of key shareholders, the board, or the equivalent of a board partner group. I wouldn’t go below that group without being absolutely sure of yourself, because if you open up to your employee base, or a significant portion of it to say, “Hey guys, we might be acquired by that company over there.” Then they’re immediately going to see that their jobs are at risk, and they’ll start honing their CVs, and that’s not really what you want. You want to control the process of transition from your firm into another firm. So be really careful about how low down in your own organization to go.
Externally of course, if you’re not experienced in M&A yourself, having an external advisor along with you can be helpful, not least because a number of people that work on the acquirer side have only ever worked for larger businesses, and they don’t really respect the amount of time that it takes for you to pull together the information they’re asking for, or the time that they’re wanting you to spend in full day workshops, to get an understanding of the degree of fit etc. So, having someone who can say, “Hang on, you don’t need to do that.” Because they’ve seen it many times before, can be useful, and equally, they can help you manage the risks involved.
So, having some form of external advisor can be helpful. People tend to turn to lawyers and accountants, yes, great. You need them at a point in the process, but probably not until you’ve got a draught heads of terms on the table. When you know it’s real, and then pull them in. You certainly want a lawyer’s view on a draught heads of terms, before you sign that you accept them.
Steve Brooks: Do you ever get false dawns so kind of dummy approaches that you need to be wary of, or are they just infrequent?
David Bailey: Used to get that a few years ago. Less so now. What you tend to get now is, in the sort of that category, are often overseas acquirers who don’t understand the market, and are just spraying themselves around, trying to find somebody. And so, yes, they might approach you, but you’re one of a 100, 200, 300 companies that has been approached, either directly by that organization, or through some corporate finance house. You really do want to be wary of those organizations, because the likelihood of a deal happening is close to nil. So be careful.
Steve Brooks: So, when you’ve got your first approach, what are the three key questions you should ask the acquirer first?
David Bailey: You want to understand what their process is, and how they’re going about it, so you can get a view as to have they actually focused in on you, or are you just a number. So that’s quite important. You want to get that fast. And then, if you form a view that it’s worth still sitting in the room, then you move on to asking questions about their strategy, the direction they’re looking to take their business, irrespective of your view of how well you might fit with them. You wanna be asking where they’re going, so you can see how it fits.
And thereafter, I suppose it depends on what your personal objective is. If you’re seeing this as a potential way to grow your business a lot quicker, then you want to understand what the acquirer can bring. Are they bringing brand strength, money to invest in your business, access to their existing client base, lots of things to ask there? If you’re not particularly bothered on growing it faster, but you plan on sticking around, then you want to understand how might your business fit into their business, and who are the people you’d be interfacing with, won’t necessarily understand that in the first meeting, but you want that in a fairly early meeting.
And of course, if actually your plan is that you’re exiting, then you need to understand what are the types of deal structures that they might want to put together. If it involves earnouts, what are the triggers for those earnouts, how long are they, so you can form a view as to how much money you’re likely to get in what time scale.
And you’ll ask those questions alongside questions around your team, and their careers, how their careers will be protected or enhanced by becoming part of the acquirer’s organization, A, because you might care, and B, because really, you wanna feel good as you depart, feeling good that you’re leaving behind something that can continue forward.
Steve Brooks: When companies look for venture capital funding, the personal relationships between them, the senior leadership, and the venture capitalists is very important, and it’s become more important in recent years. How important are personal relationships during the acquisition process, or can it be done more at a hands-off level, especially with the larger organizations? Or do you look to change the people working on that negotiation at all?
David Bailey: No, I think you want the key people in from the very beginning. Even when I’ve been helping large businesses do acquisitions of small businesses, you really want to get from the acquirer side the guy who’s gonna be the boss of the MD of the business you’re buying to meet, you want them both in the room together very early on, because if they don’t get on, it’s not gonna work, and that personal relationship, that personal chemistry is very important.
Steve Brooks: Looking forward into 2017-2018, how’s the market looking out for M&A activity?
David Bailey: At the moment, very buoyant. We’ve got quite a bit of focus from overseas acquirers. Surprise, surprise, with a weak pound. So, US companies’ dollars go a bit further. Europeans’ euros go a bit further. So, they can be seen to be putting a bit more on the table, whilst it’s still being cheaper than it might have been two or three years ago. Quite buoyant from that perspective. Within the UK, also pretty buoyant in some of the hot areas, as the larger firms are looking to build up their cyber practice, or get their digital transformation group, or whatever it is going. So those sorts of things are quite hot, but of course, there aren’t many of those types of firms around.
Steve Brooks: So should firms look to involve themselves in digital transformation projects and cybersecurity projects?
David Bailey: Digital and transformation, two words to put together. Fantastic. I’m quite amused, seeing firms that are re-spraying themselves to look hot. Transformation, digital, cyber, are three keywords that you see on loads of consultancies’ websites. Many of these firms however don’t really have that depth of expertise, so they’ll get found out pretty quickly. If, however, it’s been a steady investment or a steady change of direction over a period of time, so you’ve been building up your digital practice over two or three years, and you’ve got a real depth of expertise, and decent client base, then that attractiveness will increase. And if you are attractive in a hot topic, you’re gonna get a much higher valuation.
Steve Brooks: You mentioned companies are valued by multiples of EBITDA, but looking through the press, those multiples vary enormously. What kind of multiples can companies expect, or how do they calculate them?
David Bailey: Yeah, you’re right. They do vary wildly at the moment. You can get a hold of reports. There are lots of reports out there you can get hold of that will tell you, for different parts of the market, the type of multiples that people are paying at a point in time. Gotta be really careful of those, however, because those reports are put together based on information that’s available, and the information that’s available tends to be associated with the larger deals in the market, and the larger deals, because they tend to have less risk associated with them tend to attract higher multiples.
So, if you’re reading a report that says you should expect a multiple of 11 to 15 in your particular part of the market, then if you’re a four million turnover firm, you’re not gonna get anything like that. You need to be wary of believing those types of things. If you’re in a four million turn over firm in a really hot area, all your four million come from cyber security, absolutely you’re gonna get those sorts of numbers, but if you are in a more standard consulting area, then that’s not gonna be the range you’re getting. Today’s multiples are in the sort of five to eight range, and they move over time.
Steve Brooks: You talked about clean business, have you got an example where you came across, naming no names, of an unclean business?
David Bailey: There’s, I suppose, two types of unclean business. The one is where a business tends to be owned by one person, and they’ve put a number of personal costs through the business, and yes, I’ve seen that, and had to ask for those things to be stripped out, and put below the EBIT line, so that I can have their flat in London removed, and similar things. So those sorts of things. The second topic, which is perhaps the more regularly seen, is where businesses have expanded, and put things in that shouldn’t really be there anymore.
As any professional services business grows. I used to have this phrase, that you end up with more offerings than you have staff, and then you have to hone in again. So, the key thing is, make sure you don’t expand too far or too quickly, or too thinly. When you move into a new area, make it real. Only have one or two incubators in your business at any one time, don’t have the US office, and the Singapore office, and entering the telecoms market, all at the same time. A, it’ll destroy your EBITDA, and B, it’ll just make you look a mess to a potential acquirer.
Steve Brooks: That’s kind of focusing in on what your priority is, and in terms of that focus, if you’re focusing on specific market, how can you evidence that in terms of your customer relationships to the acquirer?
David Bailey: So, if you focus on a particular market, particular sector, or geography, or whatever it might be, then, well, you ought to, if you’re running your business properly, have plans that match that. If you are a financial services consultancy, then you should have a sector plan for financial services that breaks it down into banking, and insurance, and capital markets, and you should know who the key players are in those markets, and you should know who your targets are, and who your existing clients are, and your existing clients should have account plans attached to them, if they’re over a certain scale.
You should be able to evidence your position in those clients, with org charts that are highlighted with who are the people we really know well, who are the ones we know less well, who do we want to know but don’t know yet, how many pieces of work have we got in there, do we have a framework agreement, or are we on a preferred supplier list, and can we evidence that. There are so many things that you can do to provide evidence beyond just, “Here’s a great case study of some work we did in this company.”
Steve Brooks: And we’ve covered it kind of indirectly. If you’re running a professional services company nowadays, and you’re entering that end game in terms of you’re thinking, “I’m now working towards my goal of being acquired.” Are there any pieces of governance that is really important to put in place now, that you might not have done in the earlier days?
David Bailey: I’d certainly make sure I’ve got the right bits of infrastructure in place. We were talking earlier about the metrics, and what acquirers might look for. You want to make sure you’ve got that information easily available. Similarly, you want to make sure you’ve got other bits of information all in one place. Take the framework agreements that we talked about earlier, put them all in one folder, so that when someone says, “How many framework agreements you’ve got?” You can not only say how many, but you know where they are. A number of organizations I’ve been into and asked the question, and they don’t actually know. There’s sort of standard housekeeping stuff to do, to put things in a nice place, so that it can be found easily initially by you, and then later by the acquirers due diligence team. They can come in, they can have a look directly into your systems.
Steve Brooks: Thank you very much, David.
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