Valuing the forces that attract potential buyers

Amanda Merron looks at the aftermath of recent mergers and acquisitions and advises consultancies to begin re-evaluating their business to optimise value

Last year saw a period of intense merger and acquisition activity in the design sector. Now that the market to buy consultancies has cooled, it is a good time to take stock of where the business is now and what needs to be done to optimise its value in the future.

What makes a business attractive to a prospective buyer is also fundamental to long-term success as an independently-owned company. The two are far from mutually exclusive.

Potential buyers will look at acquisitions for a whole range of reasons, but, except in very rare circumstances, the price they will pay will be a function of their confidence in the underlying profits they are buying.

What gives them that confidence? Evidence of certain inherent qualities within the business that attract high calibre staff and create more business from new and existing clients, which in turn indicate continued future growth.

This can be broken down into:

Well spread, quality client base

Client loyalty

Management in depth

A high quality profile

Historic growth indicative of future growth

Other factors buyers consider will be:

Strategic fit

Size and profitability

Sector

Territory

You may not be able to influence all of these, but if selling is a genuine goal then there is a lot you can plan for and control.

One of the main routes to acquiring a reputation as a ‘quality’ organisation is in the people you hire. Staff excellence will lead to more imaginative and more effective creative solutions, which will in turn lead to an enhanced reputation among clients and prospective clients. Also, the skills being employed by the consultancy must be in keeping with the size and nature of the organisation as a whole. Finding a way to attract and keep the right people is of prime importance. Buyers will look askance at companies where the up-and-coming management team has not been tied in with long-term incentives.

A buyer will also need to see a diversified, quality client-base, one without over-dependence on any one or two clients. Ideally, any one client should not account for more than 20 per cent of income. Aside from this making sound commercial sense in sheltering the business from client gains and losses, it is also evidence of an effective business development team. Client loyalty is an important yardstick and will certainly be measured in years rather than months. The depth of relationship is also important. The more client contacts, and the higher in the organisation they are, the better.

Boosting income levels is obviously one side of the coin, but must be translated into increased bottom line profits. This means ensuring that costs do not grow faster than the actual business generated. The most difficult, and expensive, area is staff costs. It is these costs that will eat large chunks of operating profit.

Equally important is to retain quality control over the client base. New business should be accurately assessed for profitability. Setting minimum fee levels, and sticking to them, is a good discipline. Obviously, exceptions can be made where there are marketing or strategic reasons to take the business on.

The absolute volume of profit is also important. Major buyers will usually consider acquisitions making profits of more than £500 000 and preferably in excess of £1m. There are buyers around for smaller businesses, but they are more limited.

A buyer wants to see past profit growth as an indication of future growth. Embarking on new ventures is risky and should be planned carefully. Attractive as business diversification sometimes seems, it is never worth standing to lose more on a new venture than any projected profit growth on the consultancy’s core business units. New ventures should aim to be profitable within 18 months.

How to finance new developments is also a key decision. Generally, it is advisable for new ventures to be funded out of cash flow from trading operations and/ or asset sales. Ideally, borrowings should be a lot less than shareholders’ funds and kept as short term as possible.

It helps to demonstrate an interest in maximising profits. Prior to sale, ‘clean up’ the balance sheet, and ensure the consultancy gives an impression of being totally results focused.

Keep the administration tidy. Make sure:

Employee contracts are sound and in place

Ensure appropriate client terms are in place, where possible

Ensure you are not exposed to extra tax on freelances

When we carry out due diligence looking at the financial and commercial position of target companies these are some of the soft targets. Other common areas for concern include lack of appropriate or regular management information, inappropriate accounting policies for recognising profit on jobs and undeclared tax on employee benefits. The messier it is the less confidence a buyer will have and the easier it is to talk down the price.

Profile helps enormously in attracting good talent and the right clients. It is also a selling point to a potential buyer.

Whatever the plans, following the above basics will ensure that the business has the strength and flexibility to give the owners choice: from borrowing to make your own acquisitions, to finding the best exit for the owners.

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