demand for acquisitions in the consulting sector? what ...qualitatively, buyers focus in on your...

Demand for acquisitions in the consulting sector? What buyers say.

Growing equity, realizing value

Equiteq’s 2015 global research report for consulting firm owners wishing to sell during 2016/17.

The 2015/16 Buyers Research Report2 © Equiteq Ltd. 2015 3

Foreword

Foreword from Paul Collins, Equiteq Founder and CEO.For the second successive year, we are pleased to present the findings of our annual survey of buyers of consulting firms. Our report focuses on buyers’ M&A appetite and what makes them tick when evaluating acquisition targets. We hope that the insights presented in this report will help you, the future sellers of consulting firms, to be better informed on key exit strategy questions, by understanding what your potential buyers will find valuable and attractive.

So what are the key questions that formed the basis of our survey this year?

Timing - Are we in an up or down market cycle and is now a good time to sell?

Size – Are you well positioned in terms of scale and financial profile?

Beauty – What does good look like and how attractive are you likely to be?

IP – How important is Intellectual Property in getting premium valuations?

Deal – What are the determinants for the realization of equity over an earn-out period?

Integration – Post deal, what are the typical buyer priorities for your people and your clients?

If any of these questions interest you, then please discover what buyers say by reading on!

I can say without hesitation that this report is a unique view through the lens of some of the hungriest strategic acquirers across the globe, as well as many of the more selective trade buyers in the main segments of our consulting industry. These are the real world views of C-Level and corporate development executives at the top of important consulting sector companies, responsible for acquisitive growth. As such I hope you find it to be authoritative, thought provoking and insightful.

Finally, thank you for taking the time to read this report, but most of all thanks to the buyers who took part in this survey in order to provide such valuable information. I would also like to acknowledge Shant Yeremian, Equiteq’s Global Buy-Side Director, for authoring it.

Paul CollinsCEO, Equiteq

The 2015/16 Buyers Research Report4

Contents

Highlights. 5

Introduction. 8-9

Acquisition activity & trends: Buyers’ acquisition expectations have more than doubled in the past year! 12-15

How hungry will buyers be over the next two to three years? 13How important are acquisitions to buyers as a source of growth? 14Are buyers seeing more or less opportunities than last year? 14How much money do buyers have for acquisitions? 15

Buyer size preferences: Larger firms are in greater demand, but buyers continue to buy firms of all sizes. 18-21

What are the size range preferences? 19Size matters for different types of buyers. 20

Deal structures: Expect around half the value up front and a 2-3 year earn-out to get the rest. 24-27

What proportion of deals involve an earn-out? 25What should you expect in terms of the consideration paid up front? 26How long is the earn-out period? 26What are the main targets used as the basis of earn-outs? 26What proportion of earn-outs hit their targets? 27

Buyer evaluation criteria: Quality of clients, profits and IP - a winning combination! 30-33

Quantitative vs Qualitative metrics. 31Ranking of quantitative metrics. 32Ranking of qualitative metrics. 33

Intellectual property: A paramount attribute, with post deal value clearly described. 36-39

The importance of IP in assessing consulting firm acquisition opportunities. 37Which types of IP are the most attractive? 38What makes IP difficult to assess amongst buyers? 39

Post-acquisition Integration: People come first! 42-43

What are the top integration priorities in the first 90 days post-acquisition? 43How long do buyers of consulting firms typically take to integrate an acquisition? 43

Conclusion. 44

© Equiteq Ltd. 2015 5

Highlights

Acquisition activity & trends: Buyers’ acquisition expectations have more than doubled in the last year!

Deal appetite and buyer sentiment about future acquisition expectations remains extremely positive, with acquisition growth expectations over 2x the levels highlighted last year! There are huge amounts of capital set aside to enable these acquisitions. Within the sample we surveyed, there is over $7.7bn of funds available for acquisition of over 400 firms in the next two to three years. This is an 11% increase from last year’s budgets and is particularly encouraging despite the economic uncertainty we have seen over the past year.

Buyer size preferences: Larger firms are in greater demand, but buyers continue to buy firms of all sizes.

In line with the expressed growth in acquisition appetite, buyers are looking to acquire larger firms compared to 2014/15. On average across all buyers, the target acquisition size for consulting firms over the next two to three years ranged between $18m and $45m in revenues, with an optimum size of $31m. This reflects a 20% increase in size preference at the lower end1 and a 15% increase at the upper end. However, if you’re looking to sell your firm, it is important to recognize that the vast majority of consulting sector deals are consistently done at the smaller end of the market. We explain this difference between buyer demand and transaction reality in our report.

Deal structures: Expect around half the value up front and the rest in an earn-out period of 2 to 3 years.

Earn-outs continue to be a reality for the majority of consulting sector transactions. The ‘average’ deal will include 45% in up-front cash, with the rest over a period of 2.7 years; 83% of buyers measure earn-out performance on Gross Margin, but measures range from partner retention to net profit performance. In practice, we find that high quality consulting firms in high demand areas generate different scenarios, potentially with more cash upfront and ‘deferred’ rather than contingent payouts. There is a wide range and lot at stake, so the need for good negotiation skills is critical to get the best deal for you and your business.

Buyer evaluation criteria: Quality of clients, profits and IP - a winning combination!

Buyers are polarized in their use of qualitative and quantitative measures when evaluating acquisition opportunities in consulting. Quantitatively, buyers prioritize margins and growth above all other metrics. Qualitatively, buyers focus in on your client base and quality of your IP. A detailed understanding of consulting sector buyers and how they evaluate deal opportunities is critically important during a sale process. This will help focus the opportunity you represent on aspects that appeal to each group of buyers and tailor your approach accordingly.

Intellectual property: A paramount attribute, with post deal value clearly described.

The right kind of IP provides significant leverage to your consulting services. Buyers recognize this and expect to leverage the IP within their own firms post acquisition. So the challenge for buyers is to find firms with the right kind of IP to leverage. Buyers prefer IP that directly generates revenue, or that supports the delivery or standardization of a target firm’s consulting services. However, 45% of all buyers found it difficult to understand how the IP described in the target consulting firms they look at contributes to the success of those firms. Clarity around your IP and its value is of paramount importance!

Post-acquisition integration: People come first!

What happens after the champagne cork is popped and the focus turns to making the acquisition a success? Buyers of consulting firms rightly focus on the integration of people above all else in the first 90 days after an acquisition. Clients are the next highly prioritized area and the integration of technology and systems follows on from these. On average, as a seller of a consulting firm you can expect to be involved in an integration period for just under 2 years following an acquisition. Buyers start thinking about integration of your services as a seller early on, so you should also consider how you would integrate into their firm, as part of your buyer considerations.

1 This represents an average across a large number of consulting firm buyers. It does not reflect the likelihood of sale for any one firm at the smaller and larger end of the market.

Introduction


Introduction

Equiteq’s strategy is to focus on one market segment – Knowledge-based businesses that deliver advisory or consulting and that are driven by people or technology. We invest in researching buyer strategies for acquisitive growth in terms of what deals have been done and what buyers are looking for in deals.

Our Global Consulting M&A Report tracks what has happened and analyzes the historical trends. Our Buyers Research Report is designed to verify the trends we are identifying with our active buyer contact program. We align our active contact program around two buyer categories:

1. Prolific and recognized buyers (2+ acquisitions per annum);

2. Regular buyers (1 acquisition every 2 years).

The purpose of our focus is to build an unprecedented level of knowledge and insight into the needs, strategy and acquisition requirements of the buyer community.

Annually, we commission independent research of consulting firm buyers to validate the picture we are continuously building. The Buyers Research Report is structured around 6 key themes that uncover the underlying trends in the market. This year’s report is structured to not only look at the supporting evidence of trends but also to provide our views of what these trends mean in the market. It is based on independent quantitative research with the intelligence we gather through our relationships and daily conversations with the buying community. This is Equiteq’s second annual report, developed to obtain a real world view from buyers of consulting firms on acquisition preferences, direction and trends.

2 107 structured quantitative interviews were carried out by Illuma Research amongst senior decision-makers in Europe and North America during September 2015.

As we did in 2014/15, we commissioned primary research to collect statistics from a diverse community of consulting firm buyers to reflect the realities of their M&A activity to date and their sentiment on acquisitions going forward. Combining results from 2014/15 and 2015/16 allowed us to compare how buyer views have changed over the last 12 months. This is particularly relevant given some of the economic uncertainty over the last year, including falling commodity prices, an ongoing slowdown of China’s economy, an increasingly unsettled Europe and ongoing challenges in the Middle East. Despite all these challenges, we are delighted to present the very positive findings of our research in Equiteq’s 2015/16 Buyers Research Report.

In this report, you will find the views from over 100 buyers of consulting firms from across the world, representing a broad range of consulting sectors and a ‘view from the top’ from senior decision makers.

An independent research company conducted 107 telephone interviews with directors and senior managers responsible for acquisitions of consulting firms2, as well as corporate and investment buyers of consulting firms.

As such, this report represents the realities of consulting firm buyers and their sentiment going forward.


Business type

(Global) Head Office

European / UK subsidiary

US subsidiary

ASEAN subsidiary

Not specified

68%

64%

7%4%

2%

2% 3%2%

23%

25%

2014/15

2015/16

Industry sectors

Accounting / Financial

Engineering

Media

Environmental

Combined services

IT Consulting

Management Consulting

Outsourcing

Research

Software

HR

Health/Pharma

Venture Capital

Other 2014/15

Other 2015/16

3%

9%

11%

4%

3%

14%

11%

4%10%

5%

4%

4%

17%18%

19%

9%21%

17%

5%

3%

9%

2014/15

2015/16

Level of buyer contacts surveyed

Board /partner level

Reporting into board

Other

2014/15

2015/16

77%

70%

26%

21%

4%

2%

Geographic profile of buyers surveyed

North America

Europe

Global

Asia Pacific

South America

2014/15

2015/16

31%

36%

23%

19%

10%

7%

2%

4%

36%

32%

Acquisition activity & trends



Buyers’ acquisition expectations have more than doubled in the past year! There is clear evidence that transactions in the consulting sector are on the rise. A number of high profile deals over the past few years reflect a pattern of larger and more frequent buyer activity in the consulting sector. We discussed this trend in our 2015 Global Consulting M&A Report, and we have continued to see frothy acquisitions in the consulting sector over the past 12 months, including:

• Korn Ferry’s $450m acquisition of the Hay Group reflects a transformational deal that broadens the buyer’s offering and adds higher value services;

• Carlyle’s 51% stake investment in PA Consulting reflects the increasing interest of private equity into this space, a trend we identified in our 2015 Global Consulting M&A report and continue to hear about in our own networks;

• Verisk Analytics’ acquisition of Wood Mackenzie reflects the ongoing trend of combining recurring subscriptions and high value consulting revenues to reinforce ongoing cross selling opportunities between the two;

• McKinsey’s continued string of recent acquisitions in non-traditional areas, including the acquisitions of LUNAR, a design and development firm, and 4tree GmbH, a German Saas delivered Big Data solutions company.

This reflects a growing M&A market in the consulting sector and one in which buyer appetite continues to increase in size and volume across consulting, corporate and private equity buyers.

Will this continue? The answer from buyers in the market is a resounding ‘yes’. Acquisitions are an integral part of growth for over 80% of firms. Looking forward, buyer sentiment about future acquisition expectations remains extremely positive, with acquisition growth expectations over 2x the levels highlighted last year. Reflecting this, there are huge amounts of capital set aside to enable these acquisitions. Within the sample we surveyed alone, there is over $7.7bn of funds available for acquisition of over 400 firms during the next two to three years. This is an 11% increase from last year’s budgets.

0%

2%

4%

6%

8%

10%

12%

14%

16%

2014/15 2015/16

1x 1x

1x

0.5x

Growth in acquisition expectations - Buyers’ expected increase in consulting firm acquisitions over the next 2-3 years

Buyers in 2014 said they expect 6% growth in acquisitions over 2-3 years

Buyers in 2015 said they expect 15% growth in acquisitions over the next 2-3 years

2.5x expectations


3 Throughout this report, ‘prolific buyers’ refers to those who acquire 2 or more firms per annum, whereas ‘regular buyers’ refers to those who acquire 1 or fewer firms per annum.

In our experience from speaking to buyers, this increase in expected levels of acquisition is driven by a number of factors:

• Deployment of pent-up equity capital: The largest global consulting firms have generally performed well since the last recession, and they have built up a considerable war chest that they have started to deploy over the past several years;

• Keeping pace with specialized skills: Specialized areas of expertise in the consulting sector are evolving at a record pace, highly driven by technology and IT change. Firms that wish to poses the depth and breadth of skills need to acquire;

• Continued low levels of debt: Access to cheap debt capital has enabled acquisition activity across most industries and this is also true of the consulting sector.

However, buyers are also seeing a greater number of consulting firm acquisition opportunities in the market, meaning an increased supply of consulting firms willing to sell. This suggests an interesting market situation in that both the supply and demand are growing together.

Compared to 2014/15, when we saw a clear seller’s market, the situation going forward is such that buyers targeting growth through acquisition can afford to be more selective relative to opportunities. For sellers of consulting firms, this still represents a good message in terms of increased buyer appetite and budget, but it also means that there is more competition out there. Standing out from the crowd will be increasingly important for sellers in order to achieve a premium price in a sale.

How hungry will buyers be over the next two to three years?Our research shows that deal appetite remains strong and is very much on the increase within the consulting sector. On average, buyers of consulting firms expect to increase the number of deals they do by 15% over the next two to three years. This is 2.5 times the 6% growth expected by buyers in 2014/15, meaning buyers have significantly increased their acquisition appetite over the last year. This is particularly encouraging despite the potential economic uncertainty we have seen during this period year.

The buyers we surveyed are anticipating acquiring an average of 3.8 consulting firms each over the next two to three years. However, it is clear that the prolific buyers are much more aggressive in their expectations. On average, prolific buyers expect to acquire 5.3 consulting firms, compared to regular buyers who are looking to purchase 1.3 firms, over the next two to three years. Nevertheless, this is a very positive trend across the market.


How important are acquisitions to buyers as a source of growth? Of the companies researched, acquisitions continue to play an important role in their growth strategies, and acquisitions are integral to over 80% of firms. 36% said their growth will be more through acquisition in the next two to three years, whereas only 13% said organic growth would be the preferred route. These figures are a significant increase over the rates stated by buyers in 2014/15. In effect, 24% more buyers said the source of their growth will be by acquisition. This is a very encouraging message for consulting firm sellers and highlights the increased expectation of acquisitions in the market going forward.

Source of growth over the next 2-3 years

13% 7%

45%

36%

Don’t know/NA

Both equally

Mostly by acquisition

Mostly organic

Acquisitive growth is integral to over 80% of buyers of consulting firms.


Are buyers seeing more or less opportunities than last year?39% of buyers said that they are seeing more opportunities than in 2014/15 – representing a 10% increase. This highlights an interesting market situation, with a greater number of consulting firm sellers in the market, bigger budgets and more acquisition appetite by consulting firm buyers.


How much money do buyers have for acquisitions?In line with this increased acquisitiveness, there is also more money to be deployed in the market compared to 2014/15. The buyers we surveyed had a total of $7.7bn in their war chest set aside for acquisitions. The average buyer budget is $72m over the next year, with the mean budgets ranging from $37m for regular buyers to $103m for more prolific buyers. This represents an 11% increase in the average acquisition budget, involving a 6% - 14% increase on the lower and upper range. So overall budgets are on the rise. However, buyers appear to be more opportunistic, as this year 44% more buyers said the budget depends more on the opportunity than the absolute number.

The buyers we surveyed had a total of $7.7bn in their war chest for acquisitions, but for many the spend depends on opportunity.

0%

5%

10%

15%

20%

25%

30%

$51 - 100MLess than $50M $101 - 150M $151 - 200M More than $200M

Depends on opportunity / no specific budget

Don’t know / NA / refused

3

27

19

26

12

76

Buyer budgets for acquistions over the next year

Buyer size preferences

Bob Hendicott, Management Consultancy. Sold.



Larger firms are in greater demand, but buyers continue to buy firms of all sizes.The size of an acquisition is typically important for any buyer. Too small and the effort involved to make an acquisition may not be worth it. Too large and the firm may be overly complicated to integrate. At either end, there is an impact on the value of the acquisition. However, buyers tend to prefer big deals that make a big impact.

This raises important concerns for some sellers at the mid or lower ends of the market, who may question whether they are too small to warrant attention from buyers. So the important question for most sellers is one of ‘how big is too big?’ or ‘how small is too small?’.

Of course, the answer to this will depend on the type of buyer, the growth rate of the seller and, in our experience, more specific factors such as the seller’s consulting sub-sector and quality of their Intellectual Property (IP). However, to understand the aggregate view across the market, we surveyed buyers to better understand the range of buyer size preferences.

We found that buyers are looking for bigger deals this year. The minimum size that buyers look for has increased by 20% and the maximum by 15%. The implication is that size matters… for some. As the average minimum level that buyers are looking for has increased more than the maximum, buyers appear to be more size sensitive at the lower end.

However, if you’re looking to sell your firm, it is important to recognize that the vast majority of consulting sector deals are consistently done at the smaller end of the market. As outlined in our 2015 Global Consulting Mergers & Acquisitions Report, the majority of acquisitions in the consulting sector occur at the smaller end of the market. 70% of consulting firm acquisitions across the world are valued at under $40m and 35% are under $5m. In our experience, this reflects two key facts about buyers:

1. Large buyers often acquire smaller firms: Buyers of consulting firms typically want to make large acquisitions. However, they also tend to look for specific consulting skills and/or capabilities to fill the gaps in their strategic growth plans. The more focused a buyer’s acquisition criteria becomes, the smaller the firms that fit that criteria tend to be. So in our experience, buyers often start out looking for larger acquisitions and find themselves acquiring smaller firms that most precisely fit their acquisition criteria;

2. Mid-sized buyers directly seek out smaller firms: Mid-sized and lower middle market buyers comprise the majority of buyers in the market. There are many large firms that are prolific buyers of consulting firms, but there are a much larger number of mid-sized and smaller firms that are regular buyers who directly target small consulting firms. This means that a large number of less frequent buyers are directly targeting small consulting firms for acquisition.

As such, there is a buyer community relevant to you regardless of your size, and it requires an expert eye and knowledge of the market to identify the right buyers.

Size matters in consulting firm acquisitions, but regardless of your size it is important to understand the type of buyers that look to acquire within your size range. Our survey reflects averages across a large number of consulting firm buyers, and while it provides an aggregate view from the market, it does not necessarily reflect the likelihood of sale for any one firm at the smaller end of the market. In a full sale process, buyers should be selected in accordance with various factors, including size, in order to ensure a successful transaction process.


What are the size range preferences?In line with the growth in acquisition appetite expressed this year, compared to 2014/15 buyers are now looking to acquire larger firms over the next two to three years. On average across all buyers, the target acquisition size for consulting firms ranged between $18m and $45m in revenues, with an optimum size of $31m. This reflects a 20% increase in size preference on the lower end and a 15% increase on the upper end.

$0

$10

$20

$30

$40

$50

Maximum Optimum

Mill

ions

Minimum

2014/15

2015/16

15

39

28

18

45

31

Min, Max and Optimum size of consulting firm that buyers are interested in (Overall)

Buyers on average are looking for bigger deals this year.



Size matters for different types of buyers.Regular buyers on average are looking to acquire smaller firms between $11m and $27m in revenue, with an optimum size of $24m. Prolific buyers on average are looking to acquire larger firms between $22m and $60m in revenue, with an optimum size of $36m. This stands to reason as prolific buyers tend to be larger and regular buyers tend to be smaller firms. However, both ends of this spectrum increased their size preference from 2014/15.

Considering different consulting sectors, our survey indicated that IT consulting and Media advisory firms have the lowest size targets for acquisition, with higher targets in management consulting, finance & accounting, and engineering and environmental consulting. In our experience, the reason is that IT and media firms can be subject to higher growth rates than those seen in the other sector groupings. They may also be more IP-rich than the others. As such, buyers of IT and media firms with these attributes of high growth and high IP can see the ability for future leverage and today’s size may become less of an issue.

$0

$10

$20

$30

$40

$50

$60

$70

$80

All IT consulting & Media advisory (29)

Engineering & Environmental consulting (19)

Other (Healthcare, Venture Capital,

Other) (18)

Management Consulting, Finance & Account firms (23)

Maximum

Optimum

Minimum

45

35

70

32

62

3127

40

26

41

1813 16

2126

Min, Max and Optimum size of consulting firms that buyers are interested in (by buyer industry grouping)

Mill

ions


This reflects a market in which buyers are increasingly looking for larger deals overall. With greater demand in the market coupled with greater supply of opportunities, buyers are looking to maximize the return on their acquisition efforts by looking for bigger consulting deals.

In our experience, buyers in the IT consulting and media advisory sectors are more likely to acquire firms with IP, such as software, tools, methodologies, etc. in these areas. Firms with valuable IP have assets, albeit intangible, beyond their people that potentially supports future revenue. Buyers in this space would therefore more often look at smaller firms with a greater breadth of revenue generating assets. Furthermore, we see that buyers of management consulting, financial & accounting firms, as well as buyers of engineering and environmental consulting firms, largely acquire expertise in these areas, so they would naturally look for larger firms that have a proven scale and leveragable model.

Interestingly compared to 2014/15, buyers are now more concerned about turnover at the lower end for acquisition targets. This is a clear sign that the minimum level of acquisition target size is a factor for buyers and that overall bigger deals are on the agenda for buyers of consulting firms.

REGULAR BUYERS$24mOPTIMUM SIZE

PROLIFIC BUYERS$36mOPTIMUM SIZE

Deal structures

Marc Jantzen, Performance Improvement Consultancy. Sold.


Deal structures

Expect around half the value up front and a 2-3 year earn-out to get the rest.Earn-outs continue to be a reality for the majority of consulting sector transactions, as buyers structure deals with earn-outs to mitigate the risks of acquiring people-based businesses with little tangible assets.

Our survey indicates that earn-outs are still on the minds of buyers. Up-front payments at around 45% of the total purchase price and earn-out periods of just under 3 years remain largely unchanged from

last year, according to buyers. Earn out measures continue to favor gross margin and revenues above EBITDA, and a majority (77%) of consulting sector deals tend to hit their earn-out targets successfully.

While this is the case for the overall market, in practice high quality consulting firms in high demand areas generate different scenarios. We are seeing more 100% cash upfront deals where there is a large management team and no individual dependencies, as well as ‘deferred’ payouts rather than contingent payouts. Increasingly, there is more flexibility regarding earn-outs on behalf of buyers. Due to the increased acquisition appetite among buyers in today’s market and the high demand for high quality firms, competition runs high for the right firm. Buyers in competitive bid situations will often alter the deal structure before the overall price. This change in approach results in higher upfront payments and shorter earn-out periods.

Proportion of total consideration paid up-front

0%

10%

20%

30%

40%

60%

50%

Less than 30% 31 - 40% 41 - 50% 51 - 60% More than 60%

12 11 14

50

12

Earn-outs continue to be a reality for consulting sector deals and the average up-front payment by buyers we surveyed is 45%. However, buyers will offer more upfront and less earn-out for the right opportunity.


The need for good negotiation skills is critical at each stage of selling your firm in order to achieve the right price and the best possible deal structure. Good negotiation can reduce the contingent element of an earn-out or worst case de-risk the contingent element to be benign.

To achieve this you need a clear understanding of what influences the buyer’s view as to how much should be paid up-front and what types of targets should be used. In a competitive auction, buyers may offer more up-front (and less in earn-out) as a negotiating tool, rather than increasing the overall price. The buyer’s use of targets will also be influenced by the target pace of integration and as a way to align incentives to support the buyer’s purpose for the acquisition (i.e. growth, IP, knowledge, capabilities, etc.)

This year’s results clearly demonstrate that earn-outs are a reality of consulting sector deals. The range of up-front payments in consulting deals is broad, but on average a 45% up-front payment is most likely, with the balance contingent upon achieving earn-out targets over roughly a 3 year period. Gross margin remains the target of choice, but as ever it is worth discussing the other metrics identified if your firm has different performance strengths.

What proportion of deals involve an earn-out?According to our survey the proportion of deals involving earn-outs is 95%, which is very slightly increased from 2014/15. These earn-outs more often achieve their targets. However, the proportion paid up-front remained largely the same and the duration of the earn-out has slightly reduced. In an environment of growing acquisition activity and appetite, this reflects an M&A market that is becoming savvier in consulting sector deals and where buyers are more focused on the success of acquisition integration.

Proportion of consulting deals involving an earn-out (average)

0%

10%

20%

40%

30%

60%

50%

100%

90%

80%

70%

2014/15 2015/16

91 95


Deal structures

What should you expect in terms of the consideration paid up front?On average amongst all buyers, a greater number of deals involve an earn-out (95%) compared to 2014/15 (91%). While earn-outs are commonplace in consulting deals, the increase in deals involving an earn-out reflects a slightly more balanced market between buyers and sellers. Nevertheless, the average proportion of total consideration paid up-front remains broadly the same as last year at 45%, although the range remains wide from less than 30% to more than 60%.

Prolific buyers have the flexibility to pay more up-front than regular buyers when the deal is a good fit. However, prolific buyers tend to be savvier in deal negotiation, so on average they offer 44% upfront, whereas regular buyers offer slightly more on average at 47% upfront.

How long is the earn-out period?This year, the average duration of an earn-out period negotiated by all buyers slightly decreased from 2.9 years to 2.7 years. It remains to be seen whether this signifies a trend in reducing earn-out periods, but as the need for more deals has increased, so would the pressure to quickly integrate those acquisitions. Reflecting this, prolific buyers are more likely to offer an earn-out period of two years or less and regular buyers are more likely to prefer three years or more.

What are the main targets used as the basis of earn-outs?The type and priority of metrics used to measure an earn-out remain the same as in 2014/15. Gross margin is by far the most common earn-out metric (83%), followed by revenue (37%) and ROI (30%). Retention of key personnel and EBITDA were given a lower priority.

Buyers often prefer sales driven metrics (gross profit and revenue) that concentrate on top line growth. These are more reflective of performance and easier to measure. Metrics such as EBITDA incorporate broader operating costs that are often integrated with the buyer after acquisition, making performance potentially more difficult to measure.

Nevertheless, acquirers often use more than one target to measure the seller’s performance during earn-out. On average, respondents typically based their earn-out targets on two different measures, as they did in 2014/15. This highlights a consistent theme that in an earn-out, you are likely to be measured on gross margin and revenue targets. Other metrics such as ROI, staff retention and EBITDA are often used as supplementary measures in looking at success in the earn-out.


On what targets do you base your earn-outs?

0

20

40

60

80

100

Gross margin Revenue ROI Retention of key personnel

EBITDA

2014/15

2015/16

77

41

18

2623

83

3724

30

20

What proportion of earn-outs hit their targets? Another positive trend this year is that a higher proportion of earn-outs are hitting their targets. On average, buyers of consulting firms in 2015/16 said that of their deals involving earn-outs 77% hit their targets compare to 74% last year. This means that buyers are either getting better at managing their earn-outs, getting better at setting earn-out targets, or both. Also, the results show that consulting firms that sell into prolific buyers are more likely to hit their earn-out targets than those acquired by regular buyers. If success is reflected by a greater number of acquisitions hitting the earn-out targets post deal, then consulting deals have been more successful this year than last.

What proportion of earn-outs hit their targets? (average)

0%

10%

20%

40%

30%

60%

50%

90%

80%

70%

2014/15 2015/16

7477

Buyer evaluation criteria

Dom Moorhouse, Management Consultancy. Sold.



Quality of clients, profits and IP - a winning combination! When presenting your firm to prospective buyers, you should clearly lay out the attributes that make your firm a good investment. We know that buyers have different ways of evaluating acquisition targets and each buyer may assign different priorities to the evaluation criteria. So this year, we asked buyers about their approach to assessing deals, their evaluation criteria and the priorities they assign to each attribute. While each buyer will clearly have a unique perspective, it is helpful to understand the common attributes that all buyers look for in an acquisition opportunity profile and how these differ across different types of buyers.

Overall, buyers were fairly polarized in their use of qualitative or quantitative measures for evaluating

whether a consulting firm acquisition opportunity should be taken forward. Very few buyers used a balanced scorecard of qualitative and quantitative measures.

In 2014/15 buyers were clear about the factors that attract them to a consulting firm, with the top three being:

• Financial stability (sales & profit growth);

• Depth of domain expertise (service or industry);

• IP (unique & leveragable).

This year, we’ve refined this view. Quantitatively, buyers care about margins and growth above specific metrics around revenue per partner or per consultant, although some buyers use the latter metrics as the defining factor. Qualitatively, the profile of your client base and quality of your IP is more important than your own future growth strategy or uniqueness of your proposition. While these responses may seem counter-intuitive, we outline some anecdotal evidence that helps explain this later in this section.

Relative ranking of quantitative metrics

0

50

100

150

Gross margin EBITDA margin EBITDA growth Revenue Revenue growth Revenue per partner

Revenue per consultant

117130

68 63

10683

75

Relative ranking of qualitative metrics

0

50

100

150

200

Size & quality of client base

Potentially leveragable IP

Quality/experience of management

Future growth strategy/direction

Uniqueness of mkt proposition

156175

111 10298


There are some significant messages for sellers embarking on this process.

Firstly, it is important to highlight a mix of quantitative and qualitative measures when initially presenting your consulting firm to a prospective buyer. Buyers are polarized in their views, but it is difficult to assess which buyer has which preference. So it is important to highlight your qualitative strengths in addition to your financial profile. Tailoring your profile to highlight the strengths that meet the demands of different types of buyers is an important step, as one size does not fit all with buyer assessment criteria.

Secondly, your profit margins and growth will be the quantitative aspects of your firm that are first looked at by most buyers. It is important to get these to an acceptable level for buyers in the market, so that the conversation can focus on the fit of your firm to the buyer.

Quantitatively, buyers care about margins and growth. Qualitatively, your client profiles and quality of your IP is what buyers will look at.

Finally, qualitative metrics are just as important to highlight to buyers as quantitative ones. The quality of your clients reflects very directly on your value as an acquisition target. Furthermore, your ability to leverage IP to enhance the delivery of your consulting work is attractive to buyers, as they will want to accelerate this across their own firm.

Overall, a detailed understanding of consulting sector buyers and how they evaluate deal opportunities is critically important during a sale process. This will help focus the opportunity you represent on aspects that appeal to each group of buyer. A good understanding of the buyer landscape will help in tailoring your approach accordingly.

Quantitative vs Qualitative metrics.Buyers are very polarized in the way that they assess acquisition opportunities, with very few firms stating that they use both quantitative and qualitative measure equally. However, on average buyers are nearly 1.5x more likely to favor quantitative metrics.

This picture is more balanced for prolific buyers, who still favor quantitative metrics overall but are more likely than regular buyers to have a balanced view and incorporate qualitative aspects of your firm. However, 57% of regular buyers only or mostly use quantitative metrics to evaluate their opportunities.

This can clearly be explained through experience. Prolific buyers have ‘been there and done that’ with many of their past acquisitions and are therefore better equipped to assess the quality of your management team or whether your IP will be leveragable going forward. Without the experience that comes with a high volume of acquisitions, regular buyers rely on the objectivity of quantitative measures to judge the value of a consulting firm acquisition opportunity.



What blend of qualitative vs quantitative metrics do you use when evaluating acquisitions

What blend of qualitative vs quantitative metrics do you use when evaluating acquisitions (by industry grouping)

Only quantitative

Mostly quantitative

Both equally

Mostly qualitative

Only qualitative

100%

80%

60%

40%

20%

0%

20

31 2733

43

16

22

5

2 3

3

50

7

38

All (107) 1 acquisition (44) 2+ acquisitions (63)

Only quantitative

Mostly quantitative

Both equally

Mostly qualitative

Only qualitative

90%

100%

70%

80%

50%

60%

30%

40%

10%

20%

0%

20

31

43

5

2All (107)

45

24

3

28

IT/Media (29)

53

5

11

32

Engineering/Environmental (19)

30

30

39

Mgt Consulting/Finance/Account (23)

50

22

6

17

Health/VC/Other (18)

6

Ranking of quantitative metrics.So we know that it’s important to highlight quantitative metrics to prospective buyers. But which metrics?

Overall, buyers are more interested in profit margins and growth than they are in more specific metrics like revenue per partner or per consultant. The trick is to get both right!

Gross Margin is the most important evaluation metric when buyers are looking at consulting acquisition opportunities. The reason for this is that your gross margin ratio (i.e. your fees to your consultant costs) reflects the extent to which you can leverage your consultants’ expertise to command a high price for your offerings in the market. Your assets are your people and if the added value of your firm allows you to sell their time for a significant multiple of what you pay them, this makes for a good investment opportunity.

EBITDA margin is also significantly important, as buyers typically have an EBITDA margin range around which they will entertain acquisition opportunities. Buyers want any acquisition, even if made for strictly strategic purposes, to be value accretive. If the EBITDA margin is too low, the investment could destroy or erode value. So it’s important to show a healthy EBITDA margin when approaching a buyer.

EBITDA growth is also important. This reflects your ability to sustainably manage the overall growth of your business, not just that of the top line. The implication is that if you can grow your business profitably on your own, your acquirer can expect to leverage and potentially accelerate the level of profitable growth, while gaining the benefits. Typically buyers will look for at least two to three years of historic growth to establish a trend that could be justified going forward for the next two to three years.


0

50

100

150

200

IT/Media Engineering/Environmental

Health/VC/Other Mgt/Accountancy

Relative ranking of quantiative metrics (by buyer industry grouping)

Revenue

Gross margin

EBITDA margin

Revenue growth

EBITDA growth

Revenue per consultant

Revenue per partner

Ranking of qualitative metrics.Buyers have a clear preference for the quality of clients and IP when looking at consulting acquisition opportunities. The size and quality of your clients reflects the quality of your offerings, and the most immediate value to a buyer is to co-sell or cross-sell their consulting services to your clients.

After the client base, leveragable IP also clearly stands out as a commonly considered qualitative factor when looking at consulting acquisition opportunities. Buyers are attracted to consulting firms that are able to capture, codify or otherwise make use of the industry or consulting expertise. However, the operative word here is ‘leveragable’. Highlighting the type and value of IP within a firm helps paint the picture that a buyer is gaining intangible assets, but what buyers are attracted to is the potential ability to propagate the use of acquired IP across their own firm.

The quality and experience of management is also highly important for buyers. However, in our experience this is much less of a priority when initially evaluating an acquisition opportunity, precisely because it requires interaction and discussion with the target firm’s management, which happens much later in the acquisition process.

0

50

100

150

250

200

IT/Media Engineering/Environmental

Health/VC/Other Mgt/Accountancy

Relative ranking of qualitative metrics (by buyer indusry grouping)

Size & quality of client base

Uniqueness of mkt proposition

Potentially leveragable IP

Quality/experience of management

Future growth strategy/direction

145

84

104

156

69

105

7867

121

84

113

150

76

105113

94

7689

83

28

62 6857

4452

6352

61

114

42

162179

141 137

114105

69

137

100

222

117

74

161

130128

7494 100

Intellectual property



A paramount attribute, with post deal value clearly described. Last year, our survey confirmed the importance of intellectual property (IP) as an attribute that attracts buyers of consulting firms. Ultimately, IP is a way for knowledge-based firms to externalize their expertise and mitigate the risk of over-reliance on human capital. However, IP can take many forms and its value is not always easy to define or articulate. So to further explore this point, we asked buyers to elaborate on the types of IP that they find valuable.

What type of IP is most preferable when acquiring a consulting firm (All buyers)

0

50

100

150

200

250

Software, subscriptions or other revenue-generating IP

Proprietary methodologies,

assessment tools and techniques

Publications, articles, thought leadership

Benchmark data or databases that provide a unique

reference

183206

141112

A significant majority of buyers confirmed that IP is an important factor in assessing potential acquisition opportunities of consulting firms. They also feel that when IP is acquired, they are effectively able to leverage the IP within their own firms. So the challenge for buyers is to find firms with the right kind of IP to leverage.

Buyers much prefer IP that directly generates revenue and complements a firm’s consulting services. What is more interesting is that IP supporting the delivery or standardization of a target firm’s consulting services was also highly valued.

A very telling response was that 45% of all buyers found it difficult to understand how the IP described in the target consulting firms that they look at contributes to the success of those firms.


The importance of IP in assessing consulting firm acquisition opportunities. We have outlined the importance that buyers attribute to IP in consulting firm acquisitions. In fact 68% of all buyers found IP extremely or very important as a factor when assessing potential acquisition opportunities. Only 4% of buyers found IP not at all important in this respect.

IP is more important to experienced buyers. 73% of prolific buyers, who potentially have more to gain from it, found IP extremely or very important, whereas this ratio dropped to 62% for regular buyers.

When looking across the type of consulting sector buyers, those in management and financial consulting attributed the highest level of importance to IP. IT and media focused firms also had a very high focus on IP. Those in engineering and environmental consulting were more polarized, with high proportions of these buyers stating that IP was either extremely important or not at all important.

IP in consulting firms provides a way to externalize the expertise of a firm and ultimately help it to learn, grow and/or sell. This is a very attractive attribute of consulting firms among buyers.

It’s not enough to have IP that helps your own firm, its value must be clearly articulated and buyers must be able to see how they themselves can leverage your IP.

It is clear that most buyers prefer IP that directly generates revenue. However, if your IP enhances your consulting offerings and standardizes your approach, buyers are better able to leverage this IP in their own firm. It is much easier to assess the value of IP if you have used it to scale your own firm, and buyers will expect this to continue in theirs post-acquisition.

LEARN GROW and/orSELL

IP



Which types of IP are the most attractive?Overall, buyers were most attracted to IP providing complementary revenue streams to consulting services, such as software or subscriptions, as opposed to any other form of IP. While this is somewhat unsurprising, among other types of IP (non-revenue generating), we found that IP used to enhance consulting offerings, standardize delivery and enhance scalability, such as methodologies and assessment tools were more highly valued than IP used to enhance consulting services with reference data, such as benchmarking data or industry specific databases. If a consulting firm has proven its ability to scale using its IP, the value of IP is more obvious than benchmark or industry data that needs to be used and tested.

However, it is worth noting the subtle differences in each of the broad sector groupings of buyers. Engineering and environmental consulting sector buyers, who look more deeply at technical

capabilities, valued proprietary methodologies, assessment tools and techniques above revenue-generating IP. IT, media, healthcare and private equity sector buyers, who collectively and increasingly are more dependent on technology than those in other sectors, most highly valued software, subscriptions and other revenue-generating IP. Although benchmarking data and industry databases were least highly valued among all buyers, buyers in the management and financial consulting sector grouping stood out as those most interested in this type of IP. This may be explained by the fact that buyers in the management consulting sector are best positioned to make use of benchmark data and industry databases, above buyers in other sector groupings.

0

50

100

150

250

200

Software, subscriptions or other revenue-

generating IP

Proprietary methodologies,

assessment tools and techniques

Publications, articles, thought leadership

Benchmark data, databases

Relative ranking of importance of four types of IP (By buyer industry grouping)

IT/Media

Engineering/Environmental

Health/VC/Other

Mgt/Accountancy

200184

217

196

166

195

167148

138126 122 130

97 95 94

126


What makes IP difficult to assess amongst buyers?IP is unique to each firm and the fact that it is only used and understood internally is what can make it a competitive advantage for a firm. However, this can also prevent buyers from fully understanding its use or result in a diluted perception of the IP value. IP value is difficult to assess, precisely because it is unique and proprietary to each firm, so we asked buyers what they find most difficult about assigning value to IP.

The largest proportion (44%) of all buyers feel that the most difficult aspect of assigning value to IP is its link to the success of the firm. Another way of looking at this is that the link between a firm’s IP and its ability to grow revenues, profits or to win new business is unclear. A large proportion of all buyers (17%) also found that when looking at acquisition opportunities in consulting, the IP in the target firms would be difficult to leverage in their own.

What do you find most difficult about assigning value to IP? (All buyers)

Accurately described, but unclear how it contributes to the success of the firm

Over-exaggerated importance of IP

Too complicated

Valuable to the target firm, but difficult to leverage in a larger firm

No value at all apparent

Don’t know / NA / None

100%

60%

70%

80%

90%

50%

40%

30%

20%

10%

0%

17 922

7 76

12 14 11

12 188

814

5

44 39 48


Post-acquisition integration


Post-acquisition integration

People come first!What happens after the champagne cork is popped and the focus turns to making the acquisition a success? We asked buyers to rank their priority of integration tasks and the duration of their typical integration process, in order to highlight some of the realities of post-merger integration.

Buyers of consulting firms rightly focus on the integration of people above all else in the first 90 days after an acquisition. Clients are the next highly prioritized area and the integration of technology and systems follows on from these.

On average, as a seller of a consulting firm you can expect to be involved in an integration period for just under 2 years following an acquisition. However, there are two key points to consider in order to put this fact into context.

The first is that the end of an integration period is not always clearly defined. Integration happens in phases, with a mix of incremental ‘quick-wins’ and larger step changes, both of which move an acquired firm closer to looking, feeling and operating like the acquirer. As such, it can be difficult to pin point the precise end date of an integration program, as there is often a long tail of smaller integration tasks within each work stream still required to complete once all the major elements of people, process and technologies

Buyers prioritize the integration of their people above clients and other operational areas.

Top integration priorities in the first 90 days of an acquisition

Technology(integration of core systems)

Financials (integration of financials and sales data)

Operations (alignment of core processes, operating

procedures and processes)

Clients (leveraging cross-sell opportunities)

People (communication, cultural integration)

0 20 12040 14060 16080 180100 200

181

170

119

98

74

have been materially integrated. It typically falls to an 80/20 rule to define the end of the program. So while the 19 month average aligns with our expectations for the duration of a post-acquisition integration program, there are many variables that determine the final completion date.

The second is the parallel post-acquisition considerations of earn-outs and integration. If not thought through properly on both the buyer’s and seller’s ends, the success measures of an earn-out can conflict with those of an integration, or the drivers of success for each can become difficult to measure. For example, an earn-out based on the seller achieving higher levels of EBITDA can be partly achieved if the buyer is not careful to separate out the effect of the seller’s back office integration (i.e. IT, HR, finance, procurement, etc.) with the buyer. In this case, the seller’s EBITDA is improved by spreading its operating costs across those of the acquirer, with the net effect of improving profits.

In reality, earn-outs are more carefully thought through by most buyers. There are many cases where earn-out agreements are reconsidered periodically, and adjusted according to the changing priorities of the combined firms. However, when negotiating deal structures in the process of selling your consulting firm, it is important for you to consider the impact that integration with your acquirer may have on the metrics agreed on your earn-out.


What are the top integration priorities in the first 90 days post-acquisition?People come first. People are the main asset in consulting firms and experienced buyers understand that attrition during or shortly following a transaction is highly corrosive to the value of a people based firm. To avoid this, experienced buyers of consulting firms know that communication with the staff of their own firm and with that of the target firms, as well as the cultural integration of both, is important to facilitate a smooth integration.

Only slightly less prioritized was the integration of clients in the first 90 days following an acquisition. Once a deal is done, the focus turns to realizing the synergies of cross-selling and on-selling with clients that were hypothesized pre-acquisition.

Buyers realize that much of the added synergy value of a consulting firm acquisition is dependent on integrating new clients from the target firm, or providing new services to their existing clients.

Operational and financial integration were distant 2nd and 3rd priorities, and the integration of technology came last.

How long do buyers of consulting firms typically take to integrate an acquisition? Across all buyers, the average post-acquisition integration process lasts 19 months. Prolific buyers are quicker at integrating their acquisitions. The average range is from 17 months for prolific buyers to 22 months taken by regular buyers.

Average duration of Post Merger Integration programs

More than 3 years

2-3 years

18-24 months

13-18 months

7-12 months

6 months (or less)

Varies / Don’t know / NA

100%

80%

60%

40%

20%

0%

18

11

22

9 711

7 5 10

21

16

25

23

32

1712

18

88 11 6


Mean: 19 months 22 months 17 months


Conclusion

Conclusion. If you are thinking about selling your firm over the next few years, the overall picture continues to be a very positive one, with buyers of consulting firms more than doubling their acquisition expectations over the last year from an average of 6% growth to 15% growth rate over the next two to three years. Accordingly, there is also more money to be deployed in the market with $7.7bn available from our sample size alone. This represents an 11% increase over 2014/15’s average budget. Buyers expect to grow through acquisition, but they are seeing more acquisition opportunities than in 2014/15, so they can afford to be more selective. For sellers of consulting firms, the increase in buyer appetite and budget is good news, but the message from buyers is also that there is more competition out there, so it is important to put your best foot forward when approaching buyers.

With more opportunities and larger budgets, buyers are now focused on acquiring larger firms than they were a year ago. So although size matters, there are still a large number of buyers looking to buy smaller firms and knowing the right buyers to approach can make the difference between success and failure when selling your firm. Small firms will continue to sell, but this will require an understanding of the buyer market and the firms who will be interested in firms of different sizes.

Earn-outs continue to be a reality for consulting sector transactions. The average proportion paid up-front remained largely the same at 45%, and so has the average duration of earn-out periods. In an environment of growing acquisition activity and appetite, this reflects a savvy M&A market in consulting sector deals, where buyers are more focused on the success of acquisition integration. So the need for good negotiation skills is critical to get the best deal for you and your business.

When presenting your firm to prospective buyers, clearly laying out both quantitative and qualitative attributes that make your firm a good investment is important, as buyers are polarized on their preferences and assign different priorities to the evaluation criteria. Profit (Gross and EBITDA) margins and growth continue to be critically important measures for buyers, as well as the quality of your clients and IP. Specifically focusing on IP, its value must be clearly articulated and buyers must be able to see how they can leverage it in their own firm. Getting this wrong will risk a prospective buyer passing you over as an acquisition opportunity.

Finally, in the first 90 days post-acquisition you can expect most buyers to focus on the integration of people and clients, before the more mechanical integration of operations, financials and technology. You can also expect to be in an integration process for 19 months on average, although this will depend on your size and complexity as a firm, as well as the acquisition and integration experience of the buyer.

We hope you have found this survey insightful in helping you to consider the realities and potential pitfalls of a sale process for your consulting firm. We wish you the very best of success and we would be happy to speak with you about the future options for you and your consulting firm – whether you are looking to sell now or want to grow and optimize value in your business for a sale in the future.


About Equiteq.

Equiteq is the leading M&A advisor for consulting firm owners, helping them to achieve a successful sale that delivers maximum value. Equiteq also advises owners on exit strategy and value growth in the months or years leading up to the sale of their firms.

For further information.

Join Equiteq Edge, our free source of information, advice and insight to help you grow and sell your consulting firm. Equiteq Edge gives you access to the findings of unique research conducted amongst buyers of consulting firms from around the world, insight from those who have sold their consulting firms and expert advice.

Join Equiteq Edge at equiteq.com/equiteq-edge

Contact usIf you would like more information on our Buyers

Research Report 2015/16, our company or the various services we offer please don’t hesitate to get in touch.

Email: [email protected]

Website: equiteq.com

Equiteq has global reach through its offices in New York, London and Singapore.

equiteqedge.com

@consultingmanda

© 2015 Equiteq Ltd. November 2015

demand for acquisitions in the consulting sector? what ...qualitatively, buyers focus in on your...

Documents