When you’re in business, you’ll usually have one eye on the future of your company. Will you expand by buying up other firms? Are you eventually going to sell up and retire? Or will you cash in and move on to the next project? I’ve spoken to lots of owners who have bought or sold professional services companies and noticed that there has been quite a change in this area in recent years.
Before we start, what do I mean by professional services companies? It’s quite a loose term, after all, but in this instance you could take it to mean businesses such as lawyers and accountants, graphic designers, digital or creative agencies, IT and managed services companies, and even SaaS companies. Essentially, any service business that would traditionally have relied on recurring revenue.
What’s involved in selling a services company?
It’s not uncommon to use a broker when selling a business. They may set up an information day, whereby interested parties pay a non-refundable fee of several hundred euros to come along and have a one-to-one with the business owner. This is quite a good system, because it immediately covers the broker’s fee, but also ensures that the potential buyers you talk to aren’t simply the mildly curious but are interested enough to have put up some cash just to meet with you.
A typical situation with a smaller practice or firm would be that you sell to the new owner but remain at the company during a transition period. This means you’re initially presenting the new owner as simply a new member of the team. Over time, this person will take over the working relationships you have with your clients so that by the time you leave, they have established all the rapport required to keep the client, despite your absence.
There is a degree of spin inherent, which you may or may not feel comfortable with. Ultimately, though, it’s in your best interest to make the process smooth for everyone involved.
It’s likely that you aren’t going to tell your clients from the outset that this is what’s happening. After all, the last thing you want is for them to think that everything is about to change, or that the company has no future, and rush off to your competitors. So there is a degree of spin inherent, which you may or may not feel comfortable with. Ultimately, though, it’s in your best interest to make the process smooth for everyone involved.
How much is your professional services business worth?
If you are thinking of selling your business, the price you can get is going to be a big factor. But just how much is your company worth to someone else? It’s almost always established as a multiple of recurring fee income. This means, essentially, that the purchaser is buying the expectation of future revenue.
Let’s say you currently turn over €300,000 per year. If you sell for 1.33 times your annual recurring turnover, this gives you a price tag of €400,000 for the business. But – and this often surprises business owners selling for the first time – you don’t get that fee paid up front. It’s typically paid in instalments over a period of two to four years. This will be structured in various ways depending on the deal made. You might, for example, get 33% initially, followed by another 33% one year on, and the rest at the end of the second year.
One thing you need to be absolutely clear about before you sign anything is whether the price negotiated can be changed depending on actual future revenue. Imagine you sell a thriving business, but the purchaser just doesn’t manage to deliver on its potential. By the second year after you sell, they only manage to bring in €250,000 instead of the expected €300,000. Well, that €50,000 disparity can actually be deducted from the price that was due to you. That’s why choosing who you sell your professional services company to is so important.
These are the three key questions to ask yourself:
- Are you selling to someone who will continue to deliver a good service to your clients?
- What multiple of your annual recurring income are they giving you?
- How long will it take for them to pay you?
The value of professional services companies has been falling
The example I gave above calculated the cost of a business based on a value of 1.33 times annual recurring revenue (ARR). But prices have been falling and I’ve come across plenty of examples of valuations being more like 0.75 times ARR.
Clearly the market doesn’t believe there is as much reliable recurring work as there used to be. I think there are a few factors at play here. In accounting, for example, you’re not seeing the level of annual audits that you used to – a reliable source of income in the past as the same clients would come back year after year. Buyer behaviour has also changed; where previously people would tend to stay with the same firm, clients will simply leave if they aren’t entirely happy with the service they’re getting.
This means that selling a professional services company has become much tougher than it used to be. When talking to the owner of a law firm recently, he told me he had been advised his company was only worth the equivalent of its unbilled work in progress. What does this mean for those of us in this sector? Well, if you’re interested in expansion and want to buy up your competition, the good news is that it’s now much cheaper. And if you’re focused on growing your company, the key takeaway is that business is a lot less sticky these days, so attracting clients away from the competition is much easier than it used to be!
What does this mean for your retirement plans?
Buying and selling a professional services business has fundamentally changed. This is having an impact on people who were counting on selling their business to fund retirement. Rather than relying on selling up, we’re going to see people looking at alternatives such as selling on to someone already active in the business, or staff ownership, or a company structure that doesn’t rely on a trade sale.
Maybe we’ll see more situations where the main shareholder steps back from the day-to-day and has an employee running the company. We may also see an increase in family businesses, where management is passed onto the next generation in return for a retirement income. As there are tax breaks in passing a business to your children, I think this could definitely become an option for some owner-operators.