In the past, mid-market private equity has tended to turn its collective nose up at consultancies, be they specialist IT consultancies, professional practices, or marketing specialists.
It hasn’t been that difficult to explain the reticence; consultancies tend to make money by selling the time of deep specialists. Those specialists tend to be highly paid, difficult to replicate and the key individuals often own the business (frequently through partnerships rather than limited companies).
The risks to an investor are clearly that the embedded specialists might exit the business or lose their drive. Replacing them or adding new specialists to drive growth is a recruitment nightmare and client relationships are forever dependent on individual delivery.
As business models go, it isn’t the most straightforward to back. In addition, once EBITDA is normalised for partner earnings then there is frequently a disconnect between the value aspirations of the vendors and the returns requirement of the investor.
None of those fundamental characteristics of a consultancy has changed, and yet the last few years have seen a shift in the attitude of private equity investors to investing in consultancies. A recent study by law firm, Mayer Brown, shows a 179% increase in private equity investments in the business and professional services sector in 2021. We have also witnessed this trend fist hand at HMT Corporate Finance, having worked recently with consultancies such as Aker Systems, VueAlta, and The Marketing Practice to secure them transformational private equity investments.
So what has changed?
One thing that has driven private equity into the arms of consultancies is the sheer volume of investment cash private equity investment funds have to deploy. With wafer thin interest rates and stable markets, PE firms have been raising bigger and bigger funds and moving inexorably up market. In estate agency parlance it is a seller’s market and for businesses with substance and scale there will be competition to invest, almost regardless of business structure.
Another factor which now makes consultancies more attractive to private equity is the use of technology to both drive efficiency and to productise those elements of the business which are capable of replication and standardisation. There is less investment risk in a business where 20% of the revenue is derived from the individually very clever, than one where 60% of it is.
Even where processes cannot be delivered or even partly delivered by technology, the embedding of intellectual property in standard toolkits and blueprints will make an investor more comfortable that the revenue engine will remain in the business and not walk out of the door. Similarly a structure which sees key client relationships spread throughout the organisation and not focussed on a few key consultants will be reassuring.
The larger and more established a consultancy is, the more likely it is to have already addressed the challenge of growth and scalability, to have created an effective recruitment machine and to have put in place recruitment, induction, training and retention programmes to ensure that there is a steady supply of the “cleverness” at the heart of the consultancy. When a consultancy business is sufficiently well established to have already demonstrated generational succession then it is considerably de-risked for an investor.
One interesting dilemma for a consultancy considering an exit, be it to Private Equity or a trade acquirer, is the balance between employed consultants and associates. On the one hand a model which is heavily dependent on associates reduces the fixed cost base and makes the business easier to flex in line with demand. On the other, unless the associate programme is very well managed and proven, there is a risk that any transaction unnerves the associate network and leaves the business significantly under-resourced post deal. IR35 risk also plays a part here and there has been a clear move in the direction of wanting most consultants on payroll. This makes it even more important that a consultancy can demonstrate strong and consistent demand for its services over time.
Private equity is driven by returns, returns are driven by market demand and market demand is influenced by shifts in societal and consumer behaviour. The flip to online working, the overnight move to single channel retail (ecommerce!) in Spring 2020 and the “work anywhere” culture which has emerged because of lockdowns, have all been favourable to the consultancy business model. Not only are key services such as digital transformation, cloud migration, social media marketing and networking often delivered through consultancies, but those consultancies are also now spending less on travel, office space, entertaining and pitching, making the model more profitable than ever.
In the past, mid-market private equity has tended to turn its collective nose up at consultancies, be they specialist IT consultancies, professional practices, or marketing specialists.
It hasn’t been that difficult to explain the reticence; consultancies tend to make money by selling the time of deep specialists. Those specialists tend to be highly paid, difficult to replicate and the key individuals often own the business (frequently through partnerships rather than limited companies).
The risks to an investor are clearly that the embedded specialists might exit the business or lose their drive. Replacing them or adding new specialists to drive growth is a recruitment nightmare and client relationships are forever dependent on individual delivery.
As business models go, it isn’t the most straightforward to back. In addition, once EBITDA is normalised for partner earnings then there is frequently a disconnect between the value aspirations of the vendors and the returns requirement of the investor.
None of those fundamental characteristics of a consultancy has changed, and yet the last few years have seen a shift in the attitude of private equity investors to investing in consultancies. A recent study by law firm, Mayer Brown, shows a 179% increase in private equity investments in the business and professional services sector in 2021. We have also witnessed this trend fist hand at HMT Corporate Finance, having worked recently with consultancies such as Aker Systems, VueAlta, and The Marketing Practice to secure them transformational private equity investments.
So what has changed?
One thing that has driven private equity into the arms of consultancies is the sheer volume of investment cash private equity investment funds have to deploy. With wafer thin interest rates and stable markets, PE firms have been raising bigger and bigger funds and moving inexorably up market. In estate agency parlance it is a seller’s market and for businesses with substance and scale there will be competition to invest, almost regardless of business structure.
Another factor which now makes consultancies more attractive to private equity is the use of technology to both drive efficiency and to productise those elements of the business which are capable of replication and standardisation. There is less investment risk in a business where 20% of the revenue is derived from the individually very clever, than one where 60% of it is.
Even where processes cannot be delivered or even partly delivered by technology, the embedding of intellectual property in standard toolkits and blueprints will make an investor more comfortable that the revenue engine will remain in the business and not walk out of the door. Similarly a structure which sees key client relationships spread throughout the organisation and not focussed on a few key consultants will be reassuring.
The larger and more established a consultancy is, the more likely it is to have already addressed the challenge of growth and scalability, to have created an effective recruitment machine and to have put in place recruitment, induction, training and retention programmes to ensure that there is a steady supply of the “cleverness” at the heart of the consultancy. When a consultancy business is sufficiently well established to have already demonstrated generational succession then it is considerably de-risked for an investor.
One interesting dilemma for a consultancy considering an exit, be it to Private Equity or a trade acquirer, is the balance between employed consultants and associates. On the one hand a model which is heavily dependent on associates reduces the fixed cost base and makes the business easier to flex in line with demand. On the other, unless the associate programme is very well managed and proven, there is a risk that any transaction unnerves the associate network and leaves the business significantly under-resourced post deal. IR35 risk also plays a part here and there has been a clear move in the direction of wanting most consultants on payroll. This makes it even more important that a consultancy can demonstrate strong and consistent demand for its services over time.
Private equity is driven by returns, returns are driven by market demand and market demand is influenced by shifts in societal and consumer behaviour. The flip to online working, the overnight move to single channel retail (ecommerce!) in Spring 2020 and the “work anywhere” culture which has emerged because of lockdowns, have all been favourable to the consultancy business model. Not only are key services such as digital transformation, cloud migration, social media marketing and networking often delivered through consultancies, but those consultancies are also now spending less on travel, office space, entertaining and pitching, making the model more profitable than ever.
HMT announced this week that we have advised the management team at digital marketing agency OMM to complete their Management Buyout (MBO) of the business, with the support of alternative debt provider Thincats.
OMM represents the latest transaction for HMT in 30 years of advising on MBOs, which remains one of the most popular deal structures for existing shareholders and management teams alike. In almost all cases however, the deal requires significant capital that is beyond the means of the purchasing management team. As such, attracting external funding becomes the most critical part of any MBO project and is one of the critical roles that HMT undertakes on a process.
A common route is to gain sponsorship from a private equity investor in exchange for a majority equity stake in the new ownership structure. Gaining the experience, resource bandwidth and follow-on capital of a seasoned investment firm can make a lot of sense for the MBO team. That’s especially true when the growth strategy includes a material change of direction through product, geographical or acquisitive expansion.
However in the right circumstances, as was the case with OMM, a debt-funded MBO can offer an alternative approach. An “inside” deal can be arranged by using a fixed-return debt instrument alongside the vendors reinvesting a share of their proceeds into a subordinated loan note or agreeing a deferred consideration structure. There are a range of advantages – sensitive business information isn’t shared externally, the MBO team retains more of the equity and there is no pressure to exit under a 3-5 year investment horizon. Most of all, passing control to a team who already know the business well can offer the smoothest route to transitioning ownership within an overall quicker and simpler process.
A debt-funded deal is most accessible to companies serving resilient demand in growing markets with strong cash generation that can service the additional debt burden. Lenders will consider MBO financing as riskier and more complex than a typical commercial loan because of the inherent uncertainty that a change of ownership can bring and the higher quantum of debt required.
For the most attractive opportunities with the most credible management teams, bank and private credit fund lenders have appetite to support with 3-5 year term loans secured on the future cash-flows of the business. For transaction sizes up to £25m, achievable debt capacity can range between 2 – 4x sustainable annual EBITDA with varying degrees of amortisation and bullet repayment available.
Engaging an experienced advisor to both structure the deal and procure the most appropriate financing is a key initial step for management teams and shareholders contemplating a debt-funded MBO. With access to a wide-range of prospective lenders, the HMT team uses their experience to articulate and position the debt opportunity to the most relevant funders achieving the best possible terms through a coordinated process.
If you would like further information or advice on how HMT can support your MBO aspirations, please get in touch.
HMT announced this week that we have advised the management team at digital marketing agency OMM to complete their Management Buyout (MBO) of the business, with the support of alternative debt provider Thincats.
OMM represents the latest transaction for HMT in 30 years of advising on MBOs, which remains one of the most popular deal structures for existing shareholders and management teams alike. In almost all cases however, the deal requires significant capital that is beyond the means of the purchasing management team. As such, attracting external funding becomes the most critical part of any MBO project and is one of the critical roles that HMT undertakes on a process.
A common route is to gain sponsorship from a private equity investor in exchange for a majority equity stake in the new ownership structure. Gaining the experience, resource bandwidth and follow-on capital of a seasoned investment firm can make a lot of sense for the MBO team. That’s especially true when the growth strategy includes a material change of direction through product, geographical or acquisitive expansion.
However in the right circumstances, as was the case with OMM, a debt-funded MBO can offer an alternative approach. An “inside” deal can be arranged by using a fixed-return debt instrument alongside the vendors reinvesting a share of their proceeds into a subordinated loan note or agreeing a deferred consideration structure. There are a range of advantages – sensitive business information isn’t shared externally, the MBO team retains more of the equity and there is no pressure to exit under a 3-5 year investment horizon. Most of all, passing control to a team who already know the business well can offer the smoothest route to transitioning ownership within an overall quicker and simpler process.
A debt-funded deal is most accessible to companies serving resilient demand in growing markets with strong cash generation that can service the additional debt burden. Lenders will consider MBO financing as riskier and more complex than a typical commercial loan because of the inherent uncertainty that a change of ownership can bring and the higher quantum of debt required.
For the most attractive opportunities with the most credible management teams, bank and private credit fund lenders have appetite to support with 3-5 year term loans secured on the future cash-flows of the business. For transaction sizes up to £25m, achievable debt capacity can range between 2 – 4x sustainable annual EBITDA with varying degrees of amortisation and bullet repayment available.
Engaging an experienced advisor to both structure the deal and procure the most appropriate financing is a key initial step for management teams and shareholders contemplating a debt-funded MBO. With access to a wide-range of prospective lenders, the HMT team uses their experience to articulate and position the debt opportunity to the most relevant funders achieving the best possible terms through a coordinated process.
If you would like further information or advice on how HMT can support your MBO aspirations, please get in touch.
