Exit Planning for Professional Services Firms
A professional service firm, also known as a personal service business, sells an intangible product (i.e., a service) to the client. These include, but are not limited to: accounting, engineering, architecture, consulting, actuarial science, law, performing arts, healthcare, and veterinary services. The key differentiating factor from a retail, wholesale, or manufacturing type is that the business owner represents its goodwill and the intangible assets the firm offers to its clients. Since the nature of the business depends on the owner’s skills and market reputation, clients, and culture, the question arises as to how much of that goodwill can be transferred to the company’s new owner.
Professional services firms heavily rely on the unique skills and reputations of individuals. Unlike regular consultancy firms responsible for giving advice, professional service providers take responsibility for the outcome. Also, in contrast to retail, distribution, or manufacturing businesses, such firms do not maintain a product inventory; instead, the company is mainly built upon the business owner’s relationships with clients, their knowledge, and industry know-how.
This is why one of the essential elements ensuring a successful business transition is to safeguard its transferrable value. The business owner may see a lot of value in their business, but transferable value makes exit goals achievable.
One should not confuse transferable value with profit. The actual transferable value is determined by how well the company runs without the business owner’s presence. The sale of such a business is based on the following:
- The amount of repeat business the company gets from the clients.
- The number of clients and how many of these can be transferred to the new business owner.
- The current and future stability of revenue flow and,
- The market reputation of the business within its domain industry.
Improving any or all of these areas should enhance the sale value of your firm. By successfully planning an exit strategy, such business owners can achieve their growth targets and exit goals.
So how do we go about it? Let’s start from the very basics.
What Is Exit Planning?
Exit planning is a detailed, structured business plan that enables business owners to transition to another company or investor. A strategic exit plan helps determine when the owner wants to exit, how they exist, and what they need to carry out their exit plan.
An exit planning advisor usually leads the exit planning process, ideally beginning at least four to five years before the owner’s desired departure date. Planning well in advance of an exit is especially critical for most professional services firms.
The exit strategy serves the business owner’s personal and business goals. It also helps to prioritize business activities, growth targets, objectives, and the owner’s individual goals.
Three things are critical to the success of an exit plan:
- Timeline of the exit: With a flexible deadline, the owner has more negotiating power, can execute value enhancement strategies, and better control when they want to exit.
- The owner’s intentions for the business: The business owner needs to be sure about their intentions. Do they wish to dissolve it or let the operation continue? An exit plan will vary for each different exit scenario.
- Market scenario: Since the business runs mainly on the owner’s goodwill, they must stay tuned to the existing market conditions.
Do I Need an Exit Plan?
There are multiple reasons for planning your business exit.
- When you plan to sell a professional services firm, the value of the business is determined by the cash flow it generates, mainly because that’s of the nature of the company. Since most companies seek to increase the business owner’s profit today, an exit plan will help you understand how a potential buyer will see your company.
- An exit plan will take you through all aspects of your business with a fine-tooth comb to improve existing procedures and processes. When done correctly, an exit plan will help you build and run a better professional services practice with less risk, less dependence on you, more repeatability, and improved operational rigor.
- Since an exit plan scrutinizes all aspects of business operation, you will be able to pinpoint precisely what you will need to transition out of your business and develop a plan to get there. It will help you fulfill both your personal and business goals.
- One of the most problematic aspects for most business owners is what will happen to all your employees once you leave the business. Another concern is what comes next once they exit. An exit plan will help you plan both these critical details. If you want to stay involved in the business, you stay on as a part of the advisory team and work out an earnout structure within the deal terms. You can also negotiate better terms for your employees as well.
How Do Professional Service Firm Owners Generally Exit?
This is an internal transition to a group of key employees, generally the company’s management team, who acquire the assets and business operations of the business. This option is favored for two reasons:
- Since the nature of the business is based on the owner’s goodwill, this exit option ensures that the same goodwill is carried forward under new management.
- Employees prefer it for the higher control and rewards they get by becoming owners, rather than just employees.
In the absence of suitable successors, the owner may opt to sell the business to a third party, such as a competitor or a more prominent firm or someone starting in the business but who doesn’t want to build the business from scratch. The owner gets a bulk of the sale price at closing. There are three ways to execute this type of deal:
- Sell to a person unrelated to the business. Sometimes, buyers are looking to become business owners but do not want to start from scratch.
- Sell to another business in the same industry. Buyers pay a high price to acquire an existing business if it is a strategic purchase. The purchase price is determined by existing operational systems, economies of scale, administration, service offerings, and sales pipelines.
- Sell your business to an investor or a private equity group. If the company requires a higher down payment, then private equity groups are also potential buyers. They acquire such businesses to diversify their portfolios and create an ecosystem of codependent companies to complement their existing companies.
What are the Key Steps to Planning My Exit?
1. Identify your exit timeline (be specific) and how you hope to exit (internally or externally). Decide when you intend to exit your business to clarify your time to build the business’ value. Simultaneously, decide how you want to exit and whether it will be an internal or an external exit.
2. Establish the baseline value of the business to address the current valuation gap. The business’s baseline value refers to its present value, market position, and fares against its competitors. The baseline value is also used to determine the exact requirements that the business must meet to reach its target value goal. Since the primary focus of an exit plan is to ensure that you get the best purchase price and best exit terms, you must take steps to increase the firm’s value and periodically measure it against the baseline value to understand the value gap.
3. Execute the transition. The next step is to transfer ownership of the business to the new buyer. During this exit planning phase, price negotiations occur, due diligence is conducted, and issues are resolved. Once both parties are in the entire agreement, the initial sales contract is drafted.
Who Can Help Me?
Most firms work with a value creation consultant or exit planning advisor working with professional service firms to develop their value creation strategies and plan for their eventual exit. Contact Quantive today to see how we can help.