Sean Magennis [00:00:16] Welcome to the Boutique with Capital 54, a podcast for owners of professional services firms. My goal with this show is to help you grow scale and sell your firm at the right time for the right price and on the right terms. I'm Sean Magennis, CEO of Capital 54 and your host. On this episode, I'll make the case that your ability to exit is impacted by your org chart. I'll try to prove this theory by interviewing Greg Alexander, Capital 54's chief investment officer. Greg will share his experience helping owners design their organization with an exit in mind. Greg, let's begin by establishing a working definition of organizational design for the purposes of this episode. How should we think about this for the duration of our call?
Greg Alexander [00:01:12] Traditionally, org design is simply what type of people do I need? How many of them do I need? And how should I deploy them? I would tweak this a bit for our listeners who are owners of boutique preserve firms. I would add leverage ratio in cost to the org design leverage ratio simply means how many employees for each owner. So for example, if my firm has three owners and 30 employees, I have a leverage ratio of ten to one. This is relevant because it impacts wealth creation greatly. More owners means less wealth for each owner due to the equity dilution that happens when adding owners slash partners. Costs, the second tweak is simply what do I pay for each role? This is a required tweak for our listeners because labor costs is the single biggest expense. Designing an org chart without considering costs could destroy a PNL if not done carefully.
Sean Magennis [00:02:08] Excellent. Greg, I've been taking notes, so let me read this back to you to make sure I got it. Org design means five things. Number one, the type of people I need. Two, the number of people I need, three, the way I should deploy them, for instance, by geography or industry, vertical, et cetera. Number four, the leverage ratio. And number five, the labor cost of the of the org model that I get this correct?
Greg Alexander [00:02:38] You did, those five things, if you keep them top of mind and you will design an excellent organizational model.
Sean Magennis [00:02:44] Outstanding. So with this understanding, help me and the audience understand how this impacts an exit.
Greg Alexander [00:02:52] Sure the connection is not obvious, but let's be sure it's there and it's very strong. So the entity that buys you a firm must figure out how to integrate it into their firm. Org design is front and center during this integration thought process. Potential buyers will not buy your firm if they feel the integration will be difficult. Difficult integrations are costly. They took a long time and they result in bad deals. In contrast, simple integrations are very attractive to buyers. They're cheap, quick, and they lead to excellent returns. This means the design of your organization can aid or hurt your ability to sell your firm. Your org model will be heavily scrutinized during diligence.
Sean Magennis [00:03:43] Yes, I can see the connection. And to summarize, the easier an organizational model is to digest, the more likely it is your firm will be bought. This begs the question, Greg, how can our listeners design their organizations now to enable them to get purchased?
Greg Alexander [00:04:01] OK, so let's start with some things to avoid. So here are three things to consider. First, eliminate all complexity. The design principle should be simplicity. Unfortunately, in my work advising boutiques, I often see overly complex org models tried to avoid making this mistake. Second, stay away from the Matrix. At times, owners of process firms struggle to make the hard decision of who reports to who. So to please everybody they let some report to more than one person. This is called the Matrix. Integrating a matrix is very hard. Stay away from it. I see deals fall apart during the diligence stage simply because the matrix exists. And then third, organize around either geography, industry or function. Organizational models built around one of these dimensions are clean and they're very easy to understand and very easy to absorb.
Sean Magennis [00:05:06] This is so right on. This is excellent. Keep it simple. Avoid the matrix. And I'm going to just say that fifteen times with a huge number of exclamation marks because I lived there for seven years. Running a global...
Greg Alexander [00:05:19] It sounds great, but it's a nightmare.
Sean Magennis [00:05:20] The complexity is so difficult for people to understand and grasp internally. And you can imagine what it's like externally. If you're trying to sell. So stick with the geography industry, vertical or job function. That makes total sense. Any other org model design ideas?
Greg Alexander [00:05:37] Yeah. Let me share one more and it's a little counterintuitive. So that would be stay small enough to be bought. Which I know right now, our listeners are probably cringing because their growth businesses. So what do I mean by this? Acquirers tend to shy away from buying boutiques with hundreds of employees. They are too difficult to integrate. The more people, the greater level of integration difficulty, some owners are insecure. And to establish credibility, they like to talk about how many employees I have. They believe the more employees they have, the more legit they are in the eyes of clients or investors. This is a flawed thinking. Investors are going to calculate your revenue per employee. They use this metric to determine the quality of your firm. The higher revenue per employee, the more desirable you are as an acquisition candidate. The formula for revenue per employee is very simple. Revenue is the numerator and employee count is the denominator. If you have a large number of employees, your revenue per employee is going to be small. So this last piece of counter-intuitive advice is stay small enough to be bought.
Sean Magennis [00:06:53] Greg, I love this. I think you're absolutely correct. It is counter-intuitive. Fewer employees are a good thing. It's really interesting.
Sean Magennis [00:07:05] And now a word from our sponsor. Collective 54, Collective 54 is a membership organization for owners of professional services firms. Members join to work with their industry peers to grow scale and someday sell live firms at the right time for the right price and on the right terms. Let us meet one of the collective 54 members.
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Sean Magennis [00:08:25] If you are trying to grow scale or sell your firm and feel you would benefit from being a part of a community of peers, visit the collective54.com.
Sean Magennis [00:08:41] OK, so this takes us to the end of this episode. And as is customary, we'll end with a 10 question yes-no checklist. We conclude each episode in this fashion to help you, our listeners apply the learnings directly to your business. This creates your take-home value. Let's jump into the checklist. Ask yourself these 10 questions. If you answer yes to eight or more of these questions, you're likely to get all of your earn-out. If you answer no too many times, you're likely to leave a lot of money on the table.
Sean Magennis [00:09:17] Question number one, will your organizational model be easy to absorb? Number two, are you organized around either geography, industry or function? Question number three, you stayed away from The Matrix? Question number four, are you large enough to be interesting, but small enough to integrate easily? Number five, does your org model reflect the niche you serve? Number six, does your org model reflect your business model?
Greg Alexander [00:10:00] So a little something on that. Generally speaking, two types of business models. The first is high margin, low volume. The second is low margin. High volume. And your org model needs to reflect that. Right. So in the high margin, low volume business, you probably have few employees. A lot more senior and a lot more expensive. On the flip side, if you have a low margin, high volume business, you probably have lots and lots of juniors right around.
Sean Magennis [00:10:36] Excellent, Greg. So number seven, is the organizational model a good starting point for an easy integration? Number eight, is your organizational model flexible enough to morph into somebody else's?
Greg Alexander [00:10:49] For example, stay away from labor unions.
Sean Magennis [00:10:51] ...and Matrix organizations. Number nine, does the organizational model reflect the true cost to operate your boutique? And number 10, will it be obvious to a potential acquirer where the synergies will come from? In summary, the perceived difficulty or ease of integrating your boutique will affect your ability to exit. Your org model directly impacts your ability to exit.
Sean Magennis [00:11:25] If you enjoyed the show and want to learn more, pick up a copy of Greg Alexander's book titled The Boutique How to Start Scale and Sell a Professional Services Firm. I'm Sean Magennis. Thank you for listening.