Your rate of growth is your most important number. Learn why it is more important than your size, client roster, and service offerings.
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 will make the case that your rate of growth is your most important number. It is much more important than the size of your firm. It is more important than your client roster, and it is more important than your service offerings. Potential acquirers want to see strong growth in top line revenue and bottom line profits. I'll try to prove this by interviewing Greg Alexander, Capital 54's chief investment officer. Greg really is a true expert when it comes to growing revenues and profits in the professional services sector. Greg, what advice do you have for the audience with regards demonstrating growth to a potential investor?
Greg Alexander [00:01:28] Yeah, so the first thing to understand is, is what does good growth look like from the perspective of an investor? So as the chief investment officer of Capital 54, you know, when I consider making an investment into a firm, I'm looking for the following... So roughly a five to ten year track record of consistent revenue and profit growth and also, you know, within those five to ten years, that means revenue growth roughly 20, 20 to 30 percent top line. Shoot for gross margins in the 70 to 80 percent range and look for net margins in the 30, the 30 to 40 percent range is probably a good number to shoot for.
Sean Magennis [00:02:08] Mm hmm. So, Greg, these are those are really high bars to to leap over. So I'm curious, tell me why the five to ten year requirement firstly.
Greg Alexander [00:02:18] Yeah. You know, I tell you a recent story that might illustrate why sustainability of growth is key and that's really the word here.
Sean Magennis [00:02:27] Yes.
Greg Alexander [00:02:27] And that's the reasons for the five to ten years. So I was recently involved in an auction run by an investment bank for an I.T. services company. This firm had a strategic relationship with a software provider in a very hot area called data analytics, and they helped clients use the data to make better decisions through data visualization and the bank running the auction touted the boutique as a high growth firm. When I met with the management team, they were very proud of what they had accomplished and I was presented with slide after slide of steep revenue and profit growth, and the growth was accelerating. Now, see, I had looked at a few firms in this space and I had a somewhat uncommon and maybe unfair information advantage. This firm was growing revenue at roughly 22 percent per year and had done so for about three years. Problem was that their boutique competitors, other firms I had looked like it, looked at, excuse me, were growing their top lines at twice the rate. You see that the data visualization space was hot and kind of high water was raising all ships. When I dropped out of the bidding process, this firm, unfortunately, was insulted and when I explained my rationale and provided my evidence, they claimed that my comparisons were not apples to apples and that the firms I compared them to would not, quote, pure place.
Greg Alexander [00:03:55] This firm ultimately was unable to find an acquirer. So it appears that I was not the only one who felt this way and had seen other firms at the command of the facts and unfortunately, the story gets worse and this is why the requirement of five to ten years is so important. You see, the data visualization space cooled off a bit. The software provider, the golden goose, so to speak, stopped laying the eggs. And as the rate of growth slowed, so did the growth rate of its service partners. So it's not enough to ride a wave so to speak you know. You have got to have a real business that can make it through let's say it's a decade.
Sean Magennis [00:04:35] So, Greg, I assume the moral of the story is growth is relative and most importantly, know your facts. Know your data if you're doing the comparisons. Is that accurate?
Greg Alexander [00:04:46] It is. You know, sometimes I get pitches and they say, you know, hey, you know, I'm a large firm. A number of employees of big revenue and you look at the growth and it's five, seven, ten percent, you know and so the size of the firm is less important to the investor. It's the rate of growth and the relative rate of growth that really matters.
Sean Magennis [00:05:05] Yes, it makes total sense and additionally, I'm curious why you include profit growth in your list of requirements. Many young firms focus on profit and we see that coming out of Silicon Valley and other places around the world. They don't focus on profit growth. They spend their time obsessing over top line revenue growth.
Greg Alexander [00:05:27] Yeah. You know, unfortunately, a lot of firms have great top line growth, but no profit growth. And that's a deal killer for most especially for me. The key thing to think about as it relates to a services business, and this is different than a product business, and maybe this is the most significant difference between selling a product firm and a services firm. Yes, a services firm has to figure out how to decouple revenue growth from headcount growth and until they can do that, they're not going to generate any profits. You can grow from 20 million to 40 million, but if you're doubling headcount in the process, you're not making any more money. So until they really figure this out and there's a lot of ways to do that, that go beyond the scope of today's podcast, but until they figure that out, they shouldn't try to sell the firm. When they do, gross margins and EBITDA margins will jump and that's the time to sell. You know, you open in your podcast, you want to sell at the right time for the right price on the right terms. That's the right time when you figure that out because you'll see lots of growth and EBITDA and that will prove that you have a sustainable, scalable business model and that's when you have lots of firms interested in making an investment in your firm.
Sean Magennis [00:06:47] Thank you, Greg. So top line growth for our listeners, bottom line profitability. Those two have to be done the right way in order for you to get the right price and an effective sale.
Greg Alexander [00:07:00] Correct.
Sean Magennis [00:07:01] Outstanding.
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Sean Magennis [00:08:50] So here we go again. Greg, in an effort to provide immediate takeaway value for you, our audience. I prepared a 10 question. Yes, no checklist. Listeners, please ask yourself these 10 questions. If you answer yes to eight or more of these questions, you have an excellent growth story that will attract investors. Number one, are you growing revenue faster than your boutique competitors? Number two, have you been doing so for more than a few years? Number three, are you growing your profits faster than your boutique competitors? Number four, have you been doing so for more than a few years? Number five, you're growing your revenue faster than the practice inside the lodge market leaders.
Greg Alexander [00:09:56] Let me. Let me interrupt you there just for one moment, because we didn't talk about this. But this is important.
Sean Magennis [00:10:00] Yes, please.
Greg Alexander [00:10:02] When you go to sell your firm, there's really two types of buyers. There's the private equity buyer and there's a strategic buyer. The strategic buyer can be defined as another firm that wants to buy your practice to expand their offerings. So when they when they consider that it's a buy versus build conversation, I can build the practice myself by hiring people and trying to sell the same service or I can buy a boutique and bring that into my firm. Those are two ways to do it. So this question number five, how you're growing your revenue faster than are you growing your revenue faster than the practice inside the the large market leaders is really important, because if you're not, those strategic buyers are not going to be interested in your firm. They can do what you do better than what you're doing. So why bother you?
Sean Magennis [00:10:50] Precisely.
Greg Alexander [00:10:51] Right. On the flip side, if they identify your practice area as strategically relevant for them and they've been trying to get it done, but they can't. You're going to become more attractive to them because they can buy you throw some money at it and solve a strategic problem. So that's why that question is in here.
Sean Magennis [00:11:07] Excellent, Greg. So very much a creative to their market, which will which will give them an opportunity to buy versus doing it themselves. And then the follow on to number five was, again, have you been growing your revenue for more than a few years?
Greg Alexander [00:11:22] Right. And that's a sustainability factor.
Sean Magennis [00:11:24] Excellent.
Sean Magennis [00:11:25] Number seven, are you growing your profits faster than the practice inside your largest marketing competitor's? Very much like your previous point. And then number eight, have you been doing so for more than a few years? Number nine, are you growing your cash balance to cover payroll for at least 12 months? And number 10, do you have at least 12 months of forward visibility?
Greg Alexander [00:11:57] Yeah. So let's talk about nine in 10 a bit. There's a difference between cash flow and income. And boutique businesses run on cash flow so it's one thing to grow your revenues and it's one thing to grow your profits but you also want to be growing your cash balance.
Sean Magennis [00:12:14] Yes.
Greg Alexander [00:12:14] So that you can use that free cash flow, so to speak, to fund growth initiatives, whether that be bringing out new services, investing in marketing, hiring new people, whatever it may be, so that the look at cash is different than the look at revenue and different than look at profits.
Sean Magennis [00:12:32] Outstanding, thank you. Greg. So what we've learned today is growth matters a lot and relative growth matters even more. A year or two of great results doesn't mean that you have a sellable, sustainable boutique. A decade of market beating growth will command an excellent price and excellent terms and profit growth. Greg, as we've discovered and experienced, is as important as revenue growth. This indicates that you have cracked the code. You were one of the few who broke the link between revenue and headcount growth. Please be sure to run a tight ship. Be prepared to demonstrate reliable forward visibility and plenty of working capital.
Sean Magennis [00:13:27] Again, thank you, Greg. And 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 your host, Sean Magennis. Thank you for listening.