Episode 9: A Little Known Secret: How Employee Loyalty Drives Up Valuation
by Collective 54

You compete in two markets. The market for clients. And the market for employees. As much effort needs to be put into employees as into clients. Owners of boutiques work for the employees, not the other way around. Would you want to work for you?




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 there is a direct correlation between your employee loyalty and your firm's valuation. I'll try to prove this theory by interviewing Greg Alexander, Capital 54's chief investment officer. Greg has developed a proprietary approach to measure the employee loyalty of a professional services firm. Greg, to begin, can you help the audience connect employee loyalty to firm valuation? 

Greg Alexander [00:01:12] Sure. So traditionally, investors have shied away from investing in pro serve firms. When asked why, they are fond of saying, quote, all the assets of a pro serve firm walk out the door each night, end quote. And this is meant to illustrate that assets of a firm are its employees. And if the employees or assets can walk out the door, the business has no value. Therefore, if you can demonstrate that the assets your employees stick around, the business does have real value in the best way to prove the assets do stick around, it's demonstrating outstanding employee loyalty. High loyalty equates to high valuation. 

Sean Magennis [00:01:52] I see. Excellent employee loyalty can then de-risk an acquisition for an investor. So how can an owner of a firm prove excellent employee loyalty? 

Greg Alexander [00:02:04] There are several ways. Let me share just a few that the listeners can try immediately. 

Greg Alexander [00:02:11] So the obvious one is employee turnover rate and that's an excellent metric to prove employee loyalty. The average turnover rate across all pro serve firms is approximately 30 percent. Best in class is about 15 percent. If an owner has a low turnover rate and he can prove high employee loyalty. So that's a easy one to go after. The next one would be tenure. And employee tenure is another excellent proof point. The listeners should challenge themselves to have average employee tenure of, let's say, greater than five years. This would prove to investor that the employees do indeed stick around. And one of my favorite ways to de-risk an investment, and prove employee loyalty is to show how many positions get filled internally. You see, boutiques are growth businesses and growth creates lots of promotion opportunities for employees. If these promotions are filled internally, this suggests outstanding employee loyalty. In fact, a well-run firm should fill all of its promotions with homegrown talent. 

Sean Magennis [00:03:16] So 15 percent employee turnover, five years or more of employee tenure and to the extent possible, 100 percent of promotions filled internally. These are three excellent goals to shoot for. Are there any other ways a listener could prove to an investor that his or her firm is worth more due to his outstanding employee loyalty? 

Greg Alexander [00:03:41] There are a few more. Here are a few others to think about. One of my favorites is Discretionary Effort. So what is discretionary effort? Discretionary effort are the hours an employee puts in above and beyond the job requirements. So, for example, let's say the job calls for 40 hours per week on the submitted time sheet and most employees log 44 hours not because they are asked to, but because they want to. This is a 10 percent discretionary effort. Some like to say, quote, My people give it 100, 110 percent effort, end quote. And this is what they mean when they say this. An investor who sees this when reviewing the timesheets during diligence will determine you have high employee loyalty and will likely pay more for your firm. And here's one more to just get the juices flowing. What are former employee is going to say about your firm when they are contacted? If they say they loved working at the firm and for the owner, investors will be very pleased. If, however, former employees say they hated working for the firm and even worse, hated working for you, the owner, the investor will run away. That's a major red flag. You know, it cracks me up. But boutique owners think that they can hide their skeletons when you try to sell your firm. Investors are going to find all the skeletons. That's their job. If the former employees do not have nice things to say, the valuation of your firm is going down. 

Sean Magennis [00:05:06] So discretionary effort and the former employee reference checks are key. This makes sense, Greg. And when added to employee turnover, tenure and promotion fill rate. This makes for an excellent list for our readers. 

Sean Magennis [00:05:23] 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 their firms at the right time for the right price and on the right terms. Let us meet one of the collective 54 members. 

Irit Elzips [00:05:50] Hello, my name is Irit Elzips I own CSM Practice, a customer success strategy consulting firm. We serve technology and services organizations from around the world. These clients turn to us to accelerate their profitable growth rate by improving their customer retention, increasing their up sell and cross-sell revenues, and creating a strong differentiation in their market through a better customer experience and maximizing values for their clients. We achieve these kind of results by designing an optimal customer success strategy. We then develop processes, protocols and policies to ensure that our strategy recommendations are adopted and we implement those in a scalable manner using both training and technologies. If you need help with accelerating your profitable growth and increasing revenues from your existing customer, install base or reach out to me at csmpractice.com. 

Sean Magennis [00:07:00] 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 Collective54.com. 

Sean Magennis [00:07:16] So this takes us to the end of this episode and as is customary, we end with a ten question, yes, no checklist. We do this to reward you, our listeners with some immediate take home value. Ask yourself these 10 questions. If you answer yes to eight or more of these questions, you can prove you have loyal employees. If you answer no too many times, you have an employee loyalty problem and this is going to hurt you when you try to sell your firm. 

Sean Magennis [00:07:45] Question number one. Is your turnover rate fifteen percent or lower? Number two, is the average tenure of your employees greater than five years? Number three, do most of your promotions get filled internally? Number four, do you get rewarded by your employees with lots of discretionary effort? Number five, will your former employees sing your praises when contacted? Number six, does your firm have a purpose that the employees believe in? Number seven, does your boutique have a vision of the future that employees want to be a part of? Number eight, does your firm have a set of values and are they actually lived by? Number nine, are you paying your employees what they are worth? And number 10, do you have an in-house recruiting engine that provides you with a stream of quality people?

Greg Alexander [00:09:04] Just one quick thing on number nine, are you paying your employees what they're worth? You know, sometimes small business owners, owners of boutique professional services firms, because labor is their biggest expense, they try to underpay because they're trying to contain costs. That's an example of being, as they say, penny wise and pound foolish, because if you're underpaying and as a result of that, your turnover is, let's say, 30 percent instead of 50 percent, you're actually hurting yourself there. Just pay a little bit more. Keep the turnover rate down and you'll benefit not only in the short term, but someday when you go to sell your firm, it'll be easier to do so. 

Sean Magennis [00:09:39] It's a great example, Greg. So in summary, remember, you compete in two markets, the market for clients and the market for employees. As much effort needs to be put into employees as into clients. Owners of boutiques work for their employees, not the other way round. Consider this question. Would you want to work for you? 

Greg Alexander [00:10:04] That's a tough one to answer. 

Sean Magennis [00:10:07] 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.