Episode 60– Create Wealth by Converting Client Relationships into Balance Sheet Assets – Member Case with Mike Stern

C54 member Mike Stern, CEO of Connected, shares insights on how to convert client relationships into appreciating assets to attract buyers for your firm.


Sean Magennis [00:00:15] Welcome to the Boutique with Collective 54, a podcast for founders and leaders of boutique professional services firms. Our goal with this show is to help you grow, scale and exit your firm bigger and faster. I’m Sean Magennis Collective 54 Advisory Board member and your host. On this episode, I will make the case that a key to attracting a buyer to purchase your firm is your ability to prove you have healthy client relationships. I’ll try to prove this theory by interviewing Mike Stern, CEO at Connected. Connected is a software product development firm founded in 2014 and headquartered in one of the most beautiful cities in the world. Downtown Toronto Connected was born out of the belief that a new category of firm was needed to help ambitious companies leverage the power of product, not a dev shop or a design agency or a strategic consultancy, but a uniquely integrated product development firm built for the long term and driven by a singular focus on realizing business impact through software powered products. You can find Mike at www.Connected.Io. Mike, great to see you and welcome. 

Mike Stern [00:01:41] Likewise, Sean. Thanks for having me here. 

Sean Magennis [00:01:43] It’s such a pleasure. So let’s start by getting you to give us an overview. Can you briefly share with the audience an example of how you have built a really healthy client relationship? 

Mike Stern [00:01:57] I think my favorite example is a client that we’ve been working with for six years now, so we’re a seven year old firm. And that means that they’ve been with us for the lion’s share and they’ve grown with us. They’ve seen us from our infant stage all the way to, you know, whatever we’re at today. Yes. And that’s that’s one of the reasons that that I like them. But let me just tell you a little bit about them. They are a consumer electronics company. We don’t share the names of our clients. Absolutely. I can assure you that the vast majority of your listeners own at least one of their products, and they have a long, long history of excellence in hardware engineering. But as software showed up and the internet showed up and connectivity and IoT showed up, they started to look around for some help to accelerate their learnings and help them compete in this kind of new software powered product world. And we were, I think, lucky to be at the right place, at the right time to start partnering with them early in their journey. And again early in our journey. And I think this particular client relationship is so special to us because they pushed us to get better and better and better, just as we pushed them to get better and better and better. And I think that is kind of quintessential about what great professional services client relationships are all about. Sometimes both clients and agencies think that it’s just a one way street. Yes, but really we’ve we built something symbiotic with them and and that’s been very fulfilling and it’s been, you know, profitable and helped us grow as a business as well. 

Sean Magennis [00:04:16] It’s outstanding, and I can only imagine that the reference ability of that client because you’ve developed so much and I would, I would probably say a very authentic because if they’re pushing you and you’re pushing them, that relationship that you’ve developed is is really a co-creation relationship in a way. Does that does that resonate? 

Mike Stern [00:04:37] Yes, it does. Yes it does. Some of our service offerings that we now go to market with today are the result of this client and and our team looking at new problems and coming up with creative solutions. Yes. And then, you know, allowing us to take those new service offerings to market and as we make those service offerings in the market even better than we can bring it back to this client and help them even more than than we did before. So it’s a great virtuous cycle 

Sean Magennis [00:05:12] Brilliant and congratulations. That is a perfect example to kick us off. So what I’d like to do is get your thoughts on some of the best practices that we recommend in this area. I’ll walk you through them one by one. Get your thoughts on each. And if you want to expand on them, just feel free to do so, Mike. So the first one is we contend that when getting ready to sell a boutique professional services firm, a buyer is purchasing your assets. One of your assets is your client relationships, and like all assets, they should be proactively managed and cared for so that they appreciate in value. What are your thoughts on this concept of the client as an asset of the business? 

Mike Stern [00:05:56] Well, first of all, I think it’s important for me to say just in case my team or my clients are listening. 

Sean Magennis [00:06:05] Absolutely. 

Mike Stern [00:06:06] I want to be clear that connected’s goal is not to sell. Yes, we have a uniquely long term vision with no plan of selling. But for all the other listeners, if you’re considering joining the collective, you know, I want you to know that I get so much value from this group, just simply helping me build a better firm. Yes. And and so I’d really recommend it. Thank you. Now, you know, of course, I can’t rule out that being part of another firm in the future won’t help us achieve our vision even more or help us achieve an even bigger or more exciting vision. But that’s not the plan. Yes. And so I think that’s important to. To state up front, but onto the question, so when I first heard this advice, I was actually really intrigued. You know, I think it makes sense conceptually, but like from an accounting and reporting perspective, like I was wondering, like, do firms that take this advice actually translate that into their balance sheet in terms of how they report? Like, of course, our clients are an important asset, just like our people or our IP. But I was intrigued and then I went to my CFO and I asked her about this and she hadn’t heard about it before. Yes. And so, yeah, frankly, you know, we we have not done this, but I’m curious to learn more about it, and I’m looking forward to conversations in the collective about it. 

Sean Magennis [00:07:50] Yeah. You know, and you bring up a really interesting point. You know, it’s not so much from a it’s not so much a financial putting it on the balance sheet as a financial category because that that’s not commonplace. It’s a it’s a mindset shift so that when you are creating the kind of value that one day whether you decide to sell your firm or not, but to create enterprise value, if you’re a partner model, you decide to bring in other members of your management team into it. It’s clearly being able to articulate an inventory. What are the value props behind your? Your business could be your service line, your product, your uniqueness, your specialty, the way that you go to market, the example that you just gave of the six year relationship. So you’ve articulated that really well, and I want to challenge our listeners. It’s not so much to put this in your in the financial context on your balance sheet, but truly think of your clients from an industry inventory perspective as assets and not just as you know, numbers on a balance sheet because there’s far more to it than that. There’s relationships, nuances, the push on both sides that you’ve articulated so well, Mike. So that’s great. I mean, you’ve expressed that really well. The second area that I’d like you to give your thoughts on is many boutiques have really good looking financial statements. However, when you peel the covers off, some generate most of their revenue and profits from a very small number of clients. So if one of those clients were to leave the, you know, the firm or the boutiques, financials would not look great. In fact, some of them would fall apart. So we recommend being sure not to have any single client concentration equal to more than 10 percent of the billings of a firm. What do you think of this idea? 

Mike Stern [00:09:43] 100 percent agree. And I think it’s very related to the earlier point you made around clients as an asset in your mindset. Yes. Maybe not on your reporting. Like I said, we’re a seven year old firm. And I’ll share that at one point. Not too long ago, we had 85 percent concentration in just two clients. Wow. The one I spoke about before was one of them. Yes. And. In those early years, building up to where we are today, which is about one hundred and sixty five people, we were kind of fooled into thinking that we had grown up as a firm because even back then we were already, you know, over 100 people. And so we had reached that scale quickly. And a lot of folks on the outside, friends, family, they would be so impressed. But I knew that we still had so many eggs, so to speak, in just so few baskets, right? And again, this was only three years ago. So we we grew up through, you know, four years. But with that much concentration and of course, like I said, even though we looked kind of bulletproof from the outside, I hardly slept at night, you know, thinking, Oh, I know that feeling. What if? What if one or or God forbid, both clients went away? Yes. Now what’s interesting is that as an owner, I think it’s actually pretty easy to understand and feel this risk, whereas for an employee, it’s not always that obvious. Yes. And in our case, not only did we. Not only did we need to figure out how to diversify and build a scalable growth engine and build a scalable service model. We actually had to fight kind of an internal cultural inertia. Yes, as we look to diversify it, we had we had some even senior leaders who liked just having a couple of clients. Right. And that was as hard to overcome as as everything else. So, you know, on balance, we also had a lot of practitioners who wanted more from connected than just to clients to get exposure to actually. And like I said, also before we had, you know, those two clients wanted us to be more scalable to to be more sustainable and so that we could be able to bring more of that knowledge back to them, too. So working with multiple clients across multiple markets and across multiple technology platforms, I think is a big reason employees want to work at connected versus, you know, one of our our client organizations, and it’s a big reason we get hired in the first place. So long story short, I 100 percent agree that creating diversification discipline is essential yes, to creating a sustainable firm. Yes. And I think it’s also about realizing a lot of other benefits for our people and our clients. And so for me, at least right now and in my stage of business, I think it’s the most important organizational capability that matters. And the trick is to, you know, make sure you’re treating your existing clients like assets, not just always looking at the new client because diversification doesn’t mean getting good at landing new logos. It means getting good at doing both, keeping existing clients happy and helping them and getting better and better with them and landing new clients. And so that’s what we’re really focused on right now. Connected. 

Sean Magennis [00:13:37] You know, that’s brilliant, and you’ve touched on a couple of things that we’re going to get to in some of these other questions that I’m going to pose you and you know, you’ve articulated so well some of the, you know, the luxuries of only having two or three as you get really used to working with those clients, they become familiar. The risk is, is that, you know, you have relationships, maybe not at the institutional level and all of the things that you’ve just driven. So the third example and you led with this is tenure of relationships. So boutiques that generate billings from clients for years are very attractive. So this suggests that the client relationships are strong. If the boutique did not deliver value, clients would churn. They’d go elsewhere. And so a rule of thumb that we recommend is that the average client tenure should be three years or more. What is your opinion on that? 

Mike Stern [00:14:30] Yeah, another hundred percent agree. You know, and and I think it’s a it’s it’s a good principle. Yes. And of course, you want long term partnerships, not just financially, because it’s a better way to build a long term business and it’s more fulfilling. Like I said earlier, I mean, if you look at your life and you take stock of the relationships that have been most meaningful, they’re usually those that have lasted and the benefits have compounded in mutually beneficial ways. And so I think it’s the same in in professional services. There’s a little bit of nuance, of course, in that are firms. You know, I remember when I heard this, I was thinking she would like some of some of the current clients that I, you know, I think, are really the future of our firm. We’ve only been with them for one year or two years. And so I think younger firms need to figure out who they are and they need time to figure out who they are and who their ideal customers are. Yes. One of the patterns of great professional services firms that I’ve looked at is that they’ve they’ve, you know, they’ve they’ve had some stumbles figuring out who not to work with. Precisely. Yeah. Trial and error. And so, you know, I think it’s a great principle. But the exceptions are, you know what, what maybe proves the rule and you know, you shouldn’t you shouldn’t try to make every client a three year plus relationship. You should try to make the right clients three year plus relationships. And yeah, and that’s that’s something that you know again, you know, it’s very much part of what we’re what we’re working through right now, connected because we want to we want to keep our current clients for the very long term. Yes. And I think we finally found out who they they ought to be. 

Sean Magennis [00:16:39] And, you know, helping them, like you’ve said with identifying their ideal customers, helping them go through that, maybe giving them some benefit of your experience with the pain of other clients when they had similar challenges? That’s what I know you were getting at as part of your, you know, co-creation symbiotic relationship. Because you know what we have found at Collective 54. You know, we can help owners of boutique professional services firms not pay what we call the dumb tax. You know, share with you through a peer based, you know, methodology. I’ve been through this. I’ve been through at this particular pain. You don’t have to go through it quite the way I did to still get the learning and the and the benefit of the wisdom from it. So yes, thank you. That was great. The fourth one and this is also in the context of creating enterprise value for a boutique professional services firm that may one day consider selling is another meant measure of client relationship is what we call client quality. So, for instance, if your boutique generates its billings from start ups or new companies that haven’t quite figured it out, it may discourage a potential buyer from, you know, making an offer on your business. Start ups typically have a higher failure rate. Revenue from that segment may be unreliable as they figuring things out. In contrast, if you’re boutique generates its billings from the Fortune 500 or from larger enterprise players, it would encourage buyers and large enterprises are unlikely to disappear overnight. Revenues from that segment can be and are typically more reliable. What are your thoughts about this? And I know it’s a nuanced question. 

Mike Stern [00:18:26] I agree. You know, rapid growth start ups can look great from the outside or even not rapidly growing startups try to make themselves look great from the outside. Yes, but they’re usually, you know, really chaotic and less reliable than not. Mm-Hmm. And I say usually because statistically, they usually are more chaotic and less reliable. But of course, a few of them, you know, a few percentage points of all start ups, you know, of course, become, you know, the biggest companies in the marketplace over time. And so I think firms get getting a lot of trouble here if they try to work with too many startups or if they try to get too fancy on choosing the right startup or even taking equity, getting into, you know, our accounts receivable troubles. Yes. And so I’m not totally against it. Connected work with some startups usually past Series A Yes, but I’m I do want to express caution to other boutique owners are probably running startup boutiques themselves that you should tread carefully and read and make sure you’re not concentrating too much of your your your energy in that segment. And that personally, I found it. It is a segment where it can be a great place to learn, a great place to try out new offerings and to work at a clip like at a speed that is maybe faster than what larger clients might be used to. And so there’s those benefits in a number of other ones that I found from working with really, really early stage companies. But unless unless you really figured out how to, you know, pick the right ones and address a lot of the inherent issues with with that segment of customer, I think it’s important that you tread carefully and you don’t put all your eggs in one basket. 

Sean Magennis [00:20:58] Yeah, I completely agree. And then finally, a risk that, you know, again, in the context of somebody looking at the value of a firm, a key driver is employee turnover. Sometimes a key client relationship sits with a key employee. And so even from managing a firm, you know, I would want to know that these relationships are with the company, not necessarily with the employee. What do you think about this concept? 

Mike Stern [00:21:29] Yeah, I think I think it’s a really important point, and especially right now, we’re in this moment that people are describing as the great resignation. 

Sean Magennis [00:21:39] Yes, I’ve heard the term a lot. 

Mike Stern [00:21:41] Yeah. So every leader I speak with is experience experiencing more turnover than ever and up and down the organization and a lot of places where they didn’t expect. And I think it’s exposing a lot of cracks and a lot of fragility. Yes, in a lot of places, but one of them is certainly in client relationships. And so, you know, I think I think it’s really, really important that boutique owners and operators are thinking very hard about this. This advice. Yes. Sure. When I when I heard this advice, I was torn, you know, I kind of, on one hand, felt that, yes, you know, institutionalizing client relationships and diversifying the key contacts across different places in the organization is important and creating systems and CRMs and all of that great stuff to to to, you know, to to to de-risk, you know, this aspect is important. But on the other hand, you know, I think it’s really important, especially in technology services. Yeah, that you remember that you know, you’re in client service and and it is about relationships and you want, I think, as an owner and operator to advocate for deeper personal connections with clients and that that’s really, really important. And great relationships drive firm value to exactly and create more meaningful work for practitioners and more meaningful long term career relationships for practitioners. And so I think it’s another place where there’s nuance and balance and, you know, it’s a bit of art and science. It is to encourage and empower. This is closeness while doing it in a way that doesn’t lead to single points of failure. 

Sean Magennis [00:23:32] Yeah. And it’s a great risk mitigation strategy. And, you know, things like culture and, you know, the kind of environment that you set up and all of those things play in. Mike, this has been phenomenal. Your insights have really added to, you know, what we have found to be recommended practices. So this brings us to the end of the episode. Let’s try to help listeners apply this. I’ve prepared a 10 question yes, no checklist. And I ask our listeners, ask yourself these 10 questions. If you answer yes to eight or more of these questions, you can prove you have healthy client relationships. Mike’s graciously agreed to be our peer example today. So, Mike, just simply answer yes or no to each of these questions as I take you through them. 

Sean Magennis [00:24:18] So, number one, are your client relationships. This is nuanced, an asset on your balance sheet, or I’ll add in your mindset? 

Mike Stern [00:24:28] Not on our balance sheet, but yes, in our mind set fantastic. 

Sean Magennis [00:24:32] Number two, is this asset appreciating in value? 

Mike Stern [00:24:38] Yes. 

Sean Magennis [00:24:40] Do you have a diversified client base with no one client worth more than 10 percent of revenue? 

Mike Stern [00:24:47] We are on our way, but we’re not quite at 10 percent yet. 

Sean Magennis [00:24:52] But that’s I mean, I heard everything you said, that’s a goal and I commend you for it. That’s really key. Number four. Does the tenure of your client relationships exceed three years? 

Mike Stern [00:25:05] Yes, some of our best clients. Absolutely, and we hope that our current ones as well. 

Sean Magennis [00:25:13] Are your clients business stable? 

Mike Stern [00:25:18] Yes. 

Sean Magennis [00:25:19] Number six, are your clients end relationships stable, so are their clients stable? 

Mike Stern [00:25:25] Yes. 

Sean Magennis [00:25:26] Number seven, do you have account plans? 

Mike Stern [00:25:30] Yes. 

Sean Magennis [00:25:31] Number eight, have you institutionalized your client relationships into a customer relationship management system? 

Mike Stern [00:25:39] Yes. 

Sean Magennis [00:25:40] Number nine, the client relationships with the firm and not with the key employee? 

Mike Stern [00:25:48] They are with the firm and with the employees. 

Sean Magennis [00:25:52] Excellent answer. Number ten, will the billings from your client relationships stay when the key employee quits? 

Mike Stern [00:26:01] We would hope so. 

Sean Magennis [00:26:03] We would all hope so. So thank you. If you answered yes to eight or more of these questions, you’ve got an excellent client relationship. This will make you extremely attractive not only to hire employees to a potential buyer as well as to your clients. So client relationships are an asset. Like other assets, some relationships appreciate in value and others depreciate. Appreciating client relationships will increase the value of your firm. Depreciating client relationships will decrease the value of your firm. So when trying to build value and or exit for a great price, please bullet proof your client relationships. I cannot emphasize that enough. Mike, thank you for sharing your wisdom. It’s always great to be with you.

Thank you for being part of Collective 54 and for our listeners, if you enjoyed the show and want to learn more. Pick up a copy of the book The Boutique How to Start, Scale and Sell the professional services firm written by Collective 54 founder Greg Alexander.

And for more expert support, check out Collective 54, the first mastermind community for founders and leaders of boutique professional services firms. Collective 54 will help you grow, scale and exit your firm bigger and faster.

Go to Collective54.com to learn more.

Thank you for listening.