Episode 21: The Boutique: The Ultimate Measure of Productivity

Yield is the ultimate measure of productivity. In this episode, we discuss how professional services firms scale faster by thinking about different ways to improve yield. 

TRANSCRIPT

Sean Magennis [00:00:15] 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 yield is the ultimate measure of productivity. I’ll try to prove this theory by interviewing Greg Alexander, Capital 54’s founder and chief investment officer. Greg has helped owner’s scale faster by thinking about different ways to improve yield. Greg, good to see you and welcome.

Greg Alexander [00:01:03] Hey, pal. Good to be with you. Appears today we are going to discuss the most often looked at metric in all of professional services.

Sean Magennis [00:01:11] Yes, we are. Yes, we are. To begin. How about you provide us a working definition of yield?

Greg Alexander [00:01:18] Sure. So yield is simply the average fee per hour times the average utilization rate of the team. For example, if a boutiques average fee per hour is 400 dollars and the average utilization rate is 75 percent, then the yield is three hundred dollars per hour.

Sean Magennis [00:01:37] OK. That is really easy to understand. And why is it relevant to our audience, which consists of owners of professional services firms who are trying to scale beyond the lifestyle business?

Greg Alexander [00:01:49] Huh. So it is mission critical to those trying to scale. And here’s why. The typical boutique runs off an assumption of a 40 hour workweek and a 48 week year. This equates to 1972 hours per employee using our earlier example at 300 dollars per hour. The boutique will do five hundred seventy thousand dollars in revenue per employee. So a 100 person firm, let’s say, with this year will do fifty seven point six million in annual revenue. Understanding yield means you understand how much you can scale to. It establishes a ceiling and therefore it is so important for our listeners to understand.

Sean Magennis [00:02:32] Got it. So the suggestion to listeners then is to do the math and determine the scale ceiling. Let’s suppose we don’t like the answer. Greg, we want to scale past the ceiling. What can they do then?

Greg Alexander [00:02:45] Good question. And that is how we want all of our listeners to be thinking, how big can I get? Most boutiques can quote you their utilization rate from memory. This is a well tracked metric and it should be boutiques that have made it past the startup stage, have already optimized for the utilization rate. They would not have survived otherwise. Therefore, an improvement in utilization rate does not lead to scale. The point of diminishing returns has occurred unless, of course, you’re going to ask employees to work on Christmas Day. The scale owners need to turn to fees.

Sean Magennis [00:03:23] So, Greg, just before we jump to fees, let me make sure I recap what was just said. You contend that most firms, when trying to scale, have reached the point of diminishing returns on utilization rates. And you feel this way because there’s only so much juice to squeeze out of the 40 hour workweek and the 48 week year, is that correct?

Greg Alexander [00:03:43] Yes, it is. So have a look at the U.S. business calendar. It is tough to get more than forty eight weeks. Employees need a couple weeks vacation. There are sick days and there are dead periods, such as the week between Christmas and New Year’s and Thanksgiving week, etc.. It is easier to get more than a 40 hour week, especially in the work from home setting as a line between work and life had blurred. Many people routinely work 50 plus hours a week. But in my experience, most of these extra hours are non billable. So they did not move the revenue line that much.

Sean Magennis [00:04:18] Okay, so let’s assume the 1920 hours per employee assumption holds as there’s not much one can do to improve it. Now you say it’s time to turn to fees. Why is that?

Greg Alexander [00:04:31] Yes. So remember, this is an equation with only two variables utilization rate and dollars per hour. Owners of boutiques have more juice to squeeze out of the dollars per hour variable and impacting the dollars per hour variable is not as easy as raising prices.

Greg Alexander [00:04:48] Most boutiques are in competitive markets. The intense competition drives downward pressure on fees. So if this is true for our listeners, what can they do to impact dollars per hour? So key to scaling in this context is to figure out how to become more valuable to clients. Clients will pay more for boutiques that bring more value to them. This is because clients turn to boutiques for specialization. These clients have moved away from the huge generalist firms. They are willing to pay more for highly specialized expertise.

Sean Magennis [00:05:27] That makes total sense, Greg. So it appears the key to higher prices is more specialization. Can you give the audience some ideas on how to increase their specialization?

Greg Alexander [00:05:38] Sure. In my experience, there are five forms of specialization that translate to higher fees, and they are, so number one specializing by industry vertical. Number two, specializing by function. So I serve the CFO or I serve the CTO. Number three is specialize in by segment. So I call on large enterprises or I call on consumers or I call on small business owners, etc. Number four is specializing on problem. So cyber security risk is a problem and I specialize around that. Number five, I specialize in geography. So here we are in Dallas, Texas, and I serve clients in Dallas, Texas. So let me give you a hypothetical example of a highly specialized firm. Clients would pay a premium for a consulting firm that helps product managers and enterprise software companies in Silicon Valley move to the cloud. To notice the five forms of specialization, we had the industry software companies, we had the function product managers, we had the segment enterprise, we had the problem moved to the cloud and we had the geography Silicon Valley. This firm’s yield, if it existed, would be high because it could charge a lot more.

Sean Magennis [00:06:56] That’s an excellent illustrative example. Thank you, Greg. 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.

Tony Mirchandani [00:07:30] Hello. My name is Tony Mirchandani. I’m the owner of RTM engineering consultants. We’re a national engineering firm focused on the built environment. We provide civil, mechanical, electrical, plumbing and specialty services around the country. Our growth has come 50 percent through acquisitive growth and 50 percent through organic growth, as well as partnering with architects and developers. If there’s anything we can do for you, please feel free to reach out to me. I can be reached at [email protected]

Sean Magennis [00:08:04] 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. So this takes us to the end of this episode. And as is customary, we end each show with a tool. We do so because this allows a listener to apply the lessons to his or her firm. Our preferred tool is a checklist. And our style of checklist is a yes no questionnaire. We aim to keep it simple by asking only 10 questions. In this instance, if you answer yes to eight or more of these questions, you are running a tight ship with excellent yield. If you said no too many times, you have a yield problem. And this will be an impediment to scaling.

Sean Magennis [00:08:59] Let’s begin. Number one, are your average utilization rates above 85 percent? Number two, senior staff above 70 percent? Number three, mid-level staff above 80 percent? Number four, junior staff above 90 percent? Number five, are you average fees above 400 dollars per hour? Number six, senior staff above seven hundred and fifty dollars an hour? Mid-level staff above 500 dollars an hour? And number eight, junior staff above 250 dollars an hour? Number nine, are you assuming a forty eight week year and 40 hours per week? And number ten, are you distinguished from the generalist, with three to five forms of specialization?

Sean Magennis [00:10:19] In summary, yield is the ultimate measure of productivity for professional services firms. Watch out for the trap of over rotating to utilization rates and under-indexing the second variable in the equation, which is dollars per hour. Drive up your fees by becoming more valuable to your clients, by becoming hyper specialized. If you do so, the limit on your scale is the sky.

Sean Magennis [00:10:52] 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.

Episode 19: The Boutique: A Smart Strategy to Make Scaling Easier

A lack of lifecycle awareness and management prevents scale. It results in expensive senior people doing junior work. Boutiques with poor cash flow and low client satisfaction do not scale.

TRANSCRIPT

Sean Magennis [00:00:15] 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 boutiques often suffer from an identity crisis, and this makes scaling harder than it needs to be. I’ll try to prove this theory by interviewing Gregg Alexander, Capital 54’s founder and chief investment officer. Greg has developed an approach to solving this problem. It’s called lifecycle management. And I’d like him to share that with you. Greg, great to see you. Welcome.

Greg Alexander [00:01:09] Hey pal, good to be with you. I think it was Aristotle that once said when asked the key to happiness, know thyself. Today I’m going to modify this quote in state when asked the key to scaling know thy firm.

Sean Magennis [00:01:24] Excellent. So why do you feel boutiques need to know thyself when trying to scale?

Greg Alexander [00:01:31] Sometimes boutiques suffer from an identity crisis. They are unsure of the type of firm they are and the types of clients and projects they should pursue. This makes the challenge of scaling a boutique harder than it needs to be. You see, conflicting client needs drive, confusing staffing models, and this leads to overly complex financials. For instance, one month there is not enough work and employees are underutilized. And yet the next month the firm is at 120 percent capacity. These violent swings between boom and bust make it very hard to scale.

Sean Magennis [00:02:09] Yeah, I can see how this can make managing the boutique difficult and frustrating. So what advice do you have for listeners who might be suffering from this?

Greg Alexander [00:02:19] So the first step is to understand what type of firm you are, in my opinion. There are three types of firms. First, we have what we call an intellect firm. Intellect firm is hired by clients to solve difficult never before seen one of a kind problems. These firms are staffed by brilliant people, very senior, with lots of experience. An example might be a think tank or something like that where there’s P.H.D.’s everywhere. Second, we have what we call a wisdom firm, a wisdom firm decided by clients because they are a been there and done that style of firm. The client problem is new to that client, but is not a new problem. Others have had it and wisdom firms have accumulated the wisdom to solve this problem. These firms are staffed in a traditional sense. Partners, mid-level managers and some junior staff examples to think about from the consulting industry are firms like Bain and McKinsey and Boston Consulting Group. Third, we have what we call a method firm, a method firm hit hard by clients because of their unique methodologies. The problem is well understood by the client, but by hiring a method firm. It can be solved faster and a lot cheaper. These firms are staffed with lots and lots of junior staff who have been trained on this highly procedurized method. Examples are the BPO firms such as Accenture and the like.

Sean Magennis [00:03:59] Got it, Greg. So three types of firms, intellect, wisdom and method. But I’m I’m not connecting the dots as to how this understanding helps firms scale.

Greg Alexander [00:04:13] OK, so let me explain. So imagine you are in Method’s firm in one of your BD people sell an intellect like Project, a never before seen one of a kind problem. How will this project be staffed?

Greg Alexander [00:04:27] Well, it cannot be because a method firm does not have a bunch of gray haired P.H.D.’s lying around. This forces them to go outside the firm and either rent some contractors or hire some new talent. Both approaches come with different salaries and utilization rates, and this will blow up staffing in the financial models. Or let’s say imagine you are a wisdom firm and one of your BD guys goes after a method style project, one where the work can be off-shored or completed with junior staff. Well, in this instance, there will not be enough junior staff to do the work. So what happens? Senior expensive staff now must perform cheap junior level work. This destroys margins in the financial model.

Sean Magennis [00:05:10] Okay, now I get it. So the advice is to collect the type of client and the project to the type of firm you are. Only go off to work that the firm is staffed to handle based on skill level. By doing so, an owner, one of our listeners can predict the skills needed to perform the work. And with this understanding of required skills, the owner can forecast labor costs and utilization rates. And then, with precision on labor costs and utilization rates, the owner can more easily scale the firm. He or she can match the demand coming in with the supply on the org chart. Did I get this correct?

Greg Alexander [00:05:53] Yes, you did. You are about to ask me why owners do not do this. And the answer is because they lack discipline. They think all revenue is good revenue and they take any deal that comes their way when in fact some deals, if taken, can destroy a firm’s ability to scale. Adopting lifecycle management, which is what this is called, requires prudence to go without today for the promise of a better future. Greg, I get the concept, but I’m struggling a little to get the name. The lifecycle management. Can you explain it? Sure. So boutiques like humans have a lifecycle. For instance. They are born. They grow. They scale an exit much like a human is born. Comes of age, matures and dies.

Greg Alexander [00:06:50] And firms like humans are different based on where they are on the life curve. For example, is very common at birth, a firm is an intellect firm. The partners have some secret sauce to a brand new problem. Then as time passes, the secret sauce gets out.

Greg Alexander [00:07:10] Others have it and eventually it becomes a commodity. Well, an owner manages a firm very differently when it is an intellect firm than a wisdom or method firm. Everything is different from the pricing of deals to staffing, utilization, salaries, etc. So lifecycle management refers to the active management by the owner of the boutique as it scales through the lifecycle stages.

Sean Magennis [00:07:36] Okay, now I get it. And it does make a lot of sense. So this is an illustration as to why there are only about 4000 firms out of about one point five million that have actually reached scale. It’s hard to do. And it takes an exceptionally skilled owner to pull it off. 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.

Rich Campe [00:08:24] Hello. My name is Rich Campe. I’m the CEO of Pro Advisor Coach. We serve executive and leadership teams. We partner with organizations to create high performance team cultures of ownership and radical honesty. Our key is gamification. It’s about leverage versus effort. What if every player in your team knew if they were winning or losing both personally and as a team in 10 seconds or less? If you’re part of the collective 54 family, please reach out to me directly at 704-752-7760. Check us out at proadvisorcoach.com or [email protected]

Sean Magennis [00:09:05] 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. So this takes us to the end of this episode. And as is customary, we end each show with a tool. We do so because this allows the listener to apply the lessons to his or her firm. Our preferred tool is a checklist. And our style of checklist is a yes-no questionnaire. We aim to keep it simple. By asking only 10 questions in this instance, if you answer yes to questions one through three. You are an intellect firm. If you answer to questions, four to six, you are wisdom firm. And if you answer yes to seven to nine, you are a method firm. And lastly, if you answer yes to question, ten lifecycle management should be a top priority.

Sean Magennis [00:10:10] Let’s begin. Number one, do your clients hire you for never before seen problems? Number two, do you employ leading experts in the field? Number three, do you have legally protected intellectual property? Number four, do your clients hire you because you have solved their problem before? Number five, do your clients hire you because you have direct, relevant case studies? Number six, do your clients hire you because you help them avoid common mistakes? Number seven, do your clients hire you because they are busy and need an extra pair of hands? Number eight, do your clients hire you because you can get the work done quickly? Number nine, do your clients hire you because you have an army of trained people to deploy immediately? And number ten, does your service offering start out as leading edge and over time become a commodity?

Greg Alexander [00:11:26] OK, so just a quick recap there. So yes, to one through three, your intellect. Yes to four to six, you’re wisdom. Yes to seven and nine, your method. And then obviously, number ten is regarding lifestyle management. So does your service offering start out as leading edge and over time become a commodity? If you answer the questions that answer, that question is yes, then you should prioritize lifecycle management.

Sean Magennis [00:11:48] Great. Thank you, Greg. So in summary, a lack of lifecycle awareness can make scaling more difficult than it needs to be. It can lead to poor cash flow and unhappy clients and employees.

Sean Magennis [00:12:01] 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.

Episode 17: The Boutique: Where to Find the Cash to Scale

Boutiques run on cash. They do not run on net income nor EBITDA. Some boutiques neglect the management of cash flow. Take a moment to understand how you can improve the flow in and out. In this podcast episode, we look at where you can find cash flow when scaling a business.

TRANSCRIPT

Sean Magennis [00:00:15]: Welcome to the Boutique with Capital 54, a podcast for owners of professional services firms. This show aims  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 boutiques run on cash-flow. They do not run on net income or EBITA. I’ll try to prove this theory by interviewing Greg Alexander, Capital 54’s chief investment officer. Greg is an expert at helping firm owners boost cash flow. Greg, good to see you. Welcome.

Greg Alexander [00:01:03]: Hey. Good to be with you. Do you remember the movie Jerry Maguire and the famous line, show me the money? Let’s start with that. So on the count of three, let me hear your best “Show me the money.” Are you ready?. One, two, three.

Sean Magennis [00:01:19]: Show me the money.

Greg Alexander [00:01:24]: Awesome, you’re a great sport. I think we’re ready to begin.

Sean Magennis [00:01:27]: Yes, we are, funny enough. I just watched that again recently. It’s a great movie.

Why is Cash Flow So Important When Scaling a Business?

Sean Magennis [00:01:32]: Okay. So why is cash flow more important than net income and EBITDA for a firm trying to scale.

Greg Alexander [00:01:41]: Sure. And when I say casual, I mean simply cash coming in and going out of a professional services firm. And it is different than net income. Net income is a profit a firm makes for a period and is often calculated for tax purposes. Whereas cash flow comes from daily activities, and cash flow is also different from  EBITDA because EBITDA does not consider capital expenditures, which are most definitely cash outflows.

Greg Alexander [00:02:06]: As to why it is more important to boutiques trying to scale, its firms run on cash. They are scaling a business, which means they are pouring the cash back into the business. They would rather invest it than give it to the government or a potential acquirer.

Sean Magennis [00:02:22]: Completely understood. And it’s often said entrepreneurs often seriously mismanage cash flow. Do you agree with the statement? And if so, is it relevant to our listeners?

Greg Alexander [00:02:34]: Yes and yes. In my capacity as Chief Investment Officer at Capital 54, I see our listeners, a.k.a. owners of boutique service firms, trying to raise capital when they don’t need it. They think they need X amount of capital to scale when in fact, they’re often generating enough cash from operations to fund scaling.

Sean Magennis [00:02:57]: And Greg, why does this happen?

Greg Alexander [00:02:59]: This happens because sometimes owners do not know how to boost cash flow because they are not measuring it properly.

Sean Magennis [00:03:06]: Please explain that to our listeners.

How to Scale a Service Business: Ways to Boost Cash Flow

Greg Alexander [00:03:08]: The best way to find ways to boost cash flow is to measure it correctly, and  the best way to measure it is at the project level. Measuring cash flow in the aggregate hides waste. Here’s a recent example. My team recently performed due diligence on a public relations firm seeking to raise growth capital, and they used the following formula. I wish I was on a whiteboard but bear with me here audio audience. 

So cash flow per project equals cash flow divided by fees times fees divided by staff times, and staff divided by project. This revealed a healthy six hundred and fifty thousand dollars per project in this instance. This told me the firm was generating plenty of cash to fund it’s  aggressive expansion plan. Yet they were on a Zoom with me looking to raise money, claiming they did not have enough cash. I’m not sure where the cash was leaking, but it was leaking like an old faucet.

Sean Magennis [00:04:14]: And Greg, the point is to measure cash flow at the project level, not at the firm level.

Greg Alexander [00:04:19]: Yes, exactly.

Sean Magennis [00:04:23]: And now a word from our sponsor. Collective 54 is a membership organization for owners of professional services firms. Members join our mastermind group 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.

Nish Parikh [00:04:49]: Hello. My name is Nish Parikh. I owned Rangam Consultants, where empathy drives innovation every single day. We serve Fortune Global 500 companies for their I.T. and all business professional leads. We serve customers in the United States, Canada, Ireland, UK, and India. 

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We build a formal, structured, and scalable program that seamlessly integrates with our clients’ existing hiring practices. If you need help with your disability and autism hiring program, reach out to me at [email protected] or visit sourceabled.com.

Sean Magennis [00:05:53]: 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 Collective 54 community page. .

Sean Magennis [00:06:10]: So this takes us to the end of this episode, and as is customary, we end each show with a tool. We do so because this allows a listener to apply the lessons to his or her professional services firm. 

Our preferred tool is a checklist. And our style of checklist is a yes-no questionnaire. We aim to keep it simple by asking only ten questions. In this instance, if you answer yes to eight or more of these questions, your cash flow is not your obstacle to scaling a business. If you answered no a lot, you are not generating enough cash to scale.

Sean Magennis [00:06:48]: So let’s begin. Question number one, will you run out of working capital if you double the size of your firm?

Greg Alexander [00:06:56]: So this happens all the time. You go sign up a bunch of work. You got net 30 terms, which means they pay net 60, and you’re literally growing yourself out of business.

Sean Magennis [00:07:07]: Yep. Got it. Number two, will you need short-term debt if you double your firm?

Greg Alexander [00:07:12]: So, in that instance, now you’re borrowing money just to make payroll.

Sean Magennis [00:07:18]: Number three, will you develop a collections problem if you double your firm.

Greg Alexander [00:07:24]: Here we go.

Sean Magennis [00:07:24]: You said it, right?

Greg Alexander [00:07:24]: Right. So all of a sudden, now you’re, instead of selling projects, you are  chasing bills.

Sean Magennis [00:07:28]: Yep. Number four, will your cash payments exceed your cash income if you double your firm?

Greg Alexander [00:07:36]: Payroll is going to kill you there. Right.

Sean Magennis [00:07:38]: Right. Number five, will you have a hard time getting enough cash on the balance sheet to double your firm?

Greg Alexander [00:07:45]: Right. So the way to handle that, if you’re going to have this cash flow problem, meaning you get paid after you do the work instead of before the work, is you get to build up cash reserves on your balance sheet to carry you through those times.

Sean Magennis [00:07:58]: Number six, when growth has spiked in the past, did your cash flow ever turn negative?

Greg Alexander [00:08:05]: Yep.

Sean Magennis [00:08:06]: Number seven, will payroll growth exceed accounts receivable growth when you double your boutique? 

Greg Alexander [00:08:13]: Yep.

Sean Magennis [00:08:14]: Number eight, will cash flow problems be hidden due to lack of forward visibility?

Greg Alexander [00:08:20]: That happens all the time.

Sean Magennis [00:08:22]: Number nine, will it be hard to generate yield on your cash deposits? Specifically in today’s day and age.

Greg Alexander [00:08:30]: Yes, exactly.

Sean Magennis [00:08:31]: And number ten, will you be at risk of paying your future obligations if you double your firm?

Greg Alexander [00:08:37]: Right. So, I mean, literally, if you think about it, if you’re one of these high growth businesses, which is our listeners, you can grow yourself into a lot of cash flow problems. So you got to be aware of that by asking yourself these ten questions. And there’s so many easy fixes here.

Sean Magennis [00:08:54]: Yes.

Greg Alexander [00:08:54]: And that’s probably content for another episode. But the easiest one just to give you the silver bullet is to get paid in advance. If you get paid in advance, you don’t have these issues.

Sean Magennis [00:09:04]: Love it. So, in summary, boutiques run on cash. They do not run on net income or EBITDA. Do not run out of cash as you try to scale.

Sean Magennis [00:09:16]: 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.” Greg, thanks for being here. I’m Sean Magennis, and thank you, our listeners.

Episode 15: The Boutique: How to Work Less and Make More!

Boutique firms often grow but do not scale. Growth means more projects delivered with the same type of staff. If nothing changes, then the growth rate is proportional to the number of partner/owners required.

TRANSCRIPT

Various Speakers [00:00:01] You can avoid these landmines. It’s a buy versus build conversation. What’s the root cause of that mistake? Very moved by your story. Dive all in on the next chapter in life.

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 sometimes boutiques grow but do not scale. I’ll try to prove this counter-intuitive theory by interviewing Greg Alexander, Capital 54’s founder and chief investment officer. Greg is an expert at helping boutique owners avoid the growth trap. Greg, great to see you as always, and welcome.

Greg Alexander [00:01:03] Hey, pal. Good to be with you. Let’s kick some “you know what” today. Too many boutique owners are growing but are not making more money in the process and I’m tired of this crap. These entrepreneurs should be properly rewarded. So let’s put an end to this nonsense.

Sean Magennis [00:01:14] Absolutely. I can see. Greg, you’re ready to go, you’re passionate about this topic. I love it. So where do you want to dive in?

Greg Alexander [00:01:21] Sorry, I can get carried away because I truly give a shit about our tribe.

Sean Magennis [00:01:25] Absolutely. I know you do as I do and how about we start with why this is happening?

Greg Alexander [00:01:31] Okay. So understand why this is happening is easy. If revenue growth and headcount growth are proportional, the owner does not increase his or her income with growth. It’s not until headcount growth is decoupled from revenue growth, does an owner grow his income.

Sean Magennis [00:01:45] You know, this makes sense as the top expense by a wide margin for a professional services firm, as you and I and our listeners know, is labor. So more headcount means more expense and less income. But as a firm takes on more work, don’t they need more heads to complete it?

Greg Alexander [00:02:03] Yes, but what type of heads and at what cost? So lazy boutique owners just do more of the same. However, the owners capable of scale do not. They re-engineer how they deliver the service so that it takes a few heads to deliver or less expensive heads to deliver. This is known as creating leverage.

Sean Magennis [00:02:26] So what is leverage in this context? And is there in fact a way to measure it?

Greg Alexander [00:02:32] There is a definition in a metric that measures it well called the leverage ratio. So allow me to explain the definition of leverage. Is the number of employees to owners. An example of how to calculate their leverage ratio as a firm with 30 employees and three owners has a leverage ratio of 10 to one. The higher the leverage ratio, the more money the owner makes. Why is this? A profit pool divided up by three people is better than a profit pool divided up by 10 people. This makes sense, Greg, but it begs the question, how does an owner increase the leverage ratio? This is the million dollar question. So it comes down to the type of work the boutique performs as this drives the type of employees they need to hire and how many of them they need. For instance, if the work requires a high skill level, the leverage ratio will be small. It is very difficult to proceduralize this type of work, which means junior staff cannot handle it. This type of firm is likely to have lots of senior people who all want to be partners with ownership stakes. In contrast, if the work is routine, junior staff can perform it. In this instance, leverage will be very high as the org will be filled with an army of junior staff and few partners.

Greg Alexander [00:03:57] This brings us to the root cause of the big issue. Owners often have expensive senior staff performing junior grade work. This destroys profitability and the owner’s income.

Sean Magennis [00:04:11] This is an aha moment for many. So what is the fix for this Greg?

Greg Alexander [00:04:17] So the fix is to proceduralize as much of the work as possible and then to have the discipline to only go after that type of work. Revenue outside of this scope gets turned away. This allows owners to push out expensive senior staff and their owners compensation requirements and replace them with junior staff capable of doing the work at a fraction of the cost. This is what pushes up the leverage ratio. And this is what allows an owner to make more money and more money as the firm grows.

Sean Magennis [00:04:55] So, Greg, this idea of leverage. It’s not new. It’s been around for a long time. This means the solution to this problem is readily available. Why is it owners keep making this mistake?

Greg Alexander [00:05:08] Human nature. Us Americans in particular pride ourselves on working hard. We equate long hours with strong character, and this mentality needs to be replaced with a work smarter, not harder mentality. If our listeners adopt the concept of leverage, they will work less and make more.

Sean Magennis [00:05:32] But that is a spectacular goal. So achieve our financial goals and have a life as well.

Sean Magennis [00:05:42] 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 cell phones at the right time for the right price and on the right terms. Let us meet one of the collective 54 members.

Mike Snyder [00:06:08] Hey there. My name is Mike Snyder. I own RSM Marketing Services in Kansas City and Wichita. We serve marketing frustrated, growth oriented principles for middle market firms across all categories nationally. These clients turn to us when they feel the need to pivot, do something remarkably different to get their company moving in strategic marketing with great online execution. We solve this problem by providing an outsourced marketing department where clients receive a fractional marketing director and all the marketing services they need for a flat monthly subscription. If you want to please the robot’s impact humans and delight your CFO, reach out to me at rsmconnect.com or email [email protected]

Sean Magennis [00:06:58] 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] Excellent. So this takes us to the end of this episode. And as is customary, we end each show with a tool. We do so because this allows a listener to apply the lessons to his or her firm. Our preferred tool is a checklist. And our style of checklist is a yes-no questionnaire. We aim to keep it simple by asking only 10 questions. In this instance, if you answer yes to eight or more of these questions on leverage or lack thereof is not preventing you from scale.

Sean Magennis [00:07:48] If you answer no, too often, poor leverage might be the reason growth is not equating to personal income. Let’s begin. Question number one, is your leverage of employee to owner at least 10 to one? Number two, is the proper mix of junior, middle and senior staff clear to you? Number three, do you understand the skills mix of a project before you sign it? Number four, do you understand which revenue is good and which is bad? Number five, do you have a zero tolerance policy for one off projects? Number six, do the owners work on the business instead of in the business? Number seven, do your service offerings come with procedure manuals for the staff? Number eight, do you assign work to teams strategically versus reactionary? Number nine, does your hiring plan forecast demand for a specific leverage ratio? And number ten, do your financial goals match up with the leverage ratio assumptions in your business plan?

Sean Magennis [00:09:23] In summary, scaling means working less and making more. It does not mean just growing. If you want to earn what you are worth, decouple revenue growth and headcount growth, the definition of success is not the number of employees you have, but rather it is how much net income you produce.

Sean Magennis [00:09:48] 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.

 

 

Episode 13: The Boutique: A DIY Approach to Raising Growth Capital

Scaling a boutique takes money. This type of money is called scale capital. There are three primary sources of scale capital. Each has a set of advantages and disadvantages. Which is best for you is highly situational.

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TRANSCRIPT

Sean Magennis [00:00:15] 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 to scale your firm requires capital, and that not all capital is the same. I’ll try to prove this theory by interviewing Greg Alexander, Capital 54’s founder and chief investment officer. Greg has been on both sides of this. While the owner-operator of consulting firm SBI, he raised capital and as chief investment officer of Capital 54, he invest capital into boutiques like yours. This makes him uniquely qualified to help boutique owners think through the need for capital during your scale stage. Greg, great to see you, and welcome.

Greg Alexander [00:01:25] Hey, pal. Good to be with you. I’m looking forward to our discussion today. By the end of the show, we will be reminded that it takes money to make money.

Sean Magennis [00:01:34] It sure does Greg, why don’t we start right there? Why do firms need capital when trying to scale?

Greg Alexander [00:01:41] So scaling usually means entering new markets, launching new service lines, adding more headcount and many other strategic initiatives. And these things take money.

Sean Magennis [00:01:52] Yes, I agree. And at the top of the show, I suggested that not all capital is the same. What sources of capital are available to boutique owners during the scale stage?

Greg Alexander [00:02:05] These days, capital is abundant and there are many kinds. You only have 10 minutes or so, therefore I would focus on a do it yourself approach, which has three types of capital. First, there is free cash flow from operations. This comes from increasing revenue and driving down costs using the spread to scale. I mean, why give it to the government in taxes. Number two is debt. It comes from banks and private lenders. There is a way to do this without mortgaging your soul. And third, we have equity partners. This is when an investor puts in cash in exchange for a piece of the action. Watch out for predators. But the right equity partner can add a lot in addition to capital.

Sean Magennis [00:02:52] This is simple enough. But what are the pros and cons of each of those?

Greg Alexander [00:02:58] Well, free cash flow from operations is the best. The reason this is the best is because it’s cheap and in unlimited supply for well-run boutiques scaling with free cash flow. Preserve the preserves the owners equity. It does not add a debt service burden to the peno in the best of the best boutiques. Know how to allocate intelligently, which acts as a flywheel throwing off more and more of this free cash flow. There are some disadvantages to relying on free cash flow to scale.

Greg Alexander [00:03:34] For instance, instead of putting the free cash back into the business to fund scale, many owners pull it out of the business and pay themselves. This retards growth and adds years to the firm’s timeline toward an eventual exit. This is a difficult temptation to resist. Debt is the next best alternative to free cash flow. In my view, it is not cheap, but it is reasonable as lenders charge modest rates and loans to boutiques and it is also readily available in the two to three times, even arrange the negatives to debt are obvious. But let me quickly point them out. It does add an expense to the PNL as a loan payments need to be made. This will reduce the owner’s income. However, it does preserve the owner’s equity. So this can balance out over time. Unfortunately, young firms cannot secure it unless they personally guaranteed a loan. In some cases, this still does not work because the owner’s personal assets are not enough to act as collateral. Lastly, there is taking on an equity partner. This is cheap in the short term, but expensive in the long term. There is no loan payment to be made, meaning more cash is available. However, the owners stake in the firm is diluted as the equity partner is taking a piece of the business. And when an owner of a boutique sells, the equity partner gets his piece of the pie.

Greg Alexander [00:05:08] And one more thing. It is difficult for a processor firm to attract an equity investor. Many equity investors simply do not invest in people driven businesses. So it is in short supply. But that was a lot. Let me stop talking here.

Sean Magennis [00:05:24] Greg, this is excellent. How about sharing a little from your personal journey to to make sense of this?

Greg Alexander [00:05:31] Sure. So my firm, SBI, used free cash flow from operations as its source of scale capital. In retrospect, this was a mistake. It took 11 years to start scale and sell my firm. If I had taken on some debt, I think I could have cut this time in half. We were able to deploy capital effectively. Each investment resulted in more clients and each initiative resulted in lower costs. More capital would have resulted in even more clients and even lower costs. During my run, the cost of debt was much lower than the return we were generating. I will say, however, I am grateful I did not take on an equity partner. We were able to sell for nine figures. If I had taken on an equity partner, my share of the price would have been much less and I would have had sellers regret.

Sean Magennis [00:06:26] That’s a great personal example Greg. Thank you for bringing this to life. Well, I can’t think of a more important strategic decision for our listeners to get right. This one comes with very high stakes.

Sean Magennis [00:06:43] 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.

Matt Rosen [00:07:09] Hello. My name is Matt Rosen and I’m the founder and CEO of Allata. Allata serves large enterprise clients in the financial services, healthcare, retail distribution and professional services spaces. Our clients are centered around our offices in Dallas, Phoenix, Provo and Boise. Clients like the Frieman companies and brinks some security turn to us for help with strategic initiatives in the business and digital transformation space, typically creating new revenue streams, building seamless customer experiences and streamlining operations. We help with these initiatives by building digital strategies and roadmaps, assisting with enterprise architecture and design, working with data as an asset and customer, developing solutions which help our clients reach their strategic objectives. If you ever need help with digital strategy data and customer development initiatives, please reach out to me at www.allata.com Or [email protected] Thank you.

Sean Magennis [00:07:57] 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 [00:08:13] So this takes us to the end of this episode. And as is customary, we end each show with a tool. We do so because this allows the listener to apply the lessons to his or her firm, our preferred tool as a checklist. And our style of checklist is a yes, no questionnaire. We aim to keep it simple by asking only 10 questions. In this instance, if you answer yes to eight or more of these questions, all three of these capital sources are available to you. If you want to know to questions one to three, do not pursue funding scale with free cash flow. If you answer no to questions, four through nine do not rely on debt to fund scale. If you answer no question, 10 do not take on an equity partner. Get it, Greg?

Greg Alexander [00:09:06] I got it.

Sean Magennis [00:09:07] So let’s begin. Number one, are you generating enough free cash flow to fund scale? Number two, do you know where to deploy this extra free cash flow? Number three, are you willing to go without today for scale, tomorrow? Number four, have you been in business for at least five years? Number five, are you generating stable EBITDA every year? Number six, Would two to three times EBITDA be enough to fund scaling your firm? Number seven, can your PNL handled a debt service burden of a loan? Number eight, are you willing to personally guarantee a loan? Number nine, do you have enough personal assets to secure the loan, if you’re open to a guarantee? And number ten, are you willing to dilute your ownership take for the right equity partner?

Sean Magennis [00:10:26] In summary, it takes money to make money. Scaling a boutique takes money. There are different funding sources, each with their own pros and cons, all work well. Which is best for you is highly situational. Take your time to consider this very important strategic decision.

Sean Magennis [00:10:51] 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.

Episode 3: How to Prove Your Firm is Not a Body Shop

How to position your firm in its marketplace is strategically important. Learn how to position yourself well in your market which is a critical way to determine the strength of your value proposition.

In Episode 3 of The Boutique, Sean and Greg talk how to position your firm in its marketplace is strategically important. Learn how to position yourself well in your market which is a critical way to determine the strength of your value proposition.

 

TRANSCRIPT

Various Speakers [00:00:01] You can avoid these landmines. It’s a buy versus build conversation. What’s the root cause of that mistake? Very moved by your story. Dive all in on the next chapter of your life.

Sean Magennis [00:00:16] Welcome to the Boutique with Capital 54, our 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 the position of your firm in its marketplace is strategically important.

I’ll try to prove this theory by interviewing Greg Alexander, Capital 54’s chief investment officer. Greg is an expert in identifying a market position and in helping firms take actions to achieve this position. An acquirer of your firm will find your boutique attractive if you are positioned well in your market. Market position is a way to determine the strength of your own value proposition. A strong market position can indicate excellent competitive positioning. So, Greg, what is
the first step in establishing the most attractive marketing position one can get for your firm?

Greg Alexander [00:01:36] You know, I think it’s important to underline something that you said there, which is market position is a way to determine the strength of your value prop. So that’s what we’re really after here is the strength of your value proposition. So with that as a grounding. Right. The first step is to think like an investor and ask this
question. How will a potential, potential buyer of my firm measure the strength of our value proposition otherwise said measure our position in the market? So there are some obvious ways to measure the strength of your value problem. So, for instance, fee level in fee volume are two basics in any due diligence process. A fee level below, let’s say 250 bucks an hour, will suggest that your body shop. Body shops, if they sell, typically do so for a very low price and on very unattractive terms, you don’t want to be a body shop. A fee level, let’s say 500 bucks an hour will suggest that you have monetize real intellectual property. You’re not selling time. You’re not selling arms and legs. Instead, you’re selling knowledge and skills. So firms such as this are capable of selling and when they do sell, they do so at a premium price. Fee volume, on the other hand, indicates market position by suggesting the size of the overall market. So, for example let’s say you’re doing 50 million dollars a year. So that’s fee volume is 50 million a year, suggests a large market opportunity. Now, why is that? It’s understood that boutiques are not the market leaders. They’re the emerging market leaders and they typically penetrate their markets at, let’s say, somewhere between one and ten percent. So in this example, if you’re doing 50 million dollars a year in fee volume, that suggests that you’re working in a market opportunity that’s greater than five hundred million dollars and could be quite a bit larger than that and buyers of firms want to buy firms that are high growth, but that also still have a lot of runway in front of them. So when they’re thinking about their position that you’re boutique has in its market relative to the competitors and they’re trying to understand the strength of your value proposition. Some of these basics, like fee level and fee volume, are ways to prove that you’re not a body shop.

 

 

Sean Magennis [00:04:07] Got it, Greg. And obviously that runway comment is vitally important to have lots of runway ahead of you. So how about some suggestions beyond the basics, such as fee level and fee volume? What else what else is there, Greg?

Greg Alexander [00:04:20] Sure. So savvy acquirers are going to consider more precise indicators of your market position. So an example that might be client return on investment and this is often overlooked in it’s absolutely critical. You know, the slang term for this is client ROI. So boutiques that can scale to market leaders can prove their worth to clients. So what’s a simple way to illustrate this? Let’s say a client buys a service for half a million dollars and the realized benefit from that project is, let’s say, five million. So this is a 10 times return on fee. That’s a clear client ROI and if you’re a firm that can prove that you’re gonna be very attractive to a buyer. That’s a savvy buyer looking at the strength of your value proposition. Is there a clear before and after result? In contrast, let’s say that a client buys a service for half a million and it’s realized benefit is something subjective, such as
well trained employees. That’s poor client ROI. Well trained employees are at benefit from the project for sure, but it’s not quantified and it’s not in relation to the cost of the project. So these boutiques are likely not to become market leaders and a savvy acquirer is gonna know that. Another way that investors measure a boutiques market position is call point.

So what does that mean? So call point refers to the title of the person buying your service. For instance, if board members are buying your service, that’s a high call point. If the CEO or the CEO’s direct reports of buying your service, that’s a high call point. However, if your call if your call point title is like a director or manager, that’s considered by investors to be a low call point and firms with low call points have a hard time scaling. This is, that’s because they’re really selling a service that’s not worthy of an executive’s time to solving a problem an executive has delegated to junior staff and this indicates that the boutiques
service is not as, not that important to clients and that’s going to make it very hard for a boutique to scale. And investors are looking for high growth firms that have lots of runway in front of them and they can scale and one way to assess that is who do you call on? Who buys your service? And maybe one more just off the top of my mind is cycle resiliency. This is particularly important as we record this. The world is suffering from COVID-19.

Sean Magennis [00:07:00] Yes.

Greg Alexander [00:07:01] And a cycle resiliency is often considered by acquirer’s as an indicator of market position or the strength of your value prop and this cycle resiliency refers to having a boutique perform in periods of recession. Recessionary periods cause clients to cut most all non-essential budgets and unfortunately, this can include discretionary budgets that many boutiques rely on. Firms that see steep declines in financial performance during recession, that have poor market position and those that do well and maybe even expand during a recession have very strong valued propositions and it’s those boutiques and have the best chance of selling their firm’s.

Sean Magennis [00:07:48] Outstanding points Greg, and lot to unpack and think about here. So client ROI call point and cycle resiliency. These are all great market proof points. Greg, when you sold your firm SBI, how did you demonstrate to the buyer that you had a really strong market position?

Greg Alexander [00:08:12] Yeah, so in my case, the strength of our value proposition and our position in the market was obvious. Our acquirer evaluated us through the lens of each of those attributes and we we happen to show really well in each category. However, we probably shined brightest when it came to cycle resiliency and in fact, I can I can tell you with clarity that that actually drove the purchase price. In fact, our purchaser paid more for our firm because of how well we did during recessions and just some quick history for those that don’t know my personal story. I found in my firm sales benchmark index in 2006
and many fragile young firms were wiped out during the great financial crisis of 2008 through, let’s say, 2010. Yet we pushed right through this period with no problems and looking back, it’s really remarkable to say that and it’s in it’s a testament to the great employees that we had there and the loyal clients that we had. You know, SBI was only three years old when the world fell apart and we were selling a discretionary item that was easily cut by clients during those brutal times but our clients didn’t cut our services. In fact, just the opposite. They added to that and our revenue and profit growth really accelerated during the Great Recession and on a peer to peer comparison basis, we were growing at roughly twice the rate of our peers during that part, period and after the deal closed, you know, the acquirer’s mentioned to us that, you know, that really struck them as to how strong our market position was and it gave them great confidence to pay a premium for our service because they felt that if we made it through the Great Recession, if another recession hit, we were likely to make it through it again and as I understand it, the firm is
doing really well during COVID-19 so that that, you know, proved out. So cycle resiliency was a big deal for us.

Sean Magennis [00:10:14] Thank you Greg, and what a great set of examples and a testament to you and your team and obviously what I’m hearing too is your loyal customers really profound. So listeners, as you can see, market position is really important to potential acquirers. It tells them whether you have a compelling value proposition. It also tells them are you a position relative to your competitors.

Sean Magennis [00:10:43] We will be right back after a word from our sponsor. Now, let’s turn the spotlight on Collective 54 members who are making an impact in the professional services field, Collective 54 is the only national peer advisory network for owners of professional services firms who are focused exclusively on growing, scaling and maximizing business valuation. Today, we have the pleasure of introducing you to an exceptional person. Joe Gagnon, he’s CEO of Performance Tea, where his mission is to help people achieve their potential.

Joe Gagnon [00:11:23] Hi, I’m Joe Gagnon, the CEO and co-founder of Performance Tea. I see myself as an adventurer, entrepreneur and innovator. I’m the author of Living the High-Performance Life, an Ordinary Joe’s Guide to the Extraordinary. I’m a multi-time turnaround CEO and founder of the High Performance Life, a philosophy regarding techniques for mental toughness, Creative Problem-Solving leadership and personal effectiveness. As an advisory board member, I provide expertise in growth strategies to emerging companies. I’m an avid blogger and passionate endurance athlete, having completed 75 marathons and ultra races and in 2017 I ran a marathon on six continents on six consecutive days.

Sean Magennis [00:12:11] Get to know Joe and other business owners who are leading innovation in the professional services industry by visiting Collective54.com. Learn more about how Collective 54 can help you accelerate your success.

Sean Magennis [00:12:31] Greg, here we go again with our top 10 checklist. Greg Alexander [00:12:34] Drumrolls.

Sean Magennis [00:12:35] Drumroll. In an effort to provide you immediate value, I prepared again 10 questions on a yes no checklist. Please ask yourself these 10 questions.

Sean Magennis [00:12:48] Number one. Is your average fee level above five hundred dollars per hour? Question number two, if not, can you prove that you are not a body shop. Number three, is your fee volume big enough to prove that you are in a large market? Number four, if not, can you prove that you are in a large and growing market with a lot of runway ahead of you. Number five, do you have a clear client return on investment? Number six, if not, can you prove that your clients realize a good cost benefit tradeoff? Number seven, do you call on the board of directors of your target client? Number eight, do you call on the CEO of your target client? Number nine, did your financial performance hold up well during the last recession? And number 10, can you prove to a potential acquirer that your boutique is cycle resilient? If you answered yes to eight or more of these questions, you occupy a really strong position in your market. If you answered no to eight or more of these questions, you have a weak market position. It would be wise to hold off on your sales process until this is addressed. Acquirer’s want to buy firms with validated market positions. This reduces their risk and increases their upside. There are many ways for a market position to be evaluated. Please be sure that your case is bulletproof.

Sean Magennis [00:15:00] If you enjoyed the show and want to learn more, pick up a copy of Greg Alexander’s book entitled, The Boutique How to Start Scale and Sell the Professional Services Firm.

Sean Magennis [00:15:14] I’m Sean Magennis. Thank you for listening.