How Much Is Your Firm Worth?

How Much Is Your Firm Worth?

Members of Collective 54 are searching for one of three things for their professional services firm: growth, scale, or exit. From our members, we realized that knowing when to exit is daunting if you don’t know how to value a professional services firm. But this doesn’t just apply to exiters. If you’re hoping to exit one day, you need to know what your firm is worth now, how much you want it to be worth in the future, and what you need to do to go from point A to point B.

This sparked the idea for the Firm Estimator, which was launched in December 2022. Since then, over three thousand founders of professional service firms have accessed it from our website. The impact of the tool has exceeded expectations. For example, we had a member of Collective 54 use the tool to value his firm so he could price an equity incentive for a key executive on his team. This member claims the tool provided him with a more accurate estimate of his firm than a local appraisal firm did. Our estimate was calculated in 20 minutes and was free; the appraisal firm took 30 days and charged $15k.

The Collective 54 membership is made up exclusively of first-time founders of boutique professional service firms. These are consulting firms, marketing agencies, systems integrators, software development firms, legal services, accounting firms, architects, etc., in North America with between 10-250 employees. Practically all of these leaders have never been through an exit before and, therefore, do not know how to go about valuing a professional services firm. They’ve never needed to know before and are surprised that 10 questions can get to an accurate estimate. But it does because it’s designed specifically for professional service firms, asking questions about what really drives a firm’s worth. The Firm Estimator provides data within +/- 10% accuracy on average to date. Meaning we may estimate a firm to be worth $5 million, and it sells for $5.5 million.

So, the most common question is, “How the heck are you guys doing this?”

The answer is straightforward: We see a lot of deals.

Valuing Professional Service Firms With Data Backed by Real Deals

Two dozen members of Collective 54 have sold their firms in the last three years, totaling close to $1.5 billion, and we had a ringside seat for each deal. Another 37 members tried to sell their firms but failed to do so, and we bore witness to these negotiations. In addition, some of the members of Collective 54 are M&A advisors and investment bankers who represent boutique professional service firms and share their knowledge with us. We have a lot of data points, and the data set is growing every month as more M&A activity takes place.

Most importantly, Collective 54’s singular focus on a tight niche—thriving boutique pro serv firms in North America—has created maybe the most accurate and reliable data in the market. This is very helpful to founders who may be wondering what their firm is worth.

For instance, some of our members are approached by potential acquirers. These acquirers will ask, “At what price would you sell your firm?” Founders don’t want to say the wrong thing and shoot themselves in the foot. If they don’t answer the question, the opportunity does not go anywhere. If they give an answer that is too low, they leave money on the table. If they give an answer that is too high, they scare away a potential acquirer. Yet, if they answer the question directly with a price range and can intelligently explain how the number was determined, the potential acquirer knows they are dealing with a capable founder and their interest increases.

This is where Collective 54’s focus on pro serv firms in North America becomes especially important. With the data being sourced from this single industry and segment, the Firm Estimator provides an accurate estimate. No money is left on the table because you accidentally lowballed years of hard work with an estimate that was designed for a different industry.

Listen to how one member leveraged Collective 54 when selling his firm.

The Magic Behind the Curtain

There’s no need to simply take our word for it. You’re a founder, and you work with hard facts. So, the following are the variables in the algorithm, why they are important, and a little bit of how they work:

1. Total EBITDA. 

An EBITDA business valuation-based calculator is important because pro serv firms are most often valued on a multiple of EBITDA. For instance, a firm with $3 million in EBITDA might be valued at $30 million if an acquirer puts a 10x multiple on the EBITDA. Total EBITDA provides a starting point for the valuation.

2. Revenue growth rate. 

Fast-growing firms are worth more than slow-growing firms. For instance, a consulting firm growing at 30% is worth more than a similar firm growing at 10%. This makes sense from an acquirer’s perspective, as they want to participate in this growth, and are willing to pay up for it.

3. Profit margin. 

Firms with healthy margins will have a higher valuation than firms with skinny margins. For instance, a systems integrator with 40% margins is worth more than a similar firm with 15% margins.

4. Recurring revenue.

Firms with recurring revenue are valued higher than firms with project-based revenue. For example, a market research firm with 80% of its revenue from subscriptions is worth more than a consulting firm with 100% of its revenue from non-recurring projects. Lumpy businesses with limited forward visibility are more risky than recurring revenue businesses, and thus are valued less.

5. Client concentration. 

Firms that have a diversified client base are worth more than a firm with a small number of clients generating the majority of revenue and profits. If one of those key clients leaves suddenly, a large portion of revenue is lost, but the diversified client base barely bats an eye losing just one customer.

6. Client tenure. 

Clients that stay with you for years suggest you have high client satisfaction and lots of demand for your services. Therefore, firms with client tenure measured in years are worth more than firms with client tenure measured in weeks or months.

7. Employee tenure. 

Turnover makes it very hard to scale a pro serv firm. Therefore, firms with low but healthy employee turnover are worth more than firms with high and unhealthy employee turnover.

8. Founder dependence in sales. 

Firms that depend on their founder to bring in clients and grow revenue are worth less than firms that have revenue being generated by multiple people. An over-dependence on a founder makes a firm risky and, therefore, not worth much.

9. Founder dependence in delivery. 

Firms that depend on a brilliant founder to deliver work are worth less than firms that have many employees delivering for clients. An over-dependence on a founder, in this case in delivery, is risky and therefore gets discounted.

10. Founder age. 

Firms run by older founders are worth less than firms run by younger founders. Why? Acquirers are buying the future, not the past. They want to know the person they are backing has a lot of runway in front of them. If the founder is older, s/he must have a fantastic successor ready to take over.

The reason these variables are included in the Firm Estimator is because they affect two things: Does a deal close and what price does the deal close for? There are other variables, such as the market the firm is in, the service it offers, the client roster, etc., but the other variables are inputs into these key 10 items. By themselves, they are irrelevant. For instance, a firm could have a gold-plated client roster, but if they are not generating high profits, no one cares.

Valuing a Professional Services Firm Isn’t Just for Exiting

There is an additional benefit to using the tool beyond determining what a firm is worth. Long before a founder might want to sell their firm, they should be managing the firm in such a way that increases its valuation. We all exit someday. We die and cannot run our firms from the afterlife.

When that time comes, you want to maximize the value of the firm, and some of these items take a while to address. For example, many boutique pro serv firms have high revenue concentration. A handful of clients represent most of the revenue and profits. This takes time to fix. Expanding a client roster to eliminate revenue concentration does not happen with the flip of a switch. Yet, some founders do not address this issue until it is too late—when they want to sell. And this can result in a failed exit attempt or a heavily discounted sale. This is unfortunate and avoidable. By using the Firm Estimator periodically, founders can keep themselves focused on what matters most—the items that drive valuation.

There has been a surprising use case worth mentioning. Inside Collective 54, there is a type of member referred to as a power member. The distinguishing characteristic of power members is that their businesses are outperforming conventional members by as much as 2x. These members behave differently in almost everything they do, and this now includes their use of the Firm Estimator. For example, power members use the Firm Estimator regularly, whereas conventional members use it once. When asked, power members claim that they want to chart the quarterly change in the estimated value of the firm over time. This empowers them to see how their efforts are affecting wealth creation, and it informs them how the macro environment is changing.

What to Do With Your Initial Estimate

So you’d love to become a power member, but first things first: Users of the Firm Estimator should schedule a call with a representative of Collective 54 to discuss the results. During these conversations, users are able to ask clarifying questions and learn ways to increase the worth of their firms.

For example, a user recently used the Firm Estimator and disagreed with the estimate. She scheduled a call with a Collective 54 representative and learned she was calculating EBITDA incorrectly. Once this was fixed, her estimate went up and it was more accurate. This was a big relief to her since she was fielding calls from potential acquirers and wanted to be armed with accurate information.

Once the estimate is accurate, which often happens on the first try but never takes more than two attempts when assisted by a representative, users can get to work on the issues that bring the estimate up.

For instance, many boutique pro serv firms are too dependent on the founder, and this reduces a firm’s valuation. We call these Hero firms—an all-powerful founder running the firm with a bunch of helpers. No one wants to buy a firm like this because if something happens to the founder, the business falls apart. Collective 54 is helping many founders replicate themselves in others, whereby employees can do what founders can do just as well as they do it. This is accomplished by applying the succession process outlined in The Founder Bottleneck, available exclusively to members of Collective 54.

And this is just one example of many wealth-creation programs members engage with in the community.

You’ve Learned How to Value A Professional Service Firm, But There’s So Much More Available

The Firm Estimator is just one tool inside a deep toolbox available to members of Collective 54. Non-members can get access to the Firm Estimator, but they do not have access to the solutions designed to fix issues dragging down the estimate. These tools are available exclusively to members. If you found the Firm Estimator interesting and want to take it a step further, consider joining Collective 54—the first mastermind community dedicated to the needs of boutique professional service firms.

Whether you’re already considering joining or want to start by talking through your firm valuation, schedule a call today. And if you haven’t already, find out the value of your firm with the Firm Estimator.