The best way to get the highest price for your firm at exit is to get the comps right. In this episode, we discuss how to drive up valuations through the proper positioning of professional services firms.
TRANSCRIPT
Sean Magennis [00:00:16] Welcome to the Boutique with Capital 54, a podcast for owners of professional services firms. My goal for 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 that the best way to get the highest price for your firm at exit is to get the comps right. I’ll try to prove this by interviewing Greg Alexander, Capital 54’s founder and chief investment officer. Greg is a master of driving up valuations through the proper positioning of professional services firms. Greg, good to see you and welcome.
Greg Alexander [00:01:06] Thanks, Sean. I’m looking forward to making our listeners some money today.
Sean Magennis [00:01:09] I love it. Let’s begin by grounding the audience in a definition of a comp. What does that mean?
Greg Alexander [00:01:17] So the term comp, comps, is short for the word comparables and the word comparables is meant to define the valuations in the terms, firms like yours get when they sell. For instance, the last time you sold your home, the price you sold for was determined by the price of similar homes in your neighborhood. By looking at comps, a buyer can get a feel for the fair market value of a firm.
Sean Magennis [00:01:44] Got it. So the last time we bought a home, our real estate agent provided me the cost per square foot of homes in our neighborhood and how they were selling. In essence, these were comps. So when selling a firm, does it work the same way?
Greg Alexander [00:02:00] It does. But in this case, there is no real estate agent. Instead, there is an investment banker who performs similar duties. Also, in this case, there is no cost per square foot. Instead, there is a multiple of EBITDA, which determines how much a firm is worth. Am I making sense here?
Sean Magennis [00:02:18] Yes, you are. So owners of firms hire typically an investment banker who markets the firm to potential buyers. And the price of the firm is determined by the multiple of EBITDA. Can you help the listeners understand how comps play a role in this?
Greg Alexander [00:02:36] Sure. It’s pretty straightforward. So when I sold my firm, I hired M.H.T. as my investment banker. I chose them because they had represented firms in my niche before and had firsthand knowledge as to how much firms like mine were sold for. This established our comps in practical terms when the price I was seeking from buyers was challenged. They justified our asking price by referencing the comps.
Sean Magennis [00:03:02] Got it. So I think it would be great. Greg, if if you could share with the audience how category positioning affects the comps.
Greg Alexander [00:03:10] Sure. So I’ll use my personal story as the use case here. So my firm, SBI, was originally placed in the sales training category and this was not correct. We did not train sales teams. We were a management consulting firm specializing in sales effectiveness. The correct comps for us were other management consulting firms. This distinction was a big deal as it affects EBITDA multiples greatly. At the time, sales training firms were being bought for five and a half times EBITDA. Management consulting firms were being bought for nine times EBITDA. In addition, sales training firms were not perceived to be high growth firms. Yet my firm had a 10 year compounded growth rate of 30 percent when we were correctly positioned. As a high growth firm in the management consulting space, our multiple went to 11 times EBITDA. These two modifications to how our firm was positioned resulted in a multi-million dollar increase in the purchase price.
Sean Magennis [00:04:18] Greg, that’s that is a great story and it solidifies the mission critical nature of really getting the comps right. So this aspect of exit readiness is literally worth millions.
Greg Alexander [00:04:31] It truly is.
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Sean Magennis [00:05:42] 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 [00:05:59] OK, 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 yes-no questions. In this instance, if you answer yes to eight or more of these questions, you have your comps right. If you answer no too many times, you might lose millions because your comps are not accurate. So let’s begin.
Sean Magennis [00:06:38] Number one, do you have a list of boutiques in your category that recently sold? Number two, do you know the price paid for each of them? Number three, do you know the deal terms for each?
Greg Alexander [00:06:57] You know, right now our listeners are saying no, no and no to the first three questions, and that’s followed up with. I get why you want this data. How do you get it? Let me tell you how I did it. I just picked up the phone and I called the owners of these boutiques. And an interesting thing happened, which is worthy for the listeners right now. People love to brag about their deals.
Sean Magennis [00:07:16] Yes, they do.
Greg Alexander [00:07:17] So when you ask him, what did your firm sell for? They stick their chest out and they give you their big number. We ask him, you know what, the terms of the deal, where they express it to you. So don’t be bashful. Just pick up the phone. You’d be surprised what you find out.
Sean Magennis [00:07:31] Great advice, Greg. Number four, do you know the investment banker who represented each? Number five, do you know the names of the investors who bid on each of these deals? Number six, do you know who won the deal for each? Number seven, do you know exactly why the winner won?
Greg Alexander [00:07:56] And the right investment banker can help you answer all of these questions.
Sean Magennis [00:08:00] Precisely. Number eight, is your boutique in the correct category? Number nine, is the correct category for your boutique, obvious to potential buyers?
Greg Alexander [00:08:13] You know, that’s an interesting question, because I learned from my personal experience. I just assumed that people that were looking at my business knew that we were a management consulting firm. And what I realized was, is they had no idea, you know, who we were, what we did. And they defaulted us to the wrong category. And if I didn’t correct them…
Sean Magennis [00:08:34] Yep.
Greg Alexander [00:08:35] It would have cost millions.
Sean Magennis [00:08:37] Excellent point, Greg. And finally, number ten, you trying to sell your boutique to the right group of buyers?
Greg Alexander [00:08:45] There’s people out there that are looking for your type of business. And there’s people out there that would never buy your type of business. So make sure that you don’t waste any time talking to the wrong buyer group.
Sean Magennis [00:08:57] Excellent, thank you, Greg. And in summary, comps are very important. They can add and subtract a huge amount to the purchase price and they can significantly alter deal terms. Be sure you are positioned in the correct category and be sure to pursue the correct buyer group.
Sean Magennis [00:09:19] 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. Thanks for listening.