Consulting: An Emerging M&A Opportunity

With plenty of capital to invest, ample debt capacity, strong business performance, and decreasing hold periods, the M&A market is robust, including in the consulting sector—a less traditional space for private equity investment.

Here, executives from the Harris Williams Business Services Group provide their perspectives on M&A opportunities in consulting.

Why have investors become interested in consulting?

Lewis: As competition for leading assets continues to increase, private equity firms are looking beyond businesses with hard assets for investment opportunities. They realize that consulting firms can be sustainable platforms for growth. Consulting is a very fragmented market with many opportunities for value creation. For example, a private equity firm can invest in people and technology to build a platform that is more competitive than founder-owned firms and small partnerships, and quickly gain market share. It can grow within a specific discipline, essentially building scale in one vertical area, or it can diversify expertise and create adjacent practices to build scale.

Are there specific kinds of consulting firms or firm attributes that appeal to investors more than others?

Walker: Diversification in revenue generation is a big determinant of whether a consulting firm is backable by private equity. Many companies in the industry are founder-owned businesses that are overly dependent on the expertise of one individual or a small group. Others have successfully diversified away from the founder's expertise, building a recognized and valuable brand in the marketplace rather than relying on a few specific individuals. This approach can offer an attractive, lower-risk investment opportunity. Some private equity firms will invest in rainmaker-dependent firms with an investment thesis based on diversifying away from the founder, either through additional acquisitions or an aggressive talent strategy.

Lewis: Investors are also looking at whether firms can build a specialty practice at scale, and there are a few ways to do this. Establishing a specialized consultancy is one thing, and growing it is another. There's a value creation opportunity in building a more scalable platform than the competition. Other firms are expanding their addressable market by leveraging subspecialties to offer clients greater breadth and depth in the specialty while applying their expertise to new end markets. There are also some highly specialized businesses that can be attractive as non-scale plays. For example, it may be a capability area where there are high barriers to entry because the specialization requires an expertise that is scarce in the market. That business may not grow as aggressively but could produce strong margins for the foreseeable future. 

Walker: Specialized expertise provides differentiation. Complicated topical areas such as engineering are attractive because they may include subspecialties such as fire and life safety and air quality, which are capabilities needed by a broad swath of clients across industries. Cybersecurity is also a hot area, as are supply chain, governance, risk and compliance, growth strategy, intellectual property, finance and accounting, and data analytics.

Lewis: Another attribute investors consider is client concentration. All else being equal, a company with many projects of lower engagement size is going to be incrementally more valuable than one with fewer clients and larger projects. Also, services and expertise tied to noncyclical or reoccurring demand is as critical to investors in professional services as it is to investors in other sectors.

How do private equity firms approach value creation with consulting firms in their portfolios?

Walker: Ultimately, it's about driving organic and inorganic growth. There are three primary ways private equity firms do this. One is through professionalization of the firm, by investing in the infrastructure, sales, marketing, and consulting talent to build a more efficient, effective, and scalable platform.

A second way to drive value creation is through M&A: helping the firm to create a market map, identify acquisition candidates, and then execute and integrate. Acquisitions in this segment can sometimes be more complicated than acquiring a business with hard assets. Well-respected, well-known people in their specialty must be integrated into the business and made a recognized part of a larger, reputable platform. Nonetheless, M&A can drive substantive value if companies can identify and bring in the right groups of people in the right practice areas.

A third value creation necessity is building a talent engine. To scale, the platform needs to continuously find, recruit, and deploy talent. Acquisitions are one way to bring in talent, but that alone won't be sufficient to scale. Hiring and developing talent from within and maintaining the culture of the firm as it grows is critically important. People are the basis of revenue generation, so having a well-developed talent engine to sustain growth can make or break the business.

What is the end game for investors in this segment?

Lewis: There's a lot of growth that can occur over different phases of ownership, and there is also a public exit opportunity. Whether a firm is founder-owned or sponsor-owned, it's important to keep in mind the end goal as the business builds. For example, the bigger and more diversified the firm becomes, the less attractive it is to a strategic buyer. Strategic buyers tend to be very specific in their M&A, looking to fill in a hole in an end market, geography, or, more often, a capability. The best strategy for a company that would like to be acquired by a strategic is to become a best-of-breed specialist in an area of expertise with high demand. In other words, be an inch wide and a mile deep in a hot area. However, if a private equity firm can partner with the management team, help to professionalize the business, and alleviate operational burdens, this can be a great option for the buyer and seller for long stretches of growth.

Walker: Whether a firm is founder- or sponsor-owned, there is always an element to consider around how important the CEO or a small group of individuals is to the ongoing business and what those individuals want to do in the future. Do they want to stay involved and continue to partner with private equity? Or are they looking for an off ramp to exit the business? In the latter case, selling to a strategic makes particular sense.

How can a consulting firm make itself attractive to potential buyers?

Walker: Attractive assets need to demonstrate sustainable organic growth and reoccurring revenue. If the majority of engagements are one and done, that's not as valuable as a client hiring the firm for projects year over year. If that client increases their spending with the firm over time, that's even better. Leading consulting companies can demonstrate that they can consistently win and grow clients every year.

Lewis: Inorganic growth is also important. Leading firms can show that they integrate and drive value from acquisitions by either increasing margins or accelerating the organic growth rate of the platform.

In sum, investors are looking for firms with four traits: specialization in high-growth areas, low reliance on founders, client diversification, and reoccurring revenue. Organizations like that should continue to drive premiums in the M&A marketplace.

The Harris Williams Business Services Group has experience advising companies that provide a range of commercial, industrial, and professional services. For more information on the firm’s Business Services Group and other recent transactions, visit the Business Services Group’s section of the Harris Williams website.

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