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How to Build a High Growth and High Value Consultancy
It's all about long-term contracts and a high projected growth rate.
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Most people interested in starting their own consultancy are in it for the immediate cashflow it provides.
And when they’ve saved up enough from it, they move on and let their business wind down naturally.
But few people realize that rather than letting it die out, it’s possible to sell your consultancy instead. This could lead to the biggest payout of all.
For example, imagine if you owned a consultancy making $10 million/year. If you were able to secure a high-multiple valuation on this, you could sell this consultancy for tens of millions when you decide to exit.
Compare this to a typical multiple of 0.75-1x for average growth consultancies.
Or worse yet, imagine someone who just lets their consultancy fizzle out on its own.
That’s a lot of potential value left on the table!
A consultancy's value extends beyond immediate cash flow, as it can accumulate transferable worth for acquisition.
Furthermore, knowing how a consultancy is valued during an acquisition is critical for consulting founders because it gives you a clearer direction for your consultancy’s growth strategy.
If you know how a buyer will value your consultancy during an acquisition, you can focus on the factors that will raise the enterprise value of a consultancy from the very beginning, while not wasting time on the factors that won’t.
It’s so important that I’ve invested time into researching how consultancies are valued during acquisitions and have compiled my findings in today’s article including:
the two biggest factors that drive a consultancy’s valuation
how this informs your growth strategy as a consulting founder
How is a Consultancy Valued?
In general, the buyer of a consultancy is interested in one thing: expectations of future revenue.
And for a consultancy, there is nothing that guarantees expectations of future revenue more than long-term contracts.
So if your consultancy takes a lot of one-off engagements, this can be good for cashflow in the short term, but it doesn’t guarantee any future revenue.
Therefore, if your consultancy’s revenue consisted of only one-off engagements, it would not command a premium valuation.
However, having many long-term contracts with clients can significantly boost your consultancy’s valuation because it secures future revenue.
For instance, if you secured a 5-year contract with a client worth $1 million/year and decided to sell your consultancy, you could argue that its potential value is as high as five times its current annual revenue.
The assurance of future revenue, with at least $1 million expected per year for the next few years, sets your consultancy apart from those reliant on one-off engagements.
So securing multi-year, long-term contracts is critical for high-multiple valuations.
Projected Growth Rates are Key for High Consulting Multiples
The second significant factor affecting valuations is the projected growth rate of your consultancy.
If investors believe there is a strong case for your earnings to grow significantly in future years, they are more willing to pay a premium to capture that future growth now.
And the best way to secure a high, projected growth rate is to base it on a proven, scalable process.
For example, let’s say you ran an ad campaign that cost you $100k, but it generated 1 million dollars worth of sales.
If you could make the case that your target audience is large enough that you could 10x your marketing to $1 million worth of ad spend, then you could project that your sales would 10x along with it.
This applies to SEO as well.
For example, if your website currently receives 10,000 monthly visitors and you’re planning to invest in SEO and content marketing, you can project future growth by estimating that these efforts would double your website traffic, and hopefully double the revenue generated as well.
A last example is by expanding your services.
If you were a consultancy with many existing clients, and you were confident that you could offer an upsell service that they would pay for, you could project that your consultancy would have an even steeper growth rate once you implemented this service.
In all 3 of these examples: ad spend, SEO, and upsells, you have a marketing program that is both proven and scalable.
You are now able to make the case for why your consultancy deserves a higher multiple valuation.
What Does This Mean for Your Consultancy?
Now we know that two of the most important factors that affect consulting valuations are: 1) long-term contracts and 2) high projected growth rates.
This implies a few things for your business strategy as well.
Startups are Not Ideal Customers
This might be a hot-take, but I think it’s better for a consultancy to target Fortune 500’s and more mature business than early-stage startups, particularly those without VC-backing.
They say that the life of a company is “power-law” distributed, which means that you can estimate the lifespan of a startup by 2x’ing how long it has been around for.
For example, since Amazon has been around for 26 years, you can predict that it will be around for another 26 years.
Microsoft has been around for 48 years, so it will be around for another 48 years.
However based on this 2x rule, a startup that has only been around for a year will likely only be around for another year.
Startups are not stable enough by nature to sign long-term contracts, so it’s better to target companies that have been around longer if you’re looking for premium valuations during an acquisition.
So a question to ask yourself is:
“Is it likely that your target audience will still be around 5 years later?”
If yes, they are likely an ideal client that could form the foundation of a long-term contract.
It’s for this reason why government contracts are so valuable. No entity is more stable and boasts a larger budget than the government.
Consider Scalable Growth Strategies Sooner Than Later
Most consultancies grow from the founders’ personal sales efforts.
Although necessary at the beginning, relying solely on the founder’s personal network or business development effort will make it difficult to justify a high valuation for a consultancy, because once the consultancy is sold, the founder is also gone.
There goes their personal network and their amazing sales skills!
Instead, it’s important to start thinking about scalable lead generation strategies earlier than later.
By scalable, I mean any growth strategies that could still run without the founder’s own personal business development efforts.
This includes things like:
Training a sales force
But if your lead generation consists of mining out your own personal network, and going on vacations and golf trips with clients, these relationships won’t transfer to the buyer of your consultancy.
Therefore, they also don’t contribute to a high valuation during an acquisition.
It’s for this reason why I also believe it’s not good to name a consultancy after a founder’s name.
Once a consultancy is sold, the founder isn’t going to be there anymore, so it’s difficult to transfer the founder’s personal brand over to a new owner.
Here are two more questions for you to reflect on:
Can you show that your business development efforts are both repeatable and can consistently generate sales?
Is this model easily scalable?
If the answer is no to these two questions, it’s OK to continue doing it in the early days.
But eventually you’re going to have to find a channel more scalable if you expect to sell your consultancy for a premium in the future.
It’s Never Too Soon to Specialize and Differentiate
If a consultancy is able to secure long-term contracts, this indicates two other things:
The client believes they will have ongoing needs
They believe you can perform this service better than anyone else
Particularly for number 2), this means you have to avoid becoming a “commodity consultancy” where any number of consultancies can easily perform your function and replace you.
This necessitates specialization and differentiation in your field in order to stand out from the “general” service providers who provide solutions to anyone and everyone.
One example of a consultancy that is specialized and able to secure these long-term contracts include, Praxent, a Fintech consultancy.
Notice how their expertise in Fintech, (not just general software engineering) gives them deep expertise in integrations with the financial sector that more general software agencies won’t know how to do.
This allows them to accumulate large contracts with big and mature clients, and build their reputation among other Fintech companies, thus attracting even more potential clients in the future.
Another example is RedHawk IT Consulting.
I know of this consultancy because I was on sam.gov once, the website for government contracts, and I noticed that this consultancy kept winning IT contracts from the government.
When I researched them further, I realized why: they specialize in providing IT services for the government.
In fact, it’s run by veterans, so they must have a lot of connections and a deep understanding of how to navigate the government system.
They are so focused on government contracts, they even have a hawk in their logo!
So a final question for your consultancy is to consider how you can be as targeted as both Praxent is with Fintech and RedHawk IT with the government.
One way to do this is to consider adding an element of “vertical positioning” where you target a specific industry for your consultancy the way they do.
It will make it easier for you to compile a list for your lead generation efforts, and help you develop “snowballing expertise” in a specific field that makes your consultancy stronger over time.
Consulting founders should study what goes into the valuation of a consultancy early on, as it could inform their consultancy’s growth strategy.
By focusing on ways to guarantee expectations of future revenue through long-term contracts, and developing scalable growth models early on, you will command a much higher valuation for your consultancy if you ever decide to sell it later on.
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