Learn more about the preparation that is recommended for buying or selling a professional services firm.
Merger and acquisition activity is healthy for the buying and selling of professional services firms, particularly those with $5 million or more in revenue. Acquirers are using M&A as a tool to reach new markets and increase market share. Prospective sellers experiencing higher growth and strong profitability, in particular, have the greatest opportunity to position themselves favorably with buyers.
According to a 2017 survey of leaders at middle-market companies in 45 industries, including construction-related firms, healthcare, financial services and other professional services companies, more than one-third of these firms expect to participate in M&A transactions in 2017. “Healthcare sectors such as ophthalmology, dermatology and dental have been particularly active from an M&A perspective,” Paul Johnson of MB Capital Markets’ Mergers & Acquisitions Advisory Group said.
One example of a firm growing through M&A activity is Illinois-based DuPage Medical Group. They received a $250 million minority investment from private equity firm Summit Partners to support DMG’s growth initiatives—including population health, expansion into new geographies and opening additional clinical lines of service.
Further, family-owned or privately held firms within service sectors looking to cash out would be some of the most promising targets for buyers, according to the Chicago Tribune. Plus, Investment News notes in its 2016 report on financial industry performance that 43 percent of all investment advisory firms plan to make an acquisition by 2018, yet just five percent have any intention to sell. This could make smaller firms desirable acquisition targets of larger firms.
When considering moving forward with acquiring or selling a firm, buyers and sellers should know proper preparation is crucial. Whether owners of professional services firms want to sell as part of a retirement exit strategy or want to expand by buying a complementary firm, there are steps that both sides should consider so that an M&A transaction goes as smoothly as possible.
Considerations for Selling Your Professional Services Firm
Preparing a business for sale is a little like selling a house. In both cases, sellers can assume that buyers will look in the closets and basement, so make sure they are in order:
- Clean up the balance sheet, including resolving bad or old receivables
- Align all partners and/or professionals with your transaction objectives
- Verify that you have all necessary licenses and permits in place
- Have executed copies of all material contracts, including amendments and extensions
- Update the billing cycle and verify it functions smoothly
- Consider getting reviewed or audited financial statements
After following these initial steps, business owners should discuss the possibilities with key advisors who know the firm well, including a relationship banker. The relationship banker can introduce an investment banker to help prepare and coordinate the sale process. Typically, a corporate attorney and accountant/CPA are also part of this strategic team of advisors who could help navigate the deal and provide the resources and support for prompt execution.
An investment banker helps owners evaluate their strategic alternatives in light of their objectives. Ultimately, if a sale is the best course of action, investment bankers will work with sellers to identify potential buyers and conduct a thoughtful, tailored process for executing a transaction. An investment banker will also provide perspectives on valuation and coordinate the activities of a team of accountants, attorneys and other advisors to minimize disruption to the business and optimize outcomes for the sellers. For example, an accounting firm can help review tax implications and perform a quality-of-earnings analysis in advance of a sale.
If the seller plans to retire, it is important to carefully consider the minimum sales price needed to generate sufficient income to support the anticipated retirement lifestyle. If not, other exit options can be explored that may provide for selling the business over time and contributing a stream of income to the seller during that time.
Owners can sell or transfer a business in a number of ways. Often, a strategic or financial partner will buy a business outright at a multiple of earnings before interest, taxes, depreciation and amortization (EBITDA), or perhaps based on the revenue of the firm. The form of consideration received in a sale may be cash, stock or seller’s note and may be structured as a one-time payment at closing or may include an earn-out.
Another possible approach is to sell to an Employee Stock Ownership Plan (ESOP). This strategy allows the business to remain closely held while providing tax benefits to the owner and effectively selling the business to employees. For more on ESOPs, read the MB Insights article, Planning for the future? Here's how an ESOP could help you and your company.
Whether an owner sells the business outright or intends on keeping it in the family, it may be prudent to transfer a portion of ownership after the seller’s current and future financial needs are met. Tools to accomplish this include family limited partnerships (FLPs), grantor retained annuity trusts (GRATs) and outright gifts. In each one, the seller can pass on some ownership interest tax-free to specified beneficiaries.
The sale of a business also presents opportunities for personal wealth and transactional planning before, at and after the closing that are unavailable or are less impactful later on. Among the pre-transaction strategies available to sellers are these:
- Estate, gift, and goods and services tax (GST) minimization
- A dynasty trust
- Sale to an intentionally defective trust
- Creation of a family limited liability company
Finally, with so many years and so much hard work invested in a firm, many sellers remain in the practice following a sale. Some sellers stay because they have no interest in retiring, while others stay to facilitate a smooth transition to the new owners. Many buyers will require that the seller remain for a defined period of time, which should be factored into the timing of a sale process. In cases of multiple offers, the seller should evaluate which potential buyer most closely matches his or her approach to serving clients and will continue the service model. In addition, the seller will likely think of his or her clients’ welfare post-departure. This aspect can be important to him or her because it helps to protect their legacy and helps to ensure clients continue to receive consistent, high-quality service.
Insights for Buyers and Considerations for Financing Acquisitions
Buyers have due diligence to do, particularly in four areas: quality of management of the target company, proof of strong revenue growth and profitability, likely retention of clients and talent, and a healthy market presence.
Buyers should also research their financing options ahead of time, including the steps they’ll take to fund the purchase. Most banks want to see that the buyer has skin in the game, and typically won’t finance 100 percent of the deal. As a result, a buyer may need to seek additional options for raising capital. Many deals include a combination of owner’s equity, bank senior debt and third-party investors.
Depending on the sector involved, Management Service Organizations (MSOs) are another source of financing and support. MSOs specialize in the administration duties associated with firms in certain industries. With the sale of a doctor’s practice, for instance, the owner must be a licensed physician, but an MSO can be a third-party participant in the deal, serving as a co-investor who manages the firm’s administrative duties while also sharing in the revenue. Some MSOs are owned by private equity firms. Using private equity or MSOs is common in the medical and engineering sectors to fund roll-ups, where firms purchase many smaller firms in the same market and merge them together to benefit from greater economies of scale.
When considering financing, buyers should also think about any additional capital the firm may need, such as a commercial mortgage to buy bigger office space or a larger working-capital line of credit to support the day-to-day operations of the combined firm.
Beyond the Sale: More Buyer Considerations
Combining firms brings additional operational changes to consider:
- Culture: Do both firms share a similar culture and can they be easily blended? If not, the buyer will need to determine which culture will survive post-acquisition. How will new employees be acclimated to the firm’s mission and culture?
- Branding and marketing: Will the firm brand itself as a combined firm or market independently? What are the additional marketing expenses that the practice will incur?
- Client impact and managing client growth: What staffing additions will be required to retain customers and/or patients in the practice, and manage the growth of additional clients? What will be the cost in terms of compensation, benefits and human resources management?
- Management team: The buyer also will have to address the processes and efficiency needs of the combined business. Post-sale, there may be a need for a permanent management team. Previously, financial, legal and human resources duties may have been outsourced. Does outside legal counsel and an independent CPA still make sense, or does the expanded company now require a CFO, COO and corporate counsel as part of the firm’s team? Is the practice or firm utilizing banking services to the fullest extent possible to maximize cash flow for the business?
Middle-Market Firms See 2017 as a Good Year for M&A
There continues to be strong M&A activity in select professional services industries. This momentum is driven by a number of factors, including:
- Strategic buyers seeking to supplement organic growth
- An abundance of capital that has been raised by private equity buyers
- Continued low interest rates that provide attractive financing
- Strong valuations that move sellers to explore liquidity options
Buyers and sellers look for synergies that lead to successful deals and the continued prosperity of a business. Yet, each acquisition is unique, so there is no one-size-fits-all deal. Whether you are a seller or a buyer, you should begin having discussions early on with your bank and team of advisors to identify strategic options that are right for you.