10 Reasons a Buyer Might Want Your Firm

David thinks principals should build their firms as if they were going to sell it while Blair’s advice is to run it as if you’ll never sell it. Being aware of options as your firm matures can give you the leverage you might need in negotiations.

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“Ten Reasons Firms Are Bought” by David C. Baker for punctuation.com

Transcript

Blair Enns: David, today we're doing another topic on the subject of selling your firm. This one is called Understanding The Reasons Why Someone Might Buy Your Firm. You have buying and selling of firms on the brain, don't you?

David C. Baker: Yes.

Blair: I wonder if there's some hidden motive.

David: Could there be?

Blair: No.

David: Could I really want to make sure people know that we do this stuff?

Blair: It's pretty busy part of your practice these days, isn't it?

David: Yes. That's why I brought Jonathan on full-time several years ago. It was just overwhelming for me. I just couldn't do both. I thought I was better suited for the advisory side and turns out I was correct. Jonathan's just been doing amazing work there and we love it. Plus, I just wrote this book about selling your professional service firm. I want people to read it. I think it's actually my best book. Unfortunately, it's written for a pretty small niche audience so not many people will experience my best book but I want people to buy it.

Blair: All right. Fair enough. I think we've done at least one episode on it and another on some subject matter in it and I think I made the point of saying it's a pretty good manual for the things to think about in order to run your firm well and properly.

David: Yes. That's the beauty of the overlap. I don't think I really thought much about that overlap until I read John Warlow's book on Built to Sell and the concept is right in the title. It hit me like it never had before when I read that book. Then, I don't know, five, six years ago, you wrote a post. You try this constraint on, "You can never sell your firm." The idea being that you're stuck with it forever and if you're stuck with it forever, what would you do differently? I thought, "Oh, wow, that's a typical overreaction from Blair," and then about five seconds later, "But dang, that's really true like so many of his others."

Blair: I didn't write that as a constraint of an exercise. I publicly said I had decided I am never going to sell this business and I'm never going to retire.

David: You want to take any of it back?

Blair: I have thoughts of both, but so far, I'm living that promise. Let's start here. As you point out, you've heard me say run your firm as though you're never going to sell it because that will force you to turn around and face the issues that you are running from and also correct the things you don't like about the business. That is a powerful idea. Run the business as though you will never sell it, but the inverse and I'll quote our friend Rory Sutherland here who's--

In his book, Alchemy, he says, "The opposite of a good idea can also be a good idea, a poorly understood idea." The opposite of that is what you say is run it as if you're going to sell it. That's also the point of view of Michael Gerber, author of The E-Myth Revisited. His advice is run your business like you're going to franchise it. My advice is run your business like you're never going to sell it. Your advice is run your business as if you're going to sell it. They're all good ideas. Would you agree? Do you think they're all good ideas?

David: I think they're all good ideas. I think probably that one of those three that's most difficult to accept is run it as if you're going to franchise it. I have actually evidence of the fact that that was the most difficult to expect or to hear because I had Michael Gerber keynote a conference I was doing and half the audience walked out because the idea of these owners of creative firms wanting to franchise their businesses has just struck at the very root of how they thought of themselves. They're in the anti-franchise business. I do agree with it.

Blair: I wasn't at that conference. I think that was 2000 or 2001. That was the early NYOB days and he was your first keynote speaker, was he?

David: Yes, exactly.

Blair: The story was he stands up and says to a room full of design firm owners, "You guys should be more like McDonald's."

David: Exactly.

Blair: Then the room emptied out.

David: Yes, because these people, not only would they not want to run their business as a franchise, if they ate at a franchise, it wouldn't be McDonald's. It was a double whammy. I think he's correct. I think the systems and how, to whatever degree you can, productize your offerings and we have an episode that's come out about that and so on. I think all three are correct. I think the last one though is the tough one to swallow.

Blair: We've talked about selling your firm on at least one other episode. When I saw you come up with this topic, I thought, "It feels like we've been over this ground." I think the reasons why somebody might buy your firm are pretty obvious. Then I read your outline here and I thought, maybe once again, I underestimated you. There is some depth here." Why do you want to talk about this now?

David: Because people are sometimes surprised when someone reaches out to them and wants to buy their firm, and then they start to get full of themselves, and they're shocked at how little somebody wants to pay, but more, it's that I think they just don't really understand why buyers might want to buy their firm. It's not about your staff. It's not about the actual work, the quality of the work that you do. It's about other things. If you know that, then you can prepare for it.

I was reading something today, it was a survey that I got from one of my clients. They said that we've tried to run this firm with a focus on employees. I thought to myself, I wonder if the firms that fall in that category, that want to run their firms with a focus on employees, are actually less profitable as a result of that. I don't know that they are. It was just a question that I had. I was thinking, "Okay, there has to be a balance between running your firm as a place where people want to work and running your firm that generates good profit consistently because only one of those things falls in the bucket of what a buyer cares about."

Anyway, it's a tough balance. There aren't black-and-white answers here. I just want people to understand that there are lots of reasons why people want to buy a firm. In any given firm, there's probably three or four of these 10 that might apply to them.

Blair: You get some initial expression of interest from a potential buyer. You go home and you say to your spouse, "Hey, somebody wants to buy my firm." Your spouse says, "Why?" Your answer is like, "What do you mean why? Because it's an awesome firm. Who wouldn't want to own this awesome firm?" That's not the reason why somebody wants to buy your firm. I like to ask the question of acquirers, "What is it that you were buying? When you bought that business, what were you buying?"

You think there's one or two answers. There's a lot more. You've got 10 answers here. Do you want to kick us off and run through the list here?

David: Sure. They're not in any particular order. I'll just run through these. Jump in when I'm not making sense, or there's something that needs to be tied together, or whatever.

Blair: When the audience needs to hear from me.

David: That's right. Your lovely voice. What did you call it before our call started?

Blair: The dulcet tones of my voice.

David: The first, and by the way, these are not in any order, they're just as they occurred to me, vertical integration. The buyer focuses on a vertical industry and they want to start offering something else to that same audience. Maybe they do SEO and they've discovered that it's really not all that practical to not also do SE, so they buy an SEM firm. Vertical integration.

Blair: That's a new service line to append to their current service offering.

David: Yes, exactly, because vertical integration and vertical positioning are actually a little bit confusing together, but right.

Blair: Go ahead. The second one is horizontal integration. What is that?

David: Here, you're buying a firm that focuses in a different industry typically. You might be buying a competitor or you could be actually not caring too much about what they do, but you feel like the service that you've perfected and offered to your vertical is really well suited to another vertical. You buy this firm to get access to their clients. You're just selling into them and using their sales force and so on. Sometimes you are buying a competitor to take them off the market, but usually, it's more just for access to that marketplace.

Blair: I'm a firm owner and I do X for Y, discipline for market. The acquirer comes along and says, "We also do X, but we do it for Z, not Y. We're interested in acquiring you because there are some synergies between X for Y and X for Z. We want to expand the market without necessarily changing the discipline. Buying you allows us to do what we're already doing into a broader market." Is that the way to think about it?

David: Yes. It could just be driven by a desire for growth, but sometimes it's like, "We don't want to be as exposed as we are to this vertical market, so let's broaden this out."

Blair: Oh, yes. Risk reduction. It's like, "We're too exposed to a vertical that might be undergoing transformation or susceptible to an economic downturn." That makes sense.

David: Yes. Vertical and horizontal integration. The other one is to solve a client concentration issue. This is the third one. You don't see this too often, but we do hear about it and it's never verbalized publicly. It's always underneath the surface. "We've done great work because of that. We have grown, in fact, most rapid growth comes on the back of a client concentration issue. Our relationship with this client is fantastic. We have tried to do new business and we keep getting sucked back into client stuff and so on, so it's just never been all that successful. Maybe what we should do is buy another firm."

All that does is it just changes the relative percentage of this client that we have against a bigger hole that's changing one side of that equation. Sometimes, actually, you're killing two birds with one stone in that the firm that you're buying also has a client concentration problem. You're putting these two firms together. This actually happens quite a bit.

Blair: You're pooling the risk.

David: Yes. The client concentration challenge is what's made new business difficult. It shouldn't, but it does. We can't take our best people and focus them over here. We have this work, let's just maximize it. I've said two things, that it happens a lot or it doesn't happen a lot. By that, to reconcile those two things, what I mean is that not a lot of acquisitions happen to solve this, but a lot of people think about solving it this way.

Blair: Got you. One of my first clients over 20 years ago, they had a large client they were very successful with and they grew so rapidly, they desperately wanted to mitigate the risk that that one client represented because first they were 20% of their business, then they're 50, 60, they were 80% of the business. What you just outlined happened, which is they could not concentrate on new business for long because their gorilla client was growing so rapidly and was so demanding.

Finally, I just said, "You know what? Let's quit trying to push this boulder up the hill. Just forget about new business altogether. Focus on growing the client. Know that at some point, the client goes away, you're going to shut it down." They ended up buying another firm that was better diversified as a way to mitigate that risk.

David: Yes, exactly. It just makes sense on the face of it.

Blair: Number four is a profit grab.

David Here the acquirer is under some pressure. It's usually outside pressure, not inside pressure. By outside pressure, I mean a lender or an investor or the people who are going to get rich when the next thing happens, some exit or whatever it is. They have a lot of business, tons of pass-through stuff, but they're just not successfully able to generate much profit from it. They buy another firm that's boring, smaller, but they have pretty nice numbers. They're 40% EBITDA instead of 5% or 10%.

The buyer just needs-- This is the quickest way to add that profitability because everything else is requiring deep change and time to happen. This is a quick fix to something like that. Now, I'm assuming that obviously people can listen to this thinking, "This is why we could buy a firm," but mainly I'm addressing people who want to sell. If you're in a selling situation and this is true of your firm, this gives you lots of leverage. Of all of these scenarios that we're talking about here, this one gives you the most, profit, EBITDA.

Then they'll poke around the edges to make sure that this profit is predictable, but this gives you tons of leverage in the relationship. Of course, this goes back to what you and I were talking about at the beginning. This is pretty good for you too.

Blair: It's pretty good for you too, especially if you can recognize that this is what they're buying. That's when you have the leverage. I can imagine that some deals were made where firms were sold for this reason and the seller didn't realize what the buyer was buying and perhaps left some money on the table.

David: Yes, because it was unlikely that they got financials from the acquiring firm, especially if there was a big size differential.

Blair: We've got 10 different reasons why someone might buy your firm. The first two are integration issues, vertical integration, horizontal integration. The third one is to solve a client concentration issue. The fourth one is a profit grab. The fifth one, smooth out a growth curve. What do you mean by that?

David: The firm that's going to buy you has an exit plan of some kind. Part of the equation in a successful exit for that firm is telling a great financial story. Maybe what happened to them last year is not a great chapter in that story. There was a big dip or maybe they see one coming or they lost a significant client or there was something in the regulatory environment that changed or whatever. What this does is it allows them to fix that top line.

The one we just talked about is about fixing the bottom-line profit. This is about fixing the top line. In this case, you have more leverage than you might expect because the profit contribution that your firm is going to make is just not that important. They're more interested in the top line here. If you're not aware of this, then you'll be unduly worried about how you'll come out in the transaction. This is a part of things, and it usually happens after there's some larger disruption in the marketplace.

You saw that after COVID, you'd see it after the 2008, 2009 thing where bigger firms need to smooth out that growth curve to tell a better financial story later when they exit.

Blair: This is quite a bit like the earlier one of a profit grab. Both of these are acquisitions designed to tell a better story for when they turn around and sell the business.

David: Yes.

Blair: The acquirer sells the whole thing, right?

David: Right. In some cases, the buyer of your firm isn't even going to need profitability. It's a market share buy for somebody else or they're buying the promise of the growth curve and so on. In many cases where this applies, your profit doesn't matter as much to them. It's more the top-line volume.

Blair: Let's say you're the advisor to the seller. Are you able to determine for your client's benefit what the reason is that the acquirer wants to buy?

David: Oh, yes.

Blair: Are they straightforward in giving that information?

David: They're not straightforward, but there's no hiding of it because of the questions they ask, the reason why they need "something", what they push back on from a negotiation standpoint. There's always ways to throw things at the discussions and see how they respond to it. It's very obvious why they're buying something.

Blair: Have you ever been involved in an acquisition, again, representing the seller where you were unable to discern the true motivation of the buyer?

David: No.

Blair: Do you think somebody who's not using-- I'm not trying to set you up for people to hire you. You facilitate transactions, you do it all the time, you see the patterns. How many times are you going to sell your own firm, the listener? You might think, "I'll do it myself." I just can imagine that somebody who hasn't sold a business before might not even consider the question of what is the acquirer really buying, let alone, do the work to determine what that answer is.

David: I think that's possible, but unlikely. I think most people, assuming that they're of average or above intelligence, and maybe they've read a book or two or they've talked with somebody that's gone through this, I don't think they'll have problem identifying why. I just think they don't know what to do with it.

Blair: It becomes pretty clear, doesn't it?

David: Yes, it's pretty clear. They just don't know how to use that. It's like a sports agent. A great sports agent should more than pay for themselves. I would think the same thing is true of an M&A advisor, too.

Blair: The sixth reason why somebody might buy your firm is buying your intellectual property. How common is this?

David: I hear you laughing.

Blair: No, I'm not.

David: It's not very common.

Blair: It could and should be more common, maybe?

David: Oh, absolutely. Yes.

Blair: As an advisor to these sellers, you would like it if they built more IP and appropriately protected it, and then monetized it on exit.

David: Yes. Our problem is usually the opposite, where if we happen to be representing the seller, the seller thinks that there's a lot of value in their IP, and we're having to deliver the bad news that there's not too much. The truth on the flip side of that is that the more IP you have, oh, my God, how it's just an amazing thing, especially if that's why they're buying it. If they aren't buying your firm for the IP and you have a lot of IP, you should have it in a separate corporation, and you should license the use of that IP to the buyer, but not exclusively.

You could have a non-commercial. Probably not. That probably wouldn't fly. If they're not willing to pay for what you think is really great IP, and you're right in this case, then you shouldn't sell it to them. You should keep it and just give them a license to use it in perpetuity.

Blair: Keep it in a different legal entity, license that IP to the acquiring organization in perpetuity, and then you're free to license it to somebody else or sell it outright.

David: Yes, do whatever you want with it. The thing about IP, if somebody's going to buy you for the IP that you have-- let me illustrate what I mean by that. It could be a tight research methodology and I probably have 10 clients where that would apply. Maybe it's a SaaS-like performance dashboard, or maybe it's some algorithm about how to interpret in a social listening environment, or consumer feedback, or testing a packaging, or whatever it is. If you have some IP, ideally, even if it's not a separate corporation, you have separate financials for that, so you know what income and what expenses to attribute to it.

This is a factor, and you should be honest with yourself about what you have. If it really is IP-able, then you should treat it that way, and if it isn't IP-able, then you probably ought to quit fooling yourself about how much value it has.

Blair: I want to bring up something that maybe doesn't fall under IP, but it's the only place where I can see on your list where I think it would make sense to put this. I've had some clients who became pricing stars, who took their profit margin from 10%, 20%, to 30%, 40%, and beyond. Some of these firms have been sold, and some have been in M&A conversations that didn't end up getting sold.

I remember talking to the CFO of a very large firm that was considering acquiring one of my clients, and the client referred us for pricing training to the large organization. They both were open with me with the fact that there's a potential acquisition. They were in discussions. I said to my client, the smaller firm that was looking to be acquired. It didn't go through. They ended up being bought by somebody else.

I said, "If you look at your new ability to drive a higher margin, you were a X, now you're consistently a Y, solely through your improved pricing. When they buy that, they're not going to value your ability to go into the larger organization, because if they buy you, you could go into that organization, and you could drive the same increase in profitability across an organization that is 20 times your size. What is the value of that?" Can they put a price on that in the acquisition?

David: Absolutely. You'd build it into the terms of the sale, so the earn-out would be dependent not 100% on what happens within the firm that was sold, but partly tied to the larger results of the large company that bought you. Now, if they ignore the-- they're not interested in that, then you just move on and say, "Fine, no problem," but then when you start to see things that could be fixed after the acquisition, then you go back to them and say, "Hey, I'm struggling here because my earn-out is not going to reward me to help you fix these things, but I really want to help you fix these things. Could we change the arrangements here?"

That happens. Yes, it can absolutely be built in, and it should be.

Blair: Fascinating. Seventh on your list of reasons why someone might buy your firm, geographic expansion. Seems straightforward.

David: Yes. Increased geographic footprint. This was more trendy in the past. You don't see it happen quite as much now. It started with PR firms. It's like, "We need a presence in New York City, so let's buy a firm there." Then the second phase was, "We're having trouble recruiting to Broken Bow, Nebraska." I have a client who lives there. [chuckles] "Let's see if we can make it easier to pick up really great developers in Austin." Then, of course, it's driven a little bit by what cities are known for.

Energy, "Oh, you got to have a presence in Houston." Silicon Valley for startups, biotech in the Northeast, Northern Indiana orthopedics. If I could throw in an ad for where I live, did you know Nashville has more healthcare corporations than any city in the world? People think of music, but no, Nashville is about healthcare, on the service side.

Blair: Bible publishers.

David: Let's leave that out of this.

[laughter]

David: Printing, transportation. If you serve the healthcare service side, you've got to have a presence in Nashville. That kind of thing drives this geographic footprint. You have to be serving the same industry that they want to serve, but this could absolutely drive it.

Blair: Got you. Eighth is subsequent succession. I'm not sure I know what you mean by that.

David: For whatever reason, you don't want to sell your firm to somebody else. You'd like to see your legacy continue. That means that when you're ready to step down, it's going to be an internal sale. There's nobody on your staff at the moment that is entrepreneurial enough or has the experience to do it, so you buy another firm that's being well run by a younger person. It's sometimes not billed as an acquisition, it's billed as more of a merger, but really it's a succession plan. It's a penultimate way to make this happen.

Between the two of you and anybody who knows what's happening, it's like, "Now four years from now, I'll be able to leave and this firm will continue." Subsequent succession.

Blair: You're buying a successor.

David: Yes.

Blair: "I'll buy you now, then you buy it back from me."

David: "You buy me, but I'm going to charge you more than I'm going to pay you."

Blair: I can see some form of merger where the bulk of the cash goes in one direction initially and then starts going the other way as the acquirer wants to phase themselves out.

David: The firm that's being bought is not as successful. They're earlier on that trajectory and they have always admired this bigger firm and they feel like, "Wow, this is a much quicker, safer way to grow quickly. It makes sense."

Blair: It's a mentorship and a succession plan.

David: Yes.

Blair: Number nine, cross-selling.

David: This one is just a little bit different from horizontal integration, but the purpose is very obviously, "We need access to your clients because what we sell, which isn't what you sell, can be directed to exactly that target." Now usually the firm that's being acquired has either really great account people and/or great salespeople that are willing to help sell this stuff to make this transition easier. Cross-selling. "We're really good at what we do. We want to move into your industry. We don't really care as much about what you do. We care about your contacts."

That's the difference between horizontal integration and cross-selling is, "We don't even really care about your revenue. We just want to use the relationships that you already have with your clients." It's really highly connected C-level people. This drives acquisition sometimes too.

Blair: "We're buying your relationships with your senior people at enviable companies because we want to sell other things to them."

David: Yes. Then the last one is just an acqui-hire. This is the reason people buy you. Now, you have to be honest with yourself here. I'm going to be honest with you to help you with that. When somebody is looking for an acqui-hire, they're looking to purchase a firm in a non-traditional setting, it's a little bit more than a hiring, but it's less than an acquisition. They don't want to spend any money. This is the least amount of leverage you have probably, but it's much better than actually walking away.

You would never walk away from your firm. You would let somebody else acqui-hire it. There's advantages there. It's like immediately you get this additional capacity, which otherwise you'd have to take lots of risks to hire people individually. They've worked together, so there's that culture that comes with it. Plus, even though there may not be a lot of profitable business, there's probably enough business to cover the cost of the people. There's very little risk here. This is more common now than ever.

I'm not really sure what's driving it. We do some of this, but it's actually harder for professional M&A advisors to do this because there's not much money in it. Usually, you get paid as a percentage of the transaction value, and there's very little transaction value here. It's a little bit tough. We just do a flat fee thing. There's more of this stuff happening than ever, coupled with the fact that there are more firms wanting to walk away who don't have an asset that is as sellable as they would otherwise like.

Those two sides of the equation are coming together for more acqui-hires than ever.

Blair: I didn't know the trend was increasing. I know of a handful of firms, maybe a couple of handfuls of firms, who've done this and sold to some very large corporations. It all ended up being win-win for everybody. I guess there is a trend in the larger market that there are probably a lot of people who would like to just shut the firm down and go work for somebody. Had enough entrepreneurship headaches for a little while, want to ride out the tumultuous times.

David: Yes. I think the primary thing driving that is just struggles in managing people and the expectations that employees bring to the table these days. It used to be clients. Now it's more weary of that. The thing is that there are way more acqui-hires than we know of simply because nobody ever calls it that. It's called an acquisition because it's embarrassing to call it an acqui-hire. Nobody really knows what the seller got, but if you saw the paperwork, you'd realize it was an acqui-hire.

Blair: Got you. Understanding The Reasons Why Someone Might Buy Your Firm, there are 10 reasons. I'm not going to list them all. We're already running a little bit late. Do you want to talk a little bit about flipping this around?

David: Yes. You could build your firm so that you could aim for one of these nine, you'd leave Aquahire off the list, one of these nine reasons, or more likely is you just stumbled onto a really good reason why somebody might want to buy your firm. What's not on this list, if you were going to flip this around and say reasons to sell your firm is, "I'm just tired of it." That's a really terrible reason to go to market, even though that's what drives much of the activity.

You can't talk about that. You should tell your advisor that obviously, because it's like your lawyer, don't hide anything from them unless you actually killed a person and then do. Do hide that from your advisor as well, would be my advice. If you're just tired and need to move on, then how are you going to explain this to the seller, because a seller is going to ask you why you want to sell? The age-old answer to that is always, "Well, we have always longed to play on a bigger stage."

When you hear that, most of the time it's not true. Most of the time, it's just, "I'm done and I'm tired." Sometimes it's true. Most of the time it isn't, but you have to really be careful about the reason why you're selling your firm. Now, the buyer does not have to be careful about why they're buying a firm, but you need to be careful about why you're selling a firm. Otherwise, that's going to show up.

This is why when you start to see yourself being less engaged, even if you predict that "Oh, I could see myself getting out of this in three to five years," you need to start thinking about it now because you're going to have to stay engaged through your sentence as well, otherwise known as an earn-out. The sooner you think about that stuff, the better. Going back to the very beginning, ideally, you're running a firm that's very sellable at a moment's notice.

That's the perfect outcome of this because then if that happens, if you get an opportunity, you'll not only have a firm that's ready to sell, you'll have so many of these reasons why they might buy wrapped up. You'll be profitable. You'll be growing all these other things. It's a win-win.

Blair: Run your firm like you're going to sell it. Run your firm like you're never going to sell it.

David: What about McDonald's? Don't forget the McDonald's thing.

Blair: Oh, and McDonald's. Run your firm like you're going to franchise it. Thanks for this, David.

David: Thanks, Blair.