This Insight has been contributed by Steve Kaye, a personal friend, friend of the firm, and the CEO who negotiated and navigated the sale and initial integration of Hay Group into Korn Ferry – a transaction that significantly changed the profile of the human capital sector globally.
In it, Steve provides his thoughts and experience on the factors that professional services firm founders/owners/leaders should consider in determining whether to sell their firm, and on the prospective journey thereafter.
While it would be easy to focus on valuation, my experience suggests that this should be only one part of the discussion if you want to address the needs of all the stakeholders. Instead, I would contend that the real considerations should be:
- Strategic fit – based on an honest assessment of current positioning; then
- Cultural fit – based on the culture required to implement the target strategy; and only then
- Valuation – with careful consideration regarding the allocation of value.
I write this Insight based largely on my experience of leading Hay Group through its 2015 sale to Korn Ferry and then serving as the CEO of Korn Ferry Hay Group through 2017. I also had knowledge of the history of Hay Group from my role as CFO from 1998 to 2013 along with older history I learned as folklore passed down through the organization.
I also want to acknowledge the huge impact of Chris Matthews, the CEO of Hay Group from its management buyout from Saatchi & Saatchi in 1990 through my appointment as CEO in 2013, and then Chairman, who recently passed away. Chris was twice involved in the sale of Hay Group, but he also bought it back once. Of just as much importance in terms of learning, however, are the times when he didn’t sell – and why – as this provides just as much insight. I owe him a huge debt!
Nature of a Professional Service Firm
To the extent that there is an academic discussion about professional services firms, it is generally simplistic and tends to treat the professional services firm as just “another” type of organization, which is inadequate. The distinct nature of such firms has been little analyzed, other than by David Maister, although I don’t recall David writing much about transactions.
In fact, many of these firms, especially the smaller and the mid-sized, tend to have many distinct attributes: ownership is often dominated by insiders but also distributed across the organization; owners are generally engaged within the organization deriving compensation from their role as such; the aggregate “compensation” may have longer-term components involving pension, ownership or partnership rights; leaders often cannot rely entirely on the kind of direct command and control mechanisms available in other corporate entities; and, finally, being a partner or equivalent in a professional services firm is often so much more than just employment – it is a career, a lifestyle, maybe even a vocation.
And, if the firm is complicated, then so is the role of its leader. In most professional services firms, the leader of the organization is either the founder or a long-time member of the firm, who has climbed the ranks before ultimately taking the leadership role. In this progression, the leader is often not only the leader of the firm, but also its steward, responsible to the organization and its wider stakeholders and not just to a shareholder group. Moreover, governance and management may also be conflated with subordinate roles in governance and oversight positions. It is naïve to understate these components.
Before You Start
Perhaps my most important observation is that you should only seriously consider selling a professional services firm if you are very confident that you can deliver it. The downside risks of a failed transaction are enormous. In avoiding this, the role of the leader is critical. You not only need to win the argument based on the facts – the strategic fit, the cultural fit, the ability to execute, the quantum and allocation of the value but you also need to have the explicit trust of the organization. At the end of the day, they will look squarely at you and ask you “are we doing the right thing?” That’s a critical element in closing the deal and one, in Hay Group’s case, where Chris’ 20 plus years of leadership building trust on the big issues was hugely important. Carefully evaluate your ability to deliver the organization before you start down this path!
And if you decide to go forward, the discussion has to start with the strategic fit. What does a potential transaction bring that cannot be addressed internally? What is it in your current strategy that you are struggling to address? If the strategic rationale for the transaction cannot be clearly and compellingly expressed by a potential acquiror then turn, walk away, and don’t look back. I can recall a couple of discussions where interest was expressed in acquiring Hay Group that got no further than this simple question.
There are always challenges running a business, but they can generally be addressed without a transaction. However, as a leader, you need to honestly evaluate the state of your organization and your ability to meet the most important challenges.
You also need appropriate sounding boards for these discussions. It may not be something you want to discuss with an Executive Team focused on the execution of the strategy. Transactions are very destabilizing so think carefully about who you want to engage in these discussions.
This leads to the second consideration, culture. However, this is more nuanced than is often considered. Often, the question is seen as “how can we maintain our culture” or “are the cultures well aligned”. In my view, this is too simplistic. While a company considering an offer to be acquired, could certainly ask this, it must also honestly assess whether it has the culture needed to succeed. Not having the right culture is just as important a barrier to achieving your strategy as having the wrong product mix.
Good leaders also recognize that changing the culture of an organization can be incredibly difficult and, in my experience, often needs a major catalyst such as a leadership change, serious financial difficulties, or a transaction, to jumpstart, as well as lots of ongoing effort to sustain.
The culture question should, therefore, not be seen in terms of maintaining the status quo. Rather, it is whether a transaction will facilitate the right kind of change and develop the culture needed to execute the stated strategy.
A critical consideration at this stage of the evaluation process is to consider whether a potential acquiror can complete the acquisition and integration successfully. I think that this is a critical capability that acquirors need and that potential targets need to evaluate.
I recall a prior well-advanced situation where the potential acquiror underwent a change in leadership late in the process. This was fundamental in the sense that there was then no ownership of or commitment to the strategy outlined previously. Never has a late breakdown in discussions been so well received by all.
To be even more explicit on this point, I am saying that if strategy is an important basis for a transaction, you must be confident that the acquiror has the capability and commitment to ensure that the integration and strategy can be implemented. Otherwise, and however you dress it up, it’s only about the money.
Allocation of Value
And this brings us to the third and final consideration, what’s the value being received? And perhaps not only the value itself, rather than the form in which it is received and the way it is allocated.
Yes, the valuation must be adequate. It must meet the first test set out above – will you be able to close the deal. Can you deliver the firm? If it doesn’t and you don’t think that you can deliver, then there really is no point going any further, whatever the strategic merits.
Assuming that this hurdle is overcome, then I really believe that you don’t want to create obstacles to integration, and, in my view, earn-outs create barriers. Earn outs and measurement systems that focus on the structure of the legacy businesses are a disincentive to full integration. And if you aren’t integrating, then why strategically are you doing a deal?
I’ve used earnouts as a buyer and come to regret them. As well-designed as you think they are, you likely haven’t thought of all the potential ways these might influence behavior and decision-making, usually in an adverse way.
Another important element is the allocation of value between the past, the present and the future and here there is more of a potential disconnect with the potential acquiror than in other types of business. All other things being equal, the potential acquiror might seek to allocate much of the consideration to the present and even more to the future of the firm.
For the seller, much of the consideration is going to go to the owners of the business. However, you would be remiss not to recognize the present. Be prepared to address those who may not make the transition and have been a part of the firm. Funding enhanced severance provisions for a period after the acquisition is not unreasonable.
You must also address the future, there’s likely a group of talented individuals who missed out on participating as owners because they were a year or two away from being a partner or owner. Accelerate their participation to engage them and engage them early on as a part of the organization going forward.
A final remark regarding valuation is to be clear early on if your expectation is that owners be compensated directly for their ownership, especially if you have discussions with partnership-based organizations. I can recall discussions with firms who had more of a partnership structure where there was a greater emphasis on current compensation and individual value being realized through pensions and such like. It can be difficult to bridge the gap in terms of their paying for the equity as we had anticipated and while, in recent years, I think that this has become easier, it should not be under-estimated as a potential source of breakdown. So, address it head on and early.
Legacy Role of the Leader
As the leader of a professional services firm, you probably have one eye on your legacy. If you go through a transaction, your legacy will in large part be determined by the success of that transaction.
However, at an individual level, you must also enter that transaction with your eyes wide-open and recognize that there will likely not be a long-term role for you. While that’s not an inevitable outcome, there is plenty of evidence that suggests it is the most likely one. You’ve been the leader of a business and you won’t be in the future: a divisional CEO is not a CEO. Your freedom to act will be diminished and that’s going to be a shock to the system if you’ve been a leader for any extended period. You want to do the right thing and make the transaction work as best you can but ultimately perhaps the new role isn’t for you.
I tend to think that most people who come up through the ranks of a professional firm value the people and the “institution”. And, while they know that a transaction won’t please everyone with some undoubtedly “harmed”, they also hope that people will, after some passage of time and reflection, say – yes, I understand why it was done, they handled it pretty fairly and – with a bit of luck – they will continue with successful careers in the new organization and be able to reflect later as this being just one of many shifts in the organization.
If you challenge the strategic fit, are realistic about the culture, carefully assess the ability to execute, achieve the right valuation and allocate this appropriately, then I think that you stand a fair chance of achieving the right kind of legacy. And if there’s a position longer-term for you then even better, but don’t bank on it.
Authored by Steve Kaye