Becoming ‘tech-enabled’
New methods are being developed for traditional person-based services. Organisations are being leveraging software to drive margins upwards and appeal to a wider client base and to drive margins upwards. Higher margins and a more deeply-embedded service into a client’s own processes is unequivocally positive from an investor perspective.
End-markets matter
Professional Services is a broad brush term describing a complicated ecosystem which covers almost every vertical and horizon. While consultancies now exist to advise on almost every aspect of a client’s business, the difficulty for an investor is spotting those that have the right mix of management talent and longevity from a product-market fit perspective.
In a very large and diverse sector, those businesses taking advantage of macro and societal driven tailwinds and avoiding exposure to cyclical industries are the most successful.
Most companies are struggling to adjust to the increasingly fast-paced nature of technological innovation, alongside having to fight with slowing organic revenue growth and rising costs as a result of the uncertain economic environment.
Organisations also need to comply with increasingly complex regulatory demands. Those service-based organisations who are able to offer assistance and advice to guide companies through this turbulent economic climate, are growing quickly.
Whether it’s a procurement consultancy helping to drive a best-in-class purchasing strategy and drive efficiency, a technology consultancy ensuring their clients understand the latest in cybersecurity or data analytics, or an organisation becoming the partner of choice for a certain professional service (legal, HR and software testing for example), if the end service is on trend, and the trend is likely to continue, half the battle is won.
The rise of minority deal structure
This is often an appealing option for founder-owners who are ambitious and would appreciate outside help, but who wish to retain the sense of entrepreneurship and dynamism that drives their business culture and growth. The founders are able to reduce risk by selling a stake, and equity incentives are used both to lock in existing management and incentivise the younger talent pushing for promotion and financial gains. This negates investor concerns around giving too much money to a small group of individuals within a business, and helps to secure the company’s key assets – its people. Fast growing businesses such as FRA (forensic accounting), Efficio (procurement) and Altius (data) are all flourishing with this structure in place.
It is now not uncommon for equity allocation within a professional services business to run to over 30 people, where traditionally in private equity only the top five to ten managers would benefit. Not every fund is comfortable with taking minority stakes, but those that do are finding strong and often high quality deal flow. Therefore, analysing project-based revenue further is allowing investors to capitalise on previously overlooked opportunities.
Embracing project-based revenue
In the most attractive businesses, investors are finding that previously concerning ‘project-based’ revenue streams are actually supported by a long track record of repeat work, often with a blue-chip client base and little personal relationship bias.
Client concentration risk can be a problem at the lower end of the market, but as businesses scale up and become a go-to brand in their niche, this issue becomes far less prominent.
Conclusion
Fundamentally, investors have woken up to the fact that there is money to be made by investing in people-led businesses, and the more success stories that are shared, the greater the likelihood that this deal activity will continue to increase.
Many of the mid-market’s most well-known private equity firms – Bridgepoint, Livingbridge, Dunedin, Graphite, Inflexion, for example – have invested in the sector. Over the next twelve months we expect to see a number of funds bring their investment to market in the hope of crystallising the value they have created. Expectations are high for interest levels and valuation, and if the businesses in the market can survive the glare of a sceptical, but increasingly open-minded investor universe, there is no reason why these expectations should not be met.
In order to benefit from increased PE investment in the sector, decision makers should look to:
- Consider minority deal structures to give more comfort to investors
- Gain exposure to more diverse end-markets
- Explore opportunities to use technology as part of their service delivery
