4 Lessons Learned From A Consultancy Due Diligence

I recently assisted an investment firm with the due diligence of buying a consultancy.

Of course, the investors did all the usual due diligence stuff – evaluating the P&L, balance sheet, contracts, client analysis, assets, and liabilities - to name a few - of the consultancy. However, on top of that, they wanted to gain a deeper understanding of the following four dimensions:

1. A special ‘reputation check’ (that’s why they reached out to me in the first place)
2. An assessment of the co-owners’ alignment on the growth strategy of the consultancy
3. An analysis of, what they called, the consultancy’s business infrastructure
4. An assessment of the firm’s performance against consulting-specific KPIs

I derived some valuable insights from this project that I believe all consultancies should pay attention to – irrespective of whether they are looking to attract investors.

1. The reputation assessment

Based on 200+ conversations I’ve had with consultancy owners, one thing is clear: most vastly underestimate the impact of their reputation.

Yet, in this instance, the investors were keen to understand if the consultancy owners had invested time and effort into building and maintaining their market reputation and had laid the foundation for a successful and long-lasting consulting firm.

The investors assessed the following dimensions of the reputation of the consultancy owners:

• Published works and thought leadership (the owners' voice in the market)
• Owners’ social media presence and quality of activity (ability to attract new business)
• Media mentions and interviews
• Professional organizations and leadership positions
• Industry recognition, awards, reviews, comments
• Feedback from clients (I did five interviews with core clients)

While I can’t reveal the results of my assessment (it’s not the main point of this post anyways), this assessment process reinforced what I’ve been telling my clients and readers for years now: The market reputation of consultancy owners/leaders is a critical factor that significantly impacts the success and growth of their consulting firm. 

My main lesson from this exercise – and what I hope consulting leaders will take away from this section – is: 

A strong reputation in the market can establish consulting leaders as credible experts in their field, differentiate their firm from competitors, build brand recognition, and attract potential clients seeking their expertise.

This special reputation assessment should be a wake-up call to all consulting leaders who think they can’t allocate the time to marketing their expertise through authority-driven, reputation-building activities. The reality: it’s imperative. 

Recommended reading: Consulting Leaders, Stop Outsourcing Your Thought Leadership Responsibility to Marketing!

2. Consultancy owners’ alignment on the growth agenda

This assessment dimension by the investors consisted of two parts:

• The alignment among the three co-owners (partners) on the growth agenda of the firm
• The alignment on the growth agenda within the core team of the firm

Here’s why they were interested in understanding internal alignment.

In old-school models of business development in consulting, consulting owners are pretty much independent and self-sufficient in running their practice. In a network-first approach, they are much more relaxed about 'what to sell and what to accept'.

But that’s not how high-growth consultancies operate in this day and age. Today, the digital-first go-to-market in consulting is more complex and requires disciplined internal alignment to remain competitive in crowded and noisy markets.

The co-owner alignment assessment by the investors was all about the definition of the positioning, focus, and expertise, combined with a strong co-owner discipline to stick to that focus and translate that into (scalable) marketing and business development efforts, including building an educational/content strategy (see part 1).

Poorly positioned consultancies will always struggle with a multitude of business development goals. They often get under mental pressure to start selling downstream availability (order takers instead of transformational experts) and usually begin overservicing the clients at a lower price.

My main lesson from this exercise – and what I hope consulting leaders will take away from this section – is: 

Consulting owners must find a way to actively ensure internal alignment on the growth agenda to function as a well-organized, digital-first consultancy with a laser-sharp positioning in the market. 

If they don’t lead the internal alignment and/or are misaligned amongst the co-owners, performance inevitably suffers. And that’s what the investors were trying to understand.

Recommended reading: Consultancies Must Rethink the Way Their Prospects Buy

3. An analysis of the consultancy’s business infrastructure

This dimension zooms out from the larger picture of the consulting firm’s market reputation and internal strategy alignment. It zooms in on the processes and mechanisms the consultancy has in place.

Here, the investors were interested in understanding two things:

• The infrastructure to run the business. Questions the investors wanted answers to include:
  • What is the software they use to operate the business?
  • How well is the CRM organized and drives business development?
  • How do they manage projects and people?
  • How is the sales pipeline organized?
  • What are the processes that nurture prospects and convert them into clients?
    
    
• The infrastructure to financially monitor and assess the business. What the investors wanted to know included:
  • What are the processes through which financial performance is assessed?
  • How are the targets set and communicated?
  • What type of financial infrastructure allows owners to spot weaknesses, make projections?

My main takeaway on this dimension is: 

Consultancies aiming for business growth can’t do so without having streamlined, organized systems and processes. 

The infrastructure behind the delivery of every client project must be documented and optimized every step of the way if firms want to maximize their profit margins.

Recommended reading: Replicate the Secret of This Highly Profitable Consultancy

4. Performance against consulting-specific KPIs

The fourth dimension – which most business people are familiar with – is the financials.

Due diligence is generally about understanding the performance of the business. Here, we’re talking about the revenue trajectory, the P&L and balance sheet analysis, the budget, the sales forecast, the cash flow, ownership structure, IP, partnerships, liabilities, risks, contracts, assets, and so on.  

In this instance, the investors did their due diligence on all of these ‘typical’ financial aspects. Of course.

However, on top of that, they executed a special assessment of these 10 consulting-specific KPIs:

1. Client: Client list and revenue per client breakdown (including understanding recurring versus one-time revenue patterns and client retention);
   
   
2. New business: Pipeline forecast, checking out the forecast disciple and quality (to understand the new project acquisition capacity) including number of leads, sales stage, average deal size, lead to opportunity conversion rate, and sales cycle duration;
   
   
3. Utilization: past, current, and forecasted utilization to understand the consulting firm's efficiency in utilizing its resources (or any reasons for deliberate goal deviations);
   
   
4. Revenue: per FTE (increasing when growing), driven mainly by project size, utilization, efficiency, and pricing;
   
   
5. Cost of sales (decreasing when growing), driven by factors such as marketing & sales costs, competition, differentiation, reputation, visibility in the market, sales cycles, or client referrals;
   
   
6. Pitch power: Win rates and win/loss analysis to understand the power and authority in the pitch;
   
   
7. Risk: Client concentration to understand dependencies on too few (big) clients;
   
   
8. Quality of work: Post-project client satisfaction;
   
   
9. Stability: Consultant/team retention to understand how well the consultancy is managed;
   
   
10. Margin: Gross margin per client, per project, per service, and total (expectations: north of 50%).

Consulting business, like any business, has its own set of rules and expectations. Profit margins are expected to be significantly higher than in many industries. 

Considering how much of a “people-first” industry it is, high employee turnover signals trouble to the firm's growth prospects. Given how reputation-dependent the consulting business is, referrals and return clients can make or break a firm.

My takeaway on this is:

There are dozens, if not hundreds, of KPIs that can indicate how well or poorly their firms are performing. However, without a solid foundation for measuring the core activities, processes, and project organization, trying to fix the problems will be fruitless.

Consulting firms that struggle with multiple performance indicators should take a step back and re-evaluate how they compete in the market.

Recommended reading: Why You Should Reverse-Engineer Your Consulting Service Offering

In conclusion

I loved the experience of working with the investors. 

I had a chance to take a step back and look at a consulting business from another perspective – that of an investor. It was an opportunity to look at a business in a much larger context and, at the same time, zoom in on dimensions many consultancies don’t even consider. 

Creating a reputational footprint is not just a solid business development strategy. It’s a factor that measures the health of a consulting business.

Internal alignment is not just something that’s important for maximizing the ROI. It’s also an indicator of the growth potential of a firm.

Business infrastructure and performance against industry-specific KPIs are not only there to ensure efficiency and measurability. They indicate whether a business is a well-oiled machine or employs a “gut feeling” strategy.

An insightful experience, truly!

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