Episode 101 Transcript

Brent Trimble: Welcome to the Professional Services Pursuit, a podcast featuring expert advice and insights on the professional services industry. Welcome back for our final installment of the Kennedy Intelligence Series. This has been a deep dive into what it really takes to scale a services firm past the elusive $30 million mark.

Today, we're tackling probably the most overlooked part of growth: operations. It might not be the most exciting part of running a services business, but ultimately it's the foundation. From pricing and cash flow to quality control and governance, your firm's back office is where scale either happens or hits a wall. Unfortunately, if your operating model lags behind your growth, your margins, cash flow, and even client experience will as well.

Welcome back Alex and Ramone from Kennedy. This one is really close to home for us at Kantata, so I'm excited to dive in and get into this one. Before we do, and if listeners have not listened to our previous installments, if you can give us just a quick intro about yourselves and then we'll dive into the content. Maybe, Alex, do you want to go first?

Alex Klein: Sure. Thank you, Brent. Alex Klein. I have 30 years in consulting as a consulting practitioner. I spent the first part of my career with A.T. Kearney. I left Kearney along with a handful of other Kearney consultants and founded Efficio, which became a leader in procurement and strategic sourcing. We grew that from five of us to 1,200 full-time employees. Though successful, I was there as a founder for 23 years. I sold my equity, left a couple of years ago, and since then have been working with Ramone as an advisor to consultancies looking to scale up and exit.

Brent Trimble: Ramone, how about you?

Ramone Param: Ramone Param, Managing Director of Kennedy M&A, also heads up the strategic advisory business at Kennedy Intelligence. I've spent about 20 years in the industry, advising professional services firms on growth, scaling, mergers and acquisitions, and preparation for sale.

I started my career with the Macquarie Group, then joined PricewaterhouseCoopers global corporate development and strategy team. I spent a lot of time there on strategy for the advisory firm in a critical juncture of the industry, and also looking for potential acquisition opportunities globally for the network.

After PwC, I took on senior roles at different boutique investment banks, all advising, consulting, and professional services firms. Even on the sell side, advising on businesses that are preparing for a future exit or looking to sell. On the buy side, advising large professional services acquirers and investors on finding acquisition opportunities in the industry.

Looking forward to our discussion. Thank you for having me back, Brent.

Brent Trimble: This is great. For the listeners, I should point out that in the show notes and at the close, we’ll let you know where to access Kennedy Intelligence and all the great data that the firm provides around the state of the consulting industry.

Having had growth and consulting roles myself in the past and struggled to scale, I went through all the growing pains. Sometimes, even in a larger consulting firm, just operations that weren't that mature, we all struggled with. I always had this notion that operations in a well-run firm help underpin the conditions for success.

Alex, in your experience, what are some of the most critical, potentially overlooked elements of back office maturity that you see in your experience growing several firms and then consulting at firms that are so critical, and why are they so important?

Alex Klein: Some back office functions are more important than others. In my experience, there are quite a few things in the back office that really are critical: pricing, cash flow management, cash collection, intellectual capital management, training, recruiting, candidate interviewing, staff performance management and career management, and engagement quality control. Quite a diverse number of things through which the back office can make a difference. I'm sure we'll talk about a lot of these in this episode.

Just to pick out one, quality control to me is crucial. It's often overlooked and often done informally. What I see is this is where firms or the founders lose control as they grow because they have more projects, more new people, and they don't have visibility over whether those projects are doing a good job, and whether they're doing things consistently and in our way rather than being a collection of disparate projects with freelancers each choosing their own approach.

Quality control, in my view, goes beyond controlling the performance of individual projects. It is a mechanism for ensuring that we're using consistent approaches across the teams and, therefore, ultimately, it's a mechanism for building a culture. You can't have a unified culture if you're a collection of teams all doing things differently.

At Efficio, we worked very hard at quality control. We ended up with a system whereby it was mandatory that every project had a blue team. It was mandatory that every proposal had a red team. That made a huge difference. It really upped the quality and, to my point before, it drove consistency across projects, consistency in methodology, consistency in project and client management approach, and consistency in how we price and how we built. In the case of Efficio, quality control was definitely one of the key drivers of our success.

Brent Trimble: That's a really interesting point. You were ensuring the quality of proposal; tonality, voice, commercials, pricing, and really setting good expectations. Protecting the firm as well as the client is important—good fences build good neighbors. Everyone agreeing before the engagement kicked off is crucial.

In the engagement itself, reviewing deliverables and splitting those into a red team and a blue team review and making that part of the process is fascinating. I would say, having discussions with as many consultancies as we do, quality control does not come up as a key driver.

Ramone, do you have any inputs on that in the work you're doing with helping scale consultancies?

Ramone Param: Following up on that quality control point, we’re often looking at different founder-led professional services firms. There are those elements that Alex mentioned that are under scrutiny. Amongst those firms are high performing. I’m thinking of things like looking at margin, high performing consulting firms, seeing that they have KPI dashboards in their business to monitor margins, utilization, pipeline, cash.

Having a disciplined approach and culture around things like working capital, governance around projects that are bringing in the right projects that are at the appropriate margin to enable client work that's at the right profitability levels. That point Alex mentioned around, I guess, knowledge management, I see that being very important.

A lot of founder-led consulting firms are often just reinventing the wheel on each project if they haven’t got it right. When you’ve got codified intellectual property, knowledge management processes, you’re able to institutionalize that knowledge. Even if key consultants leave, that knowledge is within the firm and, more importantly, you’re not reinventing the wheel on each project.

What does that really mean? Why is that important? My perspective advising firms are scaling with a view to a potential exit at the back end. All of these quality control points can feed into bottom line EBITDA margin and EBITDA margin growth on a sustainable basis. Thinking about what strategic buyers, investors are looking for when they’re assessing a professional services firm as a potential acquisition opportunity is critical. The pay off you’ll see through margin improvements and ultimately a potential better valuation when you look to exit.

Brent Trimble: I’m just going to restate these. KPI monitoring on quality of earnings, margin utilization, pipeline cash, day sales outstanding, working capital discipline, project governance to avoid the write-offs. In the previous episode, Alex was talking about how clients perceive billable hours as so fungible; the ability to control that and then codifying IP and knowledge reuse for velocity, all that benefiting an exit but probably just good to do as you scale anyway, right?

Ramone Param: Absolutely.

Brent Trimble: What we hear a lot, and we've talked about this in previous episodes, is just the notion that the cost of entry into consulting and services is low. You could get some folks together who have some industry expertise in a key vertical or come from big consulting, want to start their own firm, get together, get a couple of clients, and start driving growth. The belief is we'll fix the back office once we grow. Why do you think this backfires? What are some early signs? When you go in and diagnose a firm and you're consulting with a firm, what do you see that you can immediately note is a drag on the business?

Alex Klein: I think to some degree it's natural. As you say, the entry barriers are low. Most firms start with a couple of people or three or four people, and they just come from a place of not needing a back office. They never grow out of that mindset. At Efficio, we did a lot of things very well, but the running joke was that our back office was always too small. It was never fit for purpose. We'd review it, we'd increase it, and three months later, it would not be fit for purpose anymore. The back office never seemed to keep up with the growth, I guess, because the growth just creeps up on you. It is critical. If you don't have that back office, then you're just a loose confederation of consultants doing consulting work and you've got nothing of value that you can scale up.

Brent Trimble: Ramone, when you're going in, pre or post, or preparation for M&A, what are symptoms that you identify early and often in that process?

Ramone Param: When we have firms that approach us, they're saying, "Look, we're looking to prepare for an exit." Often, they approach us just as they're looking to press the button on selling the firm. This idea of operational inefficiencies is thought of when they were in the growth phase and continued throughout the lifecycle, which is a common theme that we see.

Often, a business comes to us at $15 million to $20 million of revenue or more. They've experienced high growth, feel that they're at a good scale, and they're ready to look at a potential exit. We then look under the hood, undertake a financial analysis, and realize that they're full of operational inefficiencies, some of which they don't even understand themselves. They're not benchmarking their margins and cost profile against the broader professional services industry.

We look at that and say, ultimately, you need to spend the next 18 months or longer on margin improvement initiatives to improve operational efficiency and your EBITDA margin to get them at a level where you're going to be competitive with the market and get the right valuation for your firm, attracting the right buyers for your business.

It's a very common theme that we see. It's often linked to a lack of discipline from the onset when a business is growing that continues as they reach a scale they think is optimal to start considering exit options.

We often advise professional service firms to get that discipline right upfront, monitor the operational efficiency initiatives you can undertake as you're growing, and that ideally will then feed into an optimal margin as you get to those larger scales and start to think about exit or investment options.

Brent Trimble: We've probably all had that experience with a founder, a team, or maybe a leader. We're racing. We use the shark analogy all the time: consultancies are sharks; they have to keep swimming or eventually drop to the bottom of the ocean floor. This idea that we'll make it up in volume or the next big deal will cure a multitude of sins. What are some examples or early symptoms you see when you go in and diagnose a firm around these ideas of maybe lack of discipline?

Ramone Param: I'd say we sit in just reviewing the cost profile of a business. There are certain operational costs which are higher as a percentage of revenue compared to the market. You also see it in specific processes as well—working capital fluctuations, identifying that clients just take a long time to pay invoices are probably symptomatic of a lack of discipline in chasing up cash at the right time.

Forecasts are often swinging wildly. I've seen that often. Consulting firms that we’ve worked with don't have a good handle of what their forecast should be on a month-to-month basis. That impacts the team, sales, staffing, and financials.

Importantly, it can impact staff morale. I've seen in many consulting firms where consultants aren't happy because they're not spending time on what they love doing, which is the client work, the strategic thinking. They’re spending time on chasing up invoices or waiting for some reimbursable expenses to hit and focusing their time on operational initiatives because it isn't being handled appropriately in the back office. That impacts staff morale and, in the worst cases, can result in high-performing consultants leaving the firm.

Brent Trimble: The things you mentioned here: profit, margin being tracked, forecasts swinging wildly. In some of our previous episodes, we talked about what acquisition partners look for, investment partners, and predictability. Are you able to hit forecasts with reasonable accuracy? In services, sometimes there's big fluctuations with deals, staff turnover, employee satisfaction, and then working capital, day sales outstanding. How many firms, just anecdotally, when you're going in and looking, either are measuring these or have to scramble? Are there highly disciplined firms that use platforms and systems effectively to manage these on a daily, weekly, monthly basis?

Ramone Param: Most of the firms I work with are scrambling. They're looking for data and they're getting their forecasts wrong. There are obviously firms that I’ve come across that have got it right. They've got the right dashboards in place. They monitor these KPIs, but they're a minority of the firms I come across at the scale of firms that we work with that are preparing for an exit.

Our growth advisory clients at Kennedy, I think that's important, just in terms of a disciplined approach to sustainable profitability as you're growing. It can also impact right in the middle of a deal. I've seen in many instances where firms have finances that are all over the place. They’re scrambling with the data. It extends the timing of a process because buyers can't undertake that due diligence properly. They start to lose confidence in the management team if they're not tracking these things correctly.

It not only can impact the firm on its growth journey for the reasons mentioned, but also it can impact them in the middle of a deal. In some instances, it can scupper a transaction or result in a price trap.

Brent Trimble: Nobody wants that. That's really interesting. I've been through a few M&A cycles myself where there's been a hidden bad surprise in the numbers. To your point, it slows down the deal, makes everybody pause, maybe drives down the exit and the valuation.

Alex, you've had some really great insight around the type of talent to hire and the type of organization, back office structure to put in place. We've talked about practices, but let's pivot a little bit to people.

In your estimation, a firm is growing and expanding. When does it make sense to go beyond maybe a split role controller or chief operating officer and break those functions into dedicated leadership roles? A full-fledged CFO or a full-fledged COO are obviously ELT members, so there's a big investment in salary and everything that goes along with that. Do you have a rule of thumb or, in your experience, thinking about our listenership—folks that are growing their firms—what's that tipping point in your estimation of when to break up these functions and bring in some heavy hitters?

Alex Klein: In our case, in the case of Efficio, we didn't bring in a fully fledged CFO until quite late, until I think we were about 16 years old and had 600 people. This time we brought in a private equity investor who was pushing for the CFO. We actually didn't think we needed it. We were quite happy with our financial controller, and they pushed us to do it. They said, "You've reached the point where you need a proper CFO." You then, of course, have to pay proper money to get that kind of person.

We brought this guy in. We made him the highest paid person in the business because you need an executive level person that you have to attract. We were skeptical and felt a little bit forced to do it. Within a few months, we realized that this person was absolutely transformational to the business. While the founders were running the business, he was in parallel running the business purely from a cash flow perspective, which was really eye opening. Cash flow was something that had dragged behind for us for years; he made it front and center. It made sense to start doing that at that time because we started growing very fast.

After we brought in private equity, I think we tripled in size over about three years. When you grow that fast, your cash is tied up in work in progress and accounts receivable, and your cash conversion doesn't keep up with your growth. As Ramone will tell you, if you're looking to sell your firm or bring in an investor, you'd better have good cash conversion. Certainly, as far as financial investors are concerned, cash conversion is definitely one of the Achilles heels of consultancies.

That was a key part for us, fixing cash conversion, which was all about bringing in discipline, billing more quickly, collecting more efficiently. It needed someone to bring that discipline in and push for that. It was clear to me that this couldn't have been done by our junior financial controller, who was junior to the founders. We needed someone who was a peer that the founders would listen to and someone who could push the founders.

That worked extremely well. We turned around our cash collection and realized that you needed a functional professional to fix the cash conversion. A bunch of consultant amateurs can't tackle that issue. You need to know what you're doing.

In terms of a COO, we talked about that, but we never brought one in because we felt that our CFO covered a lot of the areas. Beyond the CFO, we did have a large ops team, and they covered a number of key areas: staffing, staffing of people on projects, intellectual capital, so building the intellectual capital platform, making sure the IC is captured and accessible to people, and quality control. The day-to-day operation of the offices and travel were also part of this.

A number of core functions sit under the potential COO role. I talked about quality control. Staffing is worth talking about a little bit as well. Staffing is absolutely key because if you don't get that right, then you don't have the right people on your projects, or your people are unhappy because they're doing something they don't want to be doing. It's key to get this right, especially in this day and age when employees have a much stronger voice than they used to have.

In my day, you'd get a call on a Thursday, get on a plane tomorrow, and you're going to Saudi Arabia for three months. You'd have no choice. That's totally changed. On one hand, you've got clients being more demanding about what resources they want to allow through the door. They're screening your CVs and interviewing your people. On the other hand, your people are more demanding in terms of what they want to do. You need someone who squares those things effectively.

Staffing has become infinitely more difficult as employees have had a larger voice and more choice.

Brent Trimble: Absolutely. To your point, those days are probably existent in some pockets of consulting, but it's a much different world than even a decade ago. That demand and the experience of arriving at your office hub on Friday to catch up on expenses, then being alerted you'll take off again on Sunday evening for a three-month engagement, has changed significantly.

Ramone, regarding the question of CFO, COO, and when to bring in those dedicated roles, what are the key triggers or inflection points? What is your take on this, especially when working with firms that are preparing for a capital event or an exit?

Ramone Param: I think some of the same themes that Alex touched on resonate firstly around scaling complexity of a business. As that increases, the need for a CFO or COO, or both, becomes increasingly important. I've seen circumstances where I've found that consulting firms have grown, they've gone past the $15 million to $20 million revenue mark. All of a sudden, you've got multiple LLCs managing different parts of a business. You've got overseas entities. You need to consolidate all those accounts into one single financial statement. On top of that, you need to monitor all those different moving parts of a business that become increasingly complex. All of that lends itself to having a CFO that has a strategic view of using financials to guide strategy. A COO that's able to improve operational efficiencies becomes increasingly important.

I have seen many firms look at earlier phases of growth, fractional CFO. You can bring in a CFO that's not necessarily full time if you're concerned about the cost of that. There are many quality CFO firms out there that offer fractional CFO services tailored to professional services industry with a vision to helping firms that are looking to prepare for an exit. We work with a bunch of firms like that. That’s increasingly important as you're approaching a potential event. Buyers or investors, if they're looking at your firm, there’s a lot of scrutiny that goes into your financials. They want to see that your forecasts are defensible. Having a CFO that can handle that means that buyers don't get bogged down in going back and forth and questioning. It makes the whole process a lot smoother and a more likely successful outcome without building loads of cost for the process.

A COO, I believe, also becomes very important as an engine for value creation in an organization. I'm thinking of improvements in operational efficiencies through transparency and clarity through the organization on KPIs. Documenting knowledge and making sure that it’s readable across the firm. Bringing in a COO dedicated to that function can be a turning point for organizations as they breach the $10 million revenue mark and look to scale beyond $30 million in the future.

The other point I'd make with the M&A hat on is the idea of key men dependency. When they're starting off, it's a founder-led business, dependent on the founder or founders of the firm. As you're looking to scale, to reduce risk, it's important to spread that key men dependency across people who have strategic and operational functions in the organization. Buyers look favorably on firms that have a CFO, a COO, a board in place where there's not huge amounts of dependency on just one or two individuals. It's spread across key people in the firm.

Brent Trimble: In our previous episodes, you and Alex talked about the firm and the dimensions of the firm that have high client concentration, like in one or two clients and spreading that out, having more horizontal depth in the revenue. In this case, you're referencing too much leadership concentration. The firm is just too reliant on one or two key individuals and spreading that around is a really interesting idea as well.

I think our last theme as we wrap this episode is the idea about governance, board governance, oversight. You don't hear this as much in ascendant consulting firms. What's our board? Who are we accountable to? In talking to you prior to coming up with the ideas around this episode, you'd said that those with strong governance outperform, are more resilient, and have higher valuation.

Alex, I'll start with you. In your experience, what does good governance look like in a firm of the sizes that we're talking about as they’re scaling to that $30 million and how can it become a competitive advantage?

Alex Klein: Good governance essentially at the end of the day is about having a disciplined, effective cadence of meetings through the company, and all of those meetings being underpinned by the data and the KPIs that are needed in those meetings to make decisions. Those meetings might look like a formal board with quarterly board meetings. Then at the next level, a management team with monthly management team meetings, a weekly BD meeting, a weekly recruitment meeting if you're growing.

Firms tend to do these things very informally and decisions tend to be made by the founders by the watercooler rather than in a formal setting. What helped us was private equity coming in. That is clearly one of the benefits of private equity: they'll professionalize you. In our case, it was like flicking a switch. One minute we were like a little family. The next minute we had all these meetings and all the data and all the KPIs. We suddenly ran like a big machine because we were pushed to do it.

To your question, how does good governance drive competitive advantage? In essence, it makes the business run like a well-oiled machine. You get more leads, you win more proposals, you make better hiring decisions, you have better cash flow, etc. The governance enables you to scale up by processizing and making everything repeatable in a way.

Brent Trimble: Ramone, from that M&A vantage point, what do you see in terms of indicative signs of good governance or potentially where it's lacking? How do you counsel firms in that space?

Ramone Param: Good governance that we see as businesses are scaling up, creating a balanced board, includes founders and independent non-executives. They're meeting on a regular basis. They have accountability for value creation across the firm. I think that's very important. That really leads into this idea of incentives across the senior team, linking that to value creation for the organization broadly.

We spend a lot of time counseling boards and strategy teams on what that can look like, those incentives around broader value creation. Good governance can be a lever to that when you have a balanced board with non-executives providing oversight. I’d say around that idea of value creation, good governance should also include ethics policies. The idea of sustainable value creation and providing that oversight around ethics, along with profit creation, is important.

The idea that we talked about on KPI and monitoring, I think good governance is about meeting regularly. Going back to the dashboards, checking in on detailed views of margin, cash, pipeline, and people statistics is often overlooked by most professional services firms that are in growth mode looking to that $30 million revenue mark. Those that get it right benefit through growth and profitability in most instances.

Brent Trimble: Everything you shared around the governance levers, would you agree that these could be put into place even as a firm is in their ascendant stage of several million dollars? It just becomes rigorous muscle memory. There's accountability to forecast, to deals, to client satisfaction, succession plans and practices that can be put into place before a firm gets to the bursting-at-the-seams idea of an exit or bringing on an acquisition or capital?

Ramone Param: Absolutely. We do work with them to try to get that right upfront.

On that point of whether it is too early to consider these things at those initial phases of growth, I really don't think so. I have seen bad stories occur where firms didn't get it right in those initial phases and they've had to deal with it later down the line.

A firm might start to grow and see rapid growth ahead. Their operating agreement isn't correct. The incentives amongst the management teams are misaligned. You have people that are not pulling their weight. It becomes difficult to realign those incentives as you start to grow.

Getting it right up front makes it a lot easier. It can also act as a fuel to grow a lot more quickly if incentives are aligned correctly and they've been bought through from the get go.

Brent Trimble: That's great insight. As we wrap here, I think this series has been packed full of tactical, applicable insights that firms can utilize. I feel in some ways we saved the best for last, because this has been full of real life examples, areas, and ideas, particularly things around quality assurance that many consulting firms don't focus on. The systemization of KPIs is crucial. Operations aren't sexy, but they are crucial. They build and underpin the conditions for success.

As we wrap up this series, the biggest takeaway is that growth isn't just about landing bigger deals, though everyone would like bigger deals. It's about building the system, structure, and culture that can support them. For our listeners, I hope you've enjoyed the series with Kennedy Intelligence. I know I have. We hope these conversations help you scale with more clarity, resilience, and impact.

If you have any follow-up questions or want to get in touch, send us an email at podcast@kantata.com. We'd be happy to get back to you. I encourage listeners to receive exclusive preferred rates on Kennedy's market research, strategic advisory, performance improvement, benchmarking, and M&A services tailored to leaders of professional services firms. Reference Kantata to receive preferred pricing on any of their assets or services. Go to kennedyintel.com to learn more.

Ramone and Alex, thank you so much for the series. This has been insightful for listeners. We look forward to promoting it and appreciate your time.

Ramone Param: Thank you, Brent.

Alex Klein: Thank you.

Brent Trimble: If you enjoyed this podcast, let us know by giving the show a five-star review on your favorite podcast platform and leaving a comment. If you haven't already subscribed to the show, you could do so anywhere you get podcasts on any podcast app. To learn more about the power of Kantata’s purpose-built technology, go to kantata.com. Thanks again for listening.