Consultancy Growth Finances: Cashflow vs Investment and Borrowing

An interesting divide between leaders that are still growing their firms and those that have sold their firms is that the former often proudly tell me that their growth is funded solely through cashflow, and the latter often tell me they wish they’d borrowed or sought investment for faster growth.

Growing From Cashflow

If you are going to grow solely through cashflow then it is important to manage this well because professional services are incredibly sensitive to cashflow challenges. This is not just because of the heavy people costs, which are hard to reduce at short notice, but also because invoices are often paid much later than salaries.

As the COVID-19 pandemic demonstrated, three months of losses, or even one big client refusing to pay, can quickly lead to a situation where staff are not paid and bankruptcy is not far off.

Cashflow Management Priorities

Strong cashflow management for a consultancy prioritises the following.

• Get paid up front or as soon as possible.
• Get invoices paid within 30 days ideally. Anything later than 60 days, add charges if suitable.
• Ensure promptly paid invoices are the responsibility of the project manager and linked to bonuses.
• With problem clients, usually a ‘letter before action’ will do the trick.
• Where possible develop assets for recurring revenue – this also looks better for investors in the firm.

How to Maximize Cashflow

Cashflow can also be maximised by what David Ogilvy described in his Principles of Management:

“To keep your ship moving through the water at maximum efficiency, you have to keep scraping the barnacles off its bottom. It is rare for a department head to recommend the abolition of a job, or even the elimination of a man; the pressure from below is always adding.

If the initiative for barnacle-scraping does not come from management, barnacles will never be scraped”.

Scraping barnacles early on often involves attention to your own lifestyle expenses, but later is primarily concerned with salaries. To some extent, salaries can be mitigated through significant performance related bonuses, a ‘high stepped’ three-year salary (low in the first year followed by significant increases), or equity.

Pros and Cons of Growing From Cashflow

Growing From Debt or Investment

Alternatives to growing from cashflow are growing from debt or taking on an equity partner (which can sometimes be a strategic investor such as another consultancy). Balance-sheet debt these days is relatively cheap and there are usually tax benefits.

Equity investment can be a benefit if the investor is providing additional expertise, a route to new clients or partnerships, or is a potential buyer at the end of the journey. Otherwise, equity investment for growth at an early stage is a more expensive option.

You should also be prepared for private equity taking a position on the board and holding you to account – especially if you fail to hit their targets.

Example of a Consultancy that Pulled It Off

The most significant early investment example I’ve come across was a consultancy that grew from nothing to a £500m business in 5 years. The founder acknowledges his good fortune in raising £100m in funding after the first year.

He didn’t particularly want that much money but the investors, with whom he had an existing relationship, didn’t do deals for less than this. It was a nice problem to have. This injection allowed the firm to recruit 150 employees and buy some well-aligned competitors, even if it also raised significant challenges for building and maintaining the firm technology, culture, and systems.

Example of a Consultancy that Didn’t

Consultancy Y had solid growth, a good reputation, and a solid family atmosphere. However, when COVID hit, they decided to take Private Equity investment to survive financially without sacking anyone. However, post-COVID, growth wasn’t strong, and the PE firm took a stronger and stronger interest in the firm which led to clashes with the founder.

As targets became more and more unrealistic, the relationship with PE broke down and the senior team were getting demoralised. Eventually, the company was put into receivership to liquidate its debts and the assets were bought by a third party.

When to Borrow or Seek Investment

Once you know you have a solid firm with great growth prospects, there is an opportunity cost to not borrowing/seeking investment for growth: bigger firms attract bigger multiples – a sub-£10m revenue firm will average a 7x EBITDA multiple, whereas a £100m consultancy will average 11x EBITDA. This is why private equity use a ‘roll-up’ strategy to maximise their investments.

Typically, I encourage firms to seek funding only when they are clear on what their company UVP is and what the investment levers for growth are. If, for example, salespeople or marketing investment are the primary barrier to growth, then it makes sense to borrow or seek investment to boost these areas. This should typically be done in a staged manner to minimise risk.

Pros and Cons of Growing From Debt or Investment

Conclusion

In summary, consultancy growth strategies, whether through cashflow, debt, or equity investment, each carry distinct advantages and challenges. Managing growth through cashflow ensures stability but may limit rapid expansion, whereas external funding through debt or equity can accelerate growth but requires careful consideration of its impact on firm culture and operations.

The choice hinges on the firm’s specific goals and market context, balancing the need for sustainable growth with the potential for increased valuation and scalability.