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A look at the UK M&A market for professional services firms

  • United Kingdom
  • Corporate
  • Mergers and acquisitions
  • Financial services

12-07-2021

UK professional services firms are continuing to become more attractive targets for M&A activity. This briefing looks at the some of the key factors currently driving deals in this sector and examines the key areas (and some recommended approaches to each) that we would recommend any potential acquirer of a professional services firm considers from the outset.

While activity in the sector has been buoyant for some time (and in large part unaffected by the COVID-19 pandemic – Mergermarket data shows that M&A in the European financial services and business services sector saw 118% and 57% increases respectively in 2020 as compared to 2019) there is a confluence of market factors that looks likely to further drive transactions in this space. In the last 12 months Mergermarket data shows that a total of £41.5bn was spent on M&A with a target in the UK consulting services sector and (while this figure incorporates a handful of extremely large deals) there is no reason to believe that this level of investment will not be sustained in the medium term.

The most pronounced recent market trend is that many external investors and private equity houses (some of whom are sitting on significant amounts of “dry powder” unspent capital) are becoming alive to the high-margin nature of professional services businesses and the reliable income streams these firms generate from recurring work and established underlying client relationships, particularly if an acquisition leads to the creation of a scalable platform for further seamless bolt-on and integration of similar businesses. Additionally, investors’ increasing familiarity with the sector has mitigated concerns that may historically have been present and warned acquirers off (for example around the regulated environment in which many firms operate), creating a favourable climate for further activity driven by greater market understanding and arguably higher risk appetite.

Aside from external investors, there are also many opportunities presenting themselves for existing market participants. While organic growth may take years to achieve, the strategic acquisition of an already established business or team can allow a professional services firm to rapidly “buy growth”. In addition, the increasing sophistication of professional services firms has also led many to invest significantly in IP and IT (for “in-sourcing” of processes as well as to enhance its offerings to clients),   additional/adjacent capabilities, and expansion into new geographies.

M&A activity can also be a consolidation exercise to acquire competitor firms or, conversely, a disposal of legacy or non-core practices or those which cause conflicts with other parts of the business. It may also be driven by external factors such as regulatory changes and reforms, with private equity firms again not averse to acquiring businesses that have been spun out of existing businesses for these reasons.

Against the backdrop of this increasing focus on the professional service sector, we have identified six areas anyone considering M&A opportunities in this sector should specifically consider at the outset of any transaction or when otherwise evaluating an opportunity:

  1. Employment

The professional services sector is fundamentally a people business, where the quality of the products and services (and therefore the underlying value of any target) is determined by the quality of the human capital delivering it. Retention of key individuals post-completion is therefore often crucial and it is worth remembering that some professional services firms are owner-managed (meaning that management will also be the sellers of the business and counterparty to deal negotiations). Contractual mechanisms such as earn outs, contingent consideration, retention payments, and share incentive or other bonus plans may incentivise key individuals to stay, while strong non-compete and non-solicit clauses in purchase agreements and employment contracts can protect the business if these individuals leave.

On asset sales, it is important to remember that the Transfer of Undertakings (Protection of Employment) Regulations 2006 (“TUPE”) will apply, meaning that a buyer will inherit a workforce’s existing employment T&Cs and be constrained in terms of making changes to those T&Cs or the makeup of the workforce. If TUPE applies there will also be a need to inform and consult with the workforce prior to the acquisition, which should be built into the deal timetable.

Finally, professional services firms often have a strong internal culture so  there should be a good cultural fit with any business being acquired. An M&A transaction will also often mark a real shift in the organisational dynamic of a firm (for example once it is subsumed within a much larger organisation, becoming subject to that organisation’s policies and procedures). As such, clear communication from the outset on the reasons for the transaction and understanding and managing the real life implications (e.g. a cultural shift and changes in management processes, decision-making and autonomy) could prove very valuable in the long run. 

  1. Client Base

Reviewing key customer contracts is a given for any business and any unusual T&Cs in key client contracts will clearly raise a red flag in the context of due diligence. It is therefore important to understand which are the key clients of the business (e.g. in terms of revenue generation) so their contracts can be properly assessed. Equally, evaluating the client portfolio as a whole and understanding the client engagement structure in light of the transaction is also important. For example, on a share sale, are there any change of control provisions in the contracts? On an asset sale, do any contracts prohibit assignment without consent? If consent to assignment needs to be sought, what is the timing and engagement strategy for doing this? If a client does not move across with the business for whatever reason, should there be an impact on the consideration payable, or is any client so crucial that their successful transfer needs to be a condition precedent to the transaction?

Diligence should also cover whether the buyer has the relevant expertise to match the target clients’ sectors and whether there are any conflicts of interest with the buyer’s existing clients (e.g. in accounting firms, an audit client cannot also be a consultancy client). Further, in terms of the post-completion approach to clients, buyers should consider how to strike a balance between a systematic structure which gives the benefit of scale and consistency, and an individualised client management structure which allows a more tailored offering and which existing key clients might expect to continue.

  1. Regulatory

Dealing with professional services companies may require regulatory approval in relevant jurisdiction(s). In the UK, finance and insurance companies and key individuals involved may require FCA and/or PRA approval in the context of an M&A transaction. On a share sale, an FCA and/or PRA change of control approval may be required. On an asset sale, the buyer must ensure it has the relevant regulatory permissions in place to operate the business seamlessly from day one post-completion (and if it does not, it will need to acquire such permissions). Certain businesses may also require consent from relevant professional bodies for a transaction (e.g. ICAEW). All these processes can be very time consuming and failure to obtain the necessary approval could well be fatal to the deal. As such, good transaction management should take into account early engagement with relevant regulatory bodies, time for application preparation, submission and further questions (which can stop the clock on the review process) as well as split exchange and completion if necessary. Also, relevant contractual provisions such as conditions precedent, pre-completion gap covenants and contingency plans in the event of failure to obtain regulatory approval should be taken into consideration to provide protection for both parties. Finally, if buyer and target are competitors or are otherwise operating in the same market, the parties should consider merger control issues at an early stage in the transaction to avoid surprises and allow the need for any clearances to be built into the transaction structure.

  1. Data Protection

The nature of professional services firms means that potentially large quantities of personal data will be held, ranging from information on employees to contact names and details of clients. As such, buyers should think early about whether there are appropriate data protection processes, safeguards and consents in place to cover the intended processing and use of personal data following the transaction. For example, for what purposes have clients consented to the use of their personal data? Will new or repapered consents need to be obtained as a result of the new owner of the business? Marketing is often a key activity for professional services firms so have clients consented to use for this purpose? Is there any cross-border transfer of personal data? Any breach of data protection law comes with potentially serious financial and reputational consequences, so buyers should be extra diligent in assessing whether sufficient data protection policies and practices are in place with the target and address any likely or actual breaches.   

  1. Integration

To maintain target value, it is in all parties’ interests to ensure seamless continuation of day to day operation in the target from the outset. The integration process should be considered and actioned during negotiations and not left as an afterthought to be dealt with post-completion. Depending on the nature of business being acquired, a detailed transitional or management services agreement may be required to govern the provision of support services post-completion (as well as the costs for providing them, which can go to overall deal value).

However, similar to the points made on employment, integration can often be as much a cultural issue as it is a matter of infrastructure alone. Parties to a transaction should work together to stay close to the business and the people at a grassroots level to ensure that everyone feels part of the business and understand the value of the transaction to the larger business and impact on the individual.

  1. Corporate Structure

It is not uncommon for professional services firms to adopt more unusual corporate structures. Limited Partnership and Limited Liability Partnership structures, which many professional service firms tend to be, can be cumbersome to deal with from an operational and governance perspective and tricky to integrate within a buyer’s existing corporate structure and compliance/reporting processes. These structures also make purchases of the relevant operating business more difficult as partners will need to be bought out in their capacity as partners and – if they are to be retained – converted to employees. This will require consideration as to how to maintain or replicate the selling partners’ economic interest and there will be personal tax implications for the selling partners that will need to be addressed.

If you would like to discuss any of these issues in further detail, please contact us.