Mergers & Snackquisitions
I happened to notice today that my old employer, Deloitte, bought Monitor Consulting this week. It’s an interesting news item – not the fact of Deloitte’s acquisition. Deloitte is a gigantic behemoth that buys more or less everything sooner or later. I more find the question of acquiring consulting firms to be an interesting question that is somewhat murky. Consulting firms, and I would assume limited partnerships in general, operate in a fairly different world than most businesses. The general firm model is that a firm has assets, and liabilities – liabilities are debts taken on in order to acquire assets, which generate cash. Consulting firms don’t really work like that – when they say “our assets are our people”, that’s not just HR-speak.
Believe it or not, a large part of consulting firms’ asset structure comes from its people. When employees make partner, they need to buy into the firm. This tends to involve big fat sums of money, which employees don’t frequently just have lying around – of course, the firm is more than happy to lend them that big fat sum of money. Which in turn becomes a loan at interest to the new partner – in other words, that partner’s loan becomes the firm’s asset. The firm actually gets a fair amount of cash from payment on those loans, which form a major part of operational cash. In turn, partners get equity shares that entitle them to cash income from the firm’s earnings. Then, when you retire, the firm buys out your equity in order to prevent dilution. Interestingly, Monitor was so far underwater that they actually have 300 “inactive partners” – retired partners for whom the firm was too broke to buy out. They never recovered their initial investment, and will be completely wiped out in the bankruptcy.
I have to wonder how these contracts shake out in bankruptcy. My guess is a nominal equity swap – Deloitte exchanges Deloitte equity for the now-worthless Monitor equity, and so Monitor partners become Deloitte partners. I would assume inactive partners get completely wiped out. Presumably Deloitte would be perfectly able to just lay down cash for the worthless Monitor equity and completely screw over Monitor partners, it’s not a good idea to start things off on a terrible foot with the Monitorians (if that’s what they’re called) whose contracts you’ve just bought out.
Which is the really odd thing – Deloitte basically laid down $116M for the option to hire Monitor’s complement of roughly 1,300. When a consulting firm buys another, you’re not buying much – there’s no luxurious office towers (usually rented), no factories, no logistics or distribution networks. The main hard assets are signed client contracts and the loans to partners, along with the liquid assets Monitor so tragically lacked. So when you buy out a consulting firm, what you’re really getting is the employees, which is why it’s so strange to me. The employees can always just walk away – and as Deloitte surely knows, many of them will do just that.
Jason Busch eloquently sets out the issue – while the success of the acquisition is measured in terms of the values of contracts close, the actual determinant of success is how many people can be integrated into the acquirer. Busch points out the large cultural gaps between the mid-sized firms like Monitor and the MegaMajors like Deloitte – which completes in the same “Strategy Consulting” marketplace, but has an approach very reminiscent of the IT consulting that is the big moneymaker. It’s a very different culture, and seems much more culturally challenging than integrating the huge wave of consultants who came over after Arthur Anderson went bust.
No great insights here – but I continue to wonder whether consultancies would work better if they had a dedicated management function instead of being run by former consultants. Law firms even more so. The skills required to be a master adviser and deliver high-quality work to a client is very different than the skills to manage a large and complex enterprise.