Do the various business models and opportunities for gaining competitive advantage in the talent management industry posited in this series present a replicable formula for success that leads to sustainable growth?

One barometer of insight into this formula: What exactly do potential purchasers of talent management firms look for when considering an acquisition, merger, or add-on? What resonates most with them? Based on 40 years of industry observations and experience buying and selling talent management firms, I have found that there are a select a number of key ingredients for success—for both buyers and sellers—in the talent management industry.

Current financial success

The most important criterion for purchasers is the current financial success of the business. No one is interested in taking on a “project,” so to speak. Revenues are important and drive the bottom line, which is the true measure of a business’s capability to consistently generate money. And consistently generating money is the first hurdle, followed by controlling costs, which together dictate margin strength.

Furthermore, high margins can often translate into scalability—taking advantage of replication as well as the opportunity to grow relatively unencumbered. For example, a technology platform that can deliver both assessment and training can be expanded to an infinite number of users by increasing memory and storage capacity at significantly less expense for each additional user.

Potential for growth

Despite margin strength, the guiding force for assessing company worth is a long and strong record of EBITDA (earnings before interest, taxes, depreciation, and amortization) growth. Companies are typically offered and bought on the basis of a multiple of EBITDA, not revenues. On occasion, a losing business—or at least a relatively unprofitable one—is bought for one or two assets that can bring considerable long-term value to that business.

For example, I was part of a firm bought for its unique selection technology that was converted into training product assets—and not for its bottom line performance. These assets brought value to the acquirer far beyond the people in the firm. So when two of the three partners left soon after the acquisition, the acquiring firm had already derived far greater value from the purchase of the product assets. Another example is a business that has all of the makings of success but needs a new direction or leadership cadre. These companies can often come relatively cheap, and increased value comes with a different business model.

The balance sheet

While EBITDA describes the current state of financial stability of a firm, it doesn’t tell the whole picture. Looking at the balance sheet will reveal the real long-term health of the company because it describes the accumulated liabilities, usually in the form of short- and long-term debt and payables against its assets. When the former are significantly greater than the latter, additional scrutiny is necessary.

It is possible that a firm’s profit and loss (P&L) can look healthy while its underlying financial burden is far too exposed to warrant a serious purchase decision. There is little question, however, that potential buyers and sellers will expect both the P&L and Balance Sheet to look healthy.

What have you, either personally or through colleagues, observed about the buying and selling of talent management firms based on their financial performance? Do you think the industry is valuing these firms correctly based on their financial performance?

Check out Steve’s full series, Managing and Growing Talent Management Firms.