Insights | Apr 01, 2019
By Tom Kosnik
Pundits tell us to always be managing a business as if you are positioning to sell it. This advice is prudent for several reasons. First, one never quite knows when a deal or aggressive buyer is going to come knocking. If an opportunistic buyer does call, you want your business to be positioned to secure the highest possible value at that time. Second, the key variables that drive value in a company are smart management practices that will obtain a strong net income year in and year out. What are the key elements or variables to focus on when managing the business and positioning for a sale? I have ear marked seven.
It’s not uncommon to see small to mid-size staffing firms with client concentration. One to three clients making up 80% of the overall revenues is client concentration. One client making up 40% or 50% of the overall revenue is client concentration. The rule of thumb is to not have any one client more than 15% of the overall revenue of the business. Additionally, it’ best to have total direct hire revenue at less than 10% of the overall revenue. Client concentration radically increases the risk to the buyer. As you build to sell, you want to reduce the risk to a potential buyer. This dynamic will place you in a position of strength when you start to negotiate the overall value and structure of the deal. When a potential buyer sees client concentration they say to themselves, “This is just a few accounts, not a real business.”
There are guidelines and benchmarks for strong gross margin in the staffing industry. Strong gross margin in light industrial is 18% or higher…, in IT staffing 28% or higher…, accounting & finance 25% or higher. Every niche in staffing has gross margin benchmarks. When you are building the business, have a “pricing strategy” and don’t waver from it, with exceptions being very special strategic account development situations. Have a game plan to cut the low margin business as you bring on higher margin accounts. Have a sales methodology with a strict “ideal client profile.” If you are a light industrial staffing business running 11% or 13% gross margins, a potential buyer is going to think, “Why buy that business? I can just hire a good sales rep and buy the business from client base.”
Regional staffing businesses that have offices in four to six markets are highly desirable businesses to buyers. For example, this may be an accounting and financial staffing business with a couple offices in Chicago, as well as an office in Minneapolis, St. Louis, Detroit and Indianapolis. These are beautiful businesses. Why are they so desirable to a buyer? It would take a potential buyer millions of dollars of organic investment plus “x” number of years to build a regional presence with established offices in several markets, as well as a team of productive employees, clientele, a robust database, etc. Now, consider a one-office staffing business – who is going to buy this business? Maybe a local competitor looking at pick up some market share, but they are not going to pay all that much for such an acquisition.
This element is quite important to buyers. Think of this scenario: A young owner that has quickly built a business over three to five years and now wants to take some money off the table and align with a much larger staffing firm that can take the back office and marketing and legal work off his or her back. Buyers typically like the scenario of a young owner that has not been in the business too long. With staffing businesses where the owner has owned and managed the business for ten, fifteen, or twenty years, buyers typically want them to exit the business.
Basically, the transition for a long-time owner into a post-acquisition employee rarely works. It’s best to work yourself out of the day-to-day operations of the business by getting managers on board who are already managing the business. For key clients, transition those relationships to senior sales reps. Tying yourself to major accounts increases the risk to a buyer.
One of the sins of a growing staffing business is that as the company grows, sales reps and recruiters get sucked up into the growing structure of the business and do not have the experience or adequate training to professionally manage employees. An owner must think this through. Buyers want managers in place who are trained and experienced in driving growth and production. Some sellers hold a big carrot to key managers. For example, once a sale of the business is had, they may offer key managers 5% of the value of the sales price. While this is not totally bad, it can backfire, as buyers may see this as an invitation for key managers to check out once they receive a big payout.
Ensure that the compensation plans align with industry standards. This element may throw a deal, but it certainly will be a cause of concern for any potential buyer. Experienced buyers do not want to immediately change the compensation plans immediately after an acquisition. Making changes to compensation plans post-acquisition creates a situation in which key sales reps and recruiters go looking for other jobs shortly after the acquisition. If a buyer sees prior to the acquisition that the compensation plans are out of line with staffing industry standards, it becomes an issue. In the end, when a staffing firm sells, it is selling very few hard assets. Buyers are acquiring soft assets, such as people (both internally and externally), customer contracts, relationships, goodwill and reoccurring margin. Simply put, buyers cannot afford to lose key players shortly after an acquisition.
It’s not wise to wake up one morning and simply decide, “I want to sell my business”. Don’t laugh, I have seen it several times. Such an impulsive decision puts you as a seller in a position of weakness. Before making any decisions, think it through and articulate an exit strategy. The best exit strategy plans three to five years out prior to the sale of the business. An exit strategy is going to force you to establish a “value” goal. For a privately held business, you must ask yourself, “How much money do I need in order to retire?” This is the “value” goal and the figure that will drive the revenue size the company must be prior to selling. An exit strategy will also outline the key internal items that need to get resolved in order to drive maximum value at the time of the sale.
I have guided many owners of staffing firms in driving value of their businesses and positioning them to be sold. Twelve months goes by really fast. Three years is here before you know it. Not only do you have to get all these elements and variables working in your favor, but you must have at least 12 solid months of top performance. This is challenging. Reach out to me if you’re interested in learning more.
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