One of the most critical questions for forward-thinking entrepreneurs to consider is “How do I maximize the value of my business for an eventual exit?” It would be tragic to spend years building a business, only to find it does not have great value beyond the income it provided during your active years.
To maximize value, owners must have an end game in mind. For most, that means an eventual exit or sale. This does not always mean an immediate 100% sale but potentially a phased approach of “taking some chips off the table” and joining a larger organization that can help you reach your ultimate financial goals more securely, faster and to a greater degree than on your own. In staffing–and IT staffing in particular–there are several areas to focus on if creating above market value is your goal.
Following is a quick look at eight critical measures you should be focused on right from the outset:
– Simply put, is your business large enough to hedge against business downturns, economic cycles and management turnover? We evaluate this in two ways: is gross revenue above $10 million and is that revenue generated by a base of at least 50 deployed contractors?
While businesses below this size and diversification will be acquired under the right circumstances, a buyer will often hedge by offering a much lower valuation and/or creative deal terms. Small scale represents greater risk in that if the business hits a rough patch, revenue and, more importantly, earnings will evaporate quickly. The bigger, the better.
– Unfortunately, all revenue is not created equal. We analyze revenue in three different ways:
- First, how much is coming from your core discipline (which under our current strategy is IT)? Some firms call themselves IT staffing while in reality their business includes a wide array of various technical and even administrative positions. We focus on businesses that support our strategy of creating a “pure play” IT staffing firm. The more pure, the higher the value. IT concentration of above 80% is preferred with a go-forward strategy aimed at 100%.
- Second, is your business concentrated within a small number of customers? Obviously, high concentration creates risk that the loss of one or two major clients could devastate a business. To minimize this risk, a business should not have a single customer contributing over 20% of their revenue, nor any five clients comprising over 50%.
- Third, do permanent placement fees represent over 10% of your revenue? Frankly, even 10% is high, but in the current environment, direct hiring is in high demand. Everyone likes how perm revenue juices up the bottom line, but the problem is its not recurring and walks out the door with the loss of key employees. It’s hard for a buyer to place a value on perm revenue, so expect it to be an area of significant negotiation.
– Businesses that are not growing likely have inherent strategic, sales or operational weaknesses. Solid operators will have a minimum three year CAGR (Compound Annual Growth Rate) above 10%, with market leaders at 20% or higher. The greater the confidence with which this trend can be projected into the future, the higher the value.
4. Deep Local Market Penetration
– The healthiest firms have longstanding, deep relationships with a diverse client base in their local marketplace. While some staffing firms operate using a long-line,
national sales model, it must be backed up by deep niche specialization within a narrow set of skills. We like to see at least 60%, and preferably 80% or higher, coming from a company’s local geography. Long average assignment lengths, preferably six months or longer, are also a good indicator of
solid service delivery and, ultimately, revenue stability.
5. Contract Gross Margins
– No metric reflects a firm’s pricing discipline and market perception better than contract gross margin percentage. High margins reflect strong leadership and exceptional talent within the sales and recruiting ranks.
We prefer businesses that achieve contract gross margins at least in the 25% range. Even with companies scrutinizing costs to a greater degree than ever before, outstanding firms are achieving margins above this level. As margins slide toward the 20% mark, firms will struggle to achieve attractive EBITDA without a higher than desired mix of perm placement revenue.
6. Bottom Line Profitability
– Firms that track positively against the value drivers above will typically generate EBITDA margins at or above industry standards. The 10% profit margin has long been a benchmark in the IT staffing industry, but 12% or higher is absolutely achievable today where technology can be leveraged across a business from
sales and recruiting to the back-office. Top, disciplined firms realize this fact and work hard to keep their organizations lean and mean.
Without considering perm placement revenue, we prefer a business to generate EBITDA margins above 8% (including market rate compensation for leadership) with a clear path to above 10% over time.
– Strong, engaged management adds significantly to a firm’s value. It goes beyond the top leaders to the team managing the day-to-day operations. Long-term stability is a predictor that the value a buyer is assigning today will continue to grow in the future. Buyers are typically not comfortable with a business that is overly dependent on one key individual, as that scenario creates risk to revenue and profitability. The bottom line is that to maximize value, a firm must have a strong team in place.
– Some entrepreneurs are faced early on with the decision of whether to build their business using diversity status. The upside is it can help you gain access to large companies quicker, but the downside is a likely discount to your firm’s market value.
In many cases, firms under this type status will have a hard time attracting the attention of a mainstream buyer; the risk of revenue and earnings loss due to change in control is often too great. Again, there are many advantages from a sales and marketing perspective, but those considering diversity status should also factor in their long-term monetizing objectives.
Different buyers may place emphasis on additional factors, but a business that achieves high scores on the measures described above should command an above average valuation. If you’re smart, you’ll put a plan in place to achieve these best practices long before you’re even considering a sale. After all, there’s no downside to superior performance.
Hire Partners is actively making majority acquisitions of well-run IT staffing and RPO firms. To learn more or to see if your firm may fit our criteria, please contact John West at jwest@hirevelocity.com.