There is a well-known business maxim: start with the end in mind. This translates into maximizing enterprise value for an eventual exit or the sale of your firm. The two main drivers to achieve this goal are growth and profitability of an IT and engineering staffing firm. But planning for a successful exit is critical, which means putting in place strategies to accelerate growth and increase profitability throughout the lifecycle of your company.
Before we dive into the different strategies, let’s first understand what enterprise value is. Here are some terms that will come up during any conversation about enterprise value.
EBITDA: Earnings before interest, taxes, depreciation, and amortization
Adjustments to EBITDA: Adding back expenses likely to be eliminated post sale (usually trailing 12 months)
Enterprise Value = Multiple X Adjusted EBITDA (TMM).
In general, staffing firms are valued based on a multiple of EBITDA. Surprisingly, 2020 was a remarkable year in terms of profitability for the IT and engineering staffing industry. According to TechServe’s 2021 Operating Practices Report, the median firm had an EBITDA of 5.7%, higher than the average EBITDA that generally hovers around 4-5% range for a typical firm.
There are several factors that can go into determining the multiple, such as:
- Revenue
- Revenue growth
- Gross margin dollars
- Gross margin percentage
- Operating income and EBITDA
- Length of client relationships
- Diversification of clients
- Strength of post-sale team
“Staffing firm owners are looking for a way they can unlock the value they have in the organization and now is a very active time in the industry,” said John Larson, Lead Consultant for TechServe’s M&A Marketplace, during a panel at last year’s Executive Summit.
While the formula to determine enterprise value is simple, the process of getting there is much more complicated. The marketplace encapsulates many firms with different business models on the sell and buy side. Dry powder in private equity is driving a lot of activity wherein firms are receiving inbound offers on selling. This continued interest from the sponsor community and private equity has pushed more staffing owners to begin considering.
Private Equity vs. Strategic Buyer
Dan Reynolds, CEO of Talon Professional Services stressed, “you have to figure out the formula that works best for you,” when discussing the pros and cons of private equity versus strategic buyer. It is vital for the owner to understand what they want to get out of the next stage. Are they prepared to truly exit? Are they confident enough to leave their business in the hands of another organization? What is that going to get them? On the other hand, being a part of a private equity group means that more than likely they’ll still run the business and look for another exit in 3-5 years from now. “Those are conversations you need to think about early on,” said Joel Leege, EVP and Chief Strategy Officer, Randstad Technologies Group.
The Importance of Your Internal Team
One of the biggest challenges is when an owner has not made the appropriate investments in their team prior to looking for an exit; as a result, they will get a discounted value. They must make the proper investments in developing their staff, recruiters, salespeople, etc. A buyer will be paying attention to this when evaluating because it’s essential for them to know there is value in the team. Larson reminded everyone of the importance of succession planning. “Do you really have a team that can function if you’re not there? Every day you should be running your business as if it’s for sale,” Larson emphasized.
Deal Terms & Earnouts in the Marketplace
Even more significant than the value of the business are the terms of the deal. Many owners desire an all-cash deal, and while this option is available in the market, you will typically need to accept a significant discount to the sales price. You’re going to find most deals include a cash component offered upfront and an earnout. Earnouts from one to three years are most common. In evaluating earnouts and other deal terms, you need to weigh its impact on the sale price as well as the potential upside as well as downside risk. Potential buyers will be doing the same type of analysis. A deal comes together when you agree on a combination of price and other terms that work for both parties.
If you’re going to go the private equity route, buyers will often want one or more partners to stay and leave some money in the firm. How much of your own capital are willing to roll forward? While it can present a ‘second bite of the apple’ and can be lucrative, it can also be risky. It is important to know your company’s strengths and weaknesses so that you can make an informed decision for you and your team.
A Surge in Direct Hire
Where does direct hire enter the value chain for the IT and engineering staffing industry? “It shouldn’t make up more than 5-10% of our business. If we’re going to do it, we must make sure it’s of value,” Reynolds suggested. Although many believe that direct hire has little benefit; it is a $13 billion market in the U.S. Direct hire is beneficial in helping smooth out the ebbs and flows of a business. However, one needs to be able to maintain or improve profit margins. Larger companies often have greater ability to reap the benefits of direct hire and weather the inevitable cyclical downturns.
Sellers: Here’s What NOT To Do
Leege emphasized that it is not helpful to dramatically cut costs in preparation for selling so as to artificially inflate profitability. Owners must continue to make appropriate investments in the operation of their firm. Other red flags for a would-be buyer are poor accounting practices and the absence of training and development of the team. Overall, planning is key. Know who you are, and don’t try to be all things to all parties – as an owner, be intentional in every decision you make. As Larson stated, “every day you should be running your business as if it’s for sale.”
