SI Review: November 2011

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Finding Your Way Out

Build value despite the economy’s twists and turns

By Tom Kosnik

Owning a staffing business lately can feel like “Hotel California” — you are trapped. Why? Simple. This is a tough environment for selling; multiples in the staffing industry are depressed and will remain that way for quite a while. An owner simply can’t make enough out of a sale to retire. And the business is not generating enough net income for the owner to save into a retirement fund. The result is clear: they are stuck.

You may not even want to sell or get out, but you don’t know how to improve your situation. What can you do? The sad fact is that many staffing firms have stagnated lately. There are multiple factors. Competition is too great. More and more customers are transitioning into vendor management systems. The national staffing firms are taking a larger piece of the staffing pie. The banks are unwilling to make loans for acquisitions or capital investments. The owners of the business are unwilling to change.

Here is a solution: grow the business. Amid all the negatives, there are still ways savvy staffing owners can grow their company. Here are a few.

Sell controlling interest

Many staffing firms cannot grow because they don’t have the cash or management expertise. Consider selling a controlling interest to a larger, privately held staffing firm that has the cash to invest in the business as well as the management expertise to help you grow your business. “Larger privately held” are the operative words here.

I have seen such arrangements work well. The seller takes a certain amount of money off the table so that his or her risk is not totally tied up in their business. Work that takes time from selling, such as operational work and back-office duties, is taken off his or her shoulders. The seller works with the larger staffing firm to put a solid plan in place and starts receiving management training.

The acquiring company has to be in the privately held, $100 million or more category. It has to be willing to put additional capital into the acquisition for growth purposes. It has to be willing to help where it can and stay out of the way when necessary. A predetermined valuation can be agreed upon for buy-out purposes. The acquiring company buys 10 percent or 15 percent a year for three to five years. The seller has an opportunity to earn an upside for exceeding numbers. I have seen some small business owners make more money selling controlling interest and aligning with a larger staffing company than operating alone.

Soft merger

This is a concept where two or three or five staffing firms that offer the same type of staffing services create a holding company. This holding company, equally owned by the participating members, takes care of the entire back-office function, including funding receivables, marketing, IT, HR and any other corporate-type administrative duties and tasks.

The participating members retain their separate corporations, which craft an “operating agreement” with the holding company regarding guidelines of operations. The guidelines would cover issues such as roles and duties of the holding company, fee structure for these duties, selling territories, account allocation, margin guidelines, type of business booked, how profits or gross margins will be distributed and when they will be distributed.

This concept can work with either a group of staffing firms in the same market place or five staffing firms offering the same type of staffing services from five different market places. The key to success is the profile of the participating members. Ego-centric characters would find it difficult to succeed in this model. In the end, a small staffing firm could retain independence and become part of a much larger entity and therefore radically increase the value of the business.

Hard merger

The staffing industry has gotten tainted on hard mergers. However, it is a concept well worth investigating in the current economy. Hard mergers work best when there are several staffing firms that are providing the same type of staffing services that are coming from different market places. Unlike a soft merger, in a hard merger, these staffing owners become blood partners on day one.

There are two big obstacles that consistently pop up here. First is not having a well thought-out transition plan. This is not a concept for the faint of heart. These separate entities are going to merge into one entity. That means one back-office system, one database system, one fulfillment process and one sales process. The fine details have to be worked out in advance. Further, who is going to run the show? Typically, any one member from the existing pool does not have what it takes to run a larger entity. Therefore, it is better to bring in someone from the outside who is not politically attached to any one business or account. The leadership from the joining companies and their roles and responsibilities need to be clearly outlined, along with reporting structures.

The results, if successful, are unparalleled. There is an immediate cost benefit from consolidation of duplicate services such as multiple back offices to one back office. There is an immediate cost savings that comes with buying power, such as job boards, computers, supplies and training services. Then there is marketing power, the option for in-house council and proposal writing, the ability to hire and have access to a national sales team, the list goes on and on. If done correctly, small business owners can double and maybe even triple their individual value and company worth.

ESOP

There has been a lot of talk about Employee Stock Ownership Programs. The benefits are almost unreal. A three-year tax credit, a discounted cash flow valuation that will typically pencil out to six times EBITDA (earnings before interest, taxes, depreciation, and amortization), potential deferment of capital gains taxes, employees that are excited and engaged, the ability to save some stock for key hires, the ability to make acquisitions without bank financing, on and on.

A down side is that it does not make sense for a small staffing company to move forward on an ESOP. When you pencil out the cost of conducting the work and to do the annual required work (get the business valued at the end of each year and administer the stock), the business really has to be dropping $1 million-plus to the bottom line. But it may work, if the sum of money needed to run this was reduced. A trial run of various numbers needs to be conducted. ESOPs generally work best when the owner of the business is looking to take some cash off the table, wants to remain involved in the business for five to 10 more years, and has some key staff who have been moving up into leadership positions. Sometimes bank financing is obtained to complete the transaction. However, an option to put a note on the balance sheet to the sellers can save quite a bit of cash in lending fees. It is a longer-term strategy, but one that can generate a much larger cash out for the owners of the business over a traditional sale of the business.

Efficiencies

If the previous options don’t seem to fit, then locking down on efficiencies is a good strategy. A business owner can increase margins and net income by focusing the business on certain skill sets or in certain industries serviced or both. Focus is critical to success here. If the business can focus on a desirable skill set in a desirable industry, even better. Contracting IT consultants to large healthcare organizations is a good example.

The idea is to run the company as if the goal were to become a very attractive acquisition target. Several smart things have to be occurring within the business. Here’s a partial list:

  • Client concentration. No one client should account for more than 10 percent of the business, revenue.
  • Healthy margins. Typically, margins should be between 25 percent and 30 percent, though that does vary among industries served.
  • Compensation plans. Evaluate your plans to ensure they are in line with staffing industry standards.
  • Low employee turnover. Replacing employees costs money and disrupts client relationships.
  • General and administrative costs. These costs should not exceed 30 percent of the gross profit production of the business. Leases. No long-term or excessive leases.

Alongside running efficiencies, the business has to grow to become greater than $10 million in annual sales. If the company is less than that, then the owners of the business are not building value in the business. In the end, they will be at the mercy of the market and will have little to no negotiating power. $10 million in revenue is the threshold to get on the value radar screen and the first big step to becoming unstuck.

Tom Kosnik assists staffing companies improve employee performance, corporate revenue and net income profits. More can be learned at www.visusgroup.com. He can be reached at (312) 527-2950 or tkosnik@visusgroup.com.

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