As an introduction, it needs to be noted that there is very little published information on recruitment agency valuations that is applicable to small to medium recruitment agencies. Press releases about large deals, especially if they involve listed companies, are misleading. Articles about deals in the US or the UK are misleading if applied to our market. Most of what happens in the recruitment industry is not published as it involves deals between private companies that are kept confidential.There is also a need to have a precise definition when discussing business valuations. Is it a share sale or an asset sale? Is working capital included or not? Are we discussing a multiple of tax before profit or a multiple of profit after tax?
Here we go.
For consistency, unless otherwise qualified, HHMC talks about business value as a multiple of normalised profit before tax excluding working capital.
The purchase of business assets for cash is still the most common structure used for the purchase of small to medium recruitment agencies.
Normalised profit means making adjustments to the revenue and expenses to reflect the business as if someone else was running it. The major adjustments are usually related to shareholders expenses (some private expenses may be able to be removed) and adjustments to shareholders salary packages (they may be paying themselves more or less than market rates).
Related: What Is Your Recruitment Business Worth?
Net Working capital, for this purpose, is most easily described as cash plus debtors less creditors less staff entitlements (such as annual leave).
Looking at the past two or three years financial performance is an important part of understanding an agency’s capability and potential. But this past performance is not an appropriate guide to future performance.
For a services industry like recruitment, the business value may be thought of as the risk associated with a new owner generating profits in the future. The seller is asking the buyer to pay a multiple of future profits for the business. What generated profits in the past? Are those characteristics available for the new owner in the future? Aspects like client contracts, business development capability, key staff and market conditions all need to be evaluated by the potential buyer.
Calculating the “average of past 3 years profit” is not a relevant valuation method and is usually misleading.
Let’s repeat that. Temp & Contract is very important to business valuation.
One of the very few ways an agency of less than, say, 5 consultants can show sustainability is to run a strong temp and contract book – something greater than 50% of gross profit contribution.
Any agency that is dominated by perm recruitment, no matter what its size or sector, will struggle to attract buyers and struggle to achieve a strong value for their business when compared to agencies that have a strong temp and contract focus.
HHMC talks about sustainability a lot. We like the definitions provided by Michael E. Gerber in his book “The E-Myth”.
Smaller companies struggle with sustainability – they will have single points of failure such as being reliant on one person for the majority of business development, or one person for the majority of billings, or one client for the majority of revenue.
Agencies that fail the sustainability test do not attract a standard valuation.
There is little disagreement that the recruitment industry has changed dramatically over the past few years and the rate of change is continuing. If your agency has not evolved to meet the current business requirements then an astute buyer will be concerned about its future.
Agency’s that have shown the ability to prosper through changes in business conditions and industry evolution will be rewarded with a lower risk rating when their business is being assessed. Conversely, start-up businesses or those agencies that have not shown the ability to grow and adapt will be assessed accordingly
There are many passionate agency owners that are justifiably proud of their achievements in market positioning, technology implementation, business processes, candidate databases and social media presence. Some are also proud of their logo, web page and even office location and fit-out.
These aspects of a business may add to the desirability of an agency – more potential buyers may be interested in evaluating the business. But what a buyer will pay for a business will primarily be determined by the profitability of the business.
Investment decisions need to reflect this reality – invest to grow profit in a sustainable manner
Purchasers are looking to reduce the risk of generating future profits. Sellers are looking to exit their business with as few risks or time delays as possible. The balance of these two requirements impacts the value of a business (and is a unique negotiation for each buyer/seller discussion).
If a seller wants to sell a business for 100% cash up-front and leave the business immediately they will receive less for the business.
Assisting the purchaser by participating in the business for a period following the sale and by reducing the buyers risk by accepting part payment for the future performance of the business will assist in maximising the amount the purchaser will be prepared to pay.
There is no such thing a standard deal, but with reference to all the above comments the value of small to medium recruitment agencies usually have these characteristics:
HHMC provides an external review and market valuation service for recruitment agency owners that will be beneficial to your strategy. Contact Rod or Richard to discuss further.