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Deal Structures in M&A


For most SME recruitment companies, business performance is tightly linked to the efforts of the key people who lead it as managers or as revenue producers. Systems, processes and technology all play an important part in determining productivity and competitive advantage, but if you lose your best people you may very well lose big parts of your business.

Any company (or individual) assessing a business to buy will factor in the risks associated with losing key staff post-acquisition. Recruitment company sellers often focus on their history of profitability and results, however, to a buyer; the only thing that matters is producing profits in the next year (and the one after that!). The entire buy – sell negotiation is driven by the assessment of risk and return by both parties, along with their advisors. Many sellers try to convince potential buyers that their business is recession-proof and next year is going to be a really great year. Buyers on the other hand emphasize the risks from every possible scenario. It can be an interesting “courtship” to be involved with as advisors.  Bringing the parties toward more objective assessments of their positions and then agreeing a deal takes time.

In an M & A transaction there are two key variables; the price paid and the timing and structure of the payments. Both are very much intertwined as they again relate to issues of risk and return. If you want to sell your business at the best possible price you can’t expect to have that price paid up-front with no contingency on future performance. The price will be less based on the increased risk absorbed by the buyer. The reverse also applies with a stronger negotiating position on price achievable by a seller if they agree to performance targets within a reasonable time-period.

Alternative deal structures

Contrary to what appears a widely held belief there are no set rules on private business sales as far as what commercial terms and parameters are agreed and how those are negotiated. Each deal is as variable as the people involved. Experienced advisors can steer that process and put sensible frameworks around it but the core parameters will be about price, timing and performance.

Related: Deal Structures in M&A

There are recruitment agency sales that are paid as one-time payments, usually at the time of the execution of a sale/purchase contract. These tend to be for very small agencies and where there are no particular advantages to having an owner stay on for any length of time. The much more common structure includes an earn-out over periods of perhaps six, twelve, eighteen or twenty four months. There are some that stretch longer than this but these are uncommon and in HHMC’s opinion not usually advised.

What does an earn-out structure look like?

While there is no set formula of course, it is not uncommon to agree an overall price with an amount paid on Completion of the transaction (the time when the sale contract is executed) and an amount paid over time based on specific performance criteria. A simple structure is 50% on Completion and 50% paid a year later once a profit target is reached. There may be some minimum and over-achievement targets defined for that final payment. There are several different scenarios that can apply to the earn-out structure and the percentages paid at different times.

An earn-out based on financial performance assumes that the current owners are able to continue to run the business, essentially under normal circumstances, for the required period of the earn-out. If the new owner wants to make changes to the way things operate then that can potentially impact on the ability of the vendors to achieve their earn-out. For a buyer who operates a business in a similar geography, recruitment field and with overlapping clients leaving the business alone for twelve months or more may be counter-productive. They may want to gain some cost benefits from integrating back-office functions, co-locating and quite possibly change the way the business markets to current clients.

Conflicting Priorities

In some circumstances where there has been an insistence on a profit based earn-out the two companies may find themselves competing actively with each other during that time. For this reason, alternatives to profit or revenue based earn-outs are adopted in order to avoid this type of situation. These can include performance agreements on retention of clients and staff and other quite innovative measures.

Profit based earn-out criteria that are too simply defined can lead to short term thinking by the vendors. For the vendor, short-term thinking is rewarded if it means each dollar saved is then multiplied by the agreed “multiplier” on EBITDA. The obvious down-side is that the vendors cut costs in important areas and doesn’t invest in those things that re-generate the business. By the time the owner is in day-to-day operational control of the business it may be in a lessened state that when they bought it. The emphasis is on agreeing mutually beneficial targets and parameters.

In some notable cases the failure to agree clear criteria on earn-out criteria and to define the extent of control held by both parties during that period has unfortunately led to legal suits.

These uncertainties and potential areas of conflict do not mean that earn-outs have no place in successful equity transactions. However, it is important for both parties to a transaction to think through the potential consequences of a deal structure. Given the nature of recruiting and the unpredictability of future results it is likely that earn-outs and similar models will be a continued part of business sales structures. Having access to external advisors with relevant recruitment sector experience can improve the outcome for both parties.

Originally Published in Recruitment Extra July 2013

Categories: M&A

Tags: Strategy, Acquisition and Divestment, Staffing, Negotiation, recruitment due diligence, Merger and Acquisition, m&a transaction, Buy and Sell Business, Business Valuation, advisory services

Picture of Richard Hayward

Richard Hayward

Richard has 35 years of experience with outsourcing, recruitment and advisory firms. His record of achievement includes national recruitment management roles, and executive search and selection across the ICT, banking & finance and sales & market sectors. Since 2003 Richard has been a principal of HHMC, guiding recruitment agencies through acquisition and exit assignments. Located in Sydney, Richard works with private and public recruitment agencies globally. HHMC’s innovative business strategies and well-grounded guidance result in clients realising their personal and corporate goals.

P: +61 2 9221 8285 M: +61 411 488 544

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