We have previously discussed the characteristics of a lifestyle recruitment agency and the choices an owner of this business type make.
We will discuss the business value that a lifestyle business can achieve in a sale process
A lifestyle business is strongly influenced by the shareholders who are usually running the business to meet the needs of the shareholders.
When viewed by an external potential acquirer, the characteristics of a lifestyle business often stand out. In addition to size, the lack of investment in the business and the lack of strategic intent to grow the business are clear. Owning and running a lifestyle business is a valid business strategy, but the implications need to be understood.
Having a lifestyle business can generate a good income for those who are involved in its operations directly or indirectly but this potentially good income is not reflected in equity value. Shareholders need to generate wealth incrementally rather than rely on strong equity value.
Valuations for lifestyle businesses are under pressure.
Profits have fluctuated wildly in recent years due to economic conditions and also due to changes in the recruitment industry structure. For other types of business multiples have remained flat but for lifestyle businesses valuations have declined and may decline further.
Lifestyle businesses usually have a profit before tax (PBT) of less than AU$500K. At this level of profitability there are too many sustainability issues and as a result the equity value of the business is usually lower.
To discuss the valuation of a business the structure of the deal needs to be considered, as well as the working capital position and finally the profit multiple.
The structure of an equity transaction is important and impacts value. As we are discussing a services business, the risk associated with earning future profits is of prime concern to the acquirer.
If an owner wants to receive the money up front and depart the business, they will receive less and may not be saleable. If they are prepared to stay, assist with the transition to new ownership, and accept future payments based on future performance, they are worth more and are more likely to achieve a sale.
Related: Agency valuations in a buoyant recruitment industry
The deal structure is a negotiated outcome between the parties based on different risk and reward assessments. For very small businesses, say 1-2 consultants, especially those that have little recurring revenue (usually in the form of a contractor book) then all “normal” conversations about deal structure don’t tend to apply. In these circumstances a successful sale is more likely to be based on an arrangement that includes employment and maybe future additional payments based on actual revenue earning activity.
The Working Capital arrangements in a business sale can dramatically impact the take-home cash for a business owner. While working capital arrangements are a negotiated item, it is becoming usual for minimum operating working capital to be included in the sale price. If a small businesses has little recurring revenue then Working Capital may not be a discussion item.
Given that commentary, most saleable Lifestyle businesses achieve a profit before tax multiple of less than three times.
Some companies are very small or have greater risk associated with future earnings and do not achieve a profit before tax multiple above one times. Some very small businesses do not achieve a “sale” but find a value added employment opportunity for themselves (that is, the value of the business is not considered). And an increasing number of very small businesses and sole traders will not be able to achieve a valid exit strategy in any form.
HHMC Global provides advisory services to the recruitment and staffing industry and is best known for its work on M&A transactions. HHMC is based in Australia and works with clients globally. To discuss your business future contact Rod Hore or Richard Hayward.