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Recruitment agency owners often appear narrowly focussed on “the multiple” they may achieve when they sell their business. It is important, of course, but there is so much more that will determine how much ends up in your pocket after the sale of your business.
The value of a recruitment agency can be defined as the risk associated with earning profits into the future. The potential purchaser of your business will make assessments of the risks associated with producing future profits. What you have done in the past is a significant and important guideline, but not a guarantee of future performance. The real question to a buyer is – will the drivers of profit remain in the business?
These risk-based considerations are a normal and appropriate part of the analysis and decision making that any buyer will undertake during the negotiations.
Once you move into the phase, as a seller, where discussions centre on price, it is important to factor in four important components that go hand-in-hand to form the overall value basis of a deal.
Multiple of Normalised Profit
What is the real profit of the business? In a perfect world, the business would account for revenue and expenses as if it were owned by another company, or as a division of a corporate entity. Expenses would be accounted correctly and consistently and there would be no extraneous items. Revenue would be allocated into standard, defined categories. The Profit & Loss statement would show market related values for expenses, especially the big items of salaries, shareholder payments, commissions, and rent. The Balance Sheet would be clean, reconciled, and free of personal items.
In reality, smaller businesses are managed for the benefit of shareholders. That is common and understandable. As such, there are usually adjustments to be made in order to bring the P&L back into a “normalised’ state. These are likely to involve items including salaries, shareholder personal expenses, office leases and debt. It may also include depreciation and amortisation adjustments to produce an EBITDA result.
In any case, it will better reflect an expense base that will remain going forward with new owners. The resulting normalised profit figure will be the basis of a discussion on a multiple.
Deal Structure
It is rare for a small to medium recruitment agency to be acquired without some type of earnout or payments into the future. While it can happen, that may be largely due to personal circumstances, perhaps the owner’s health or other pressing external factors, increasing the perceived risk for the buyer. Increased risk translates to lower price.
Negotiations around earnouts are a balance of risk and reward for both parties – the seller wants as much money as possible upfront and no ongoing performance obligations; the buyer wants to arrange an ownership transition and pay on future performance.
How this future payment is negotiated has a significant bearing on the overall risk of the transaction and on the potential size of the deal and then the ultimate return to the seller.
The more a seller agrees to be paid on future performance (i.e. the more risk sellers accept) the greater the potential deal value. The multiple of profit may vary with the deal structure agreed. This can be a very challenging area to negotiate without experienced advice and assistance. And is the case for both parties.
Working Capital Considerations
It is common, but not standard, that the acquirer will be seeking an agreed amount of working capital to be left within the business. This can be a major negotiation item during the sale process. There are plenty of examples of complex negotiations around this issue. Unfortunately, it is not a ‘black and white’ issue.
Each recruitment business has different working capital requirements and different shareholders will manage their balance sheet in different ways. For example, a perm placement-oriented business usually generates excess cash, and the owner can choose to leave that in the business or withdraw it for other activity. A contractor-oriented company requires working capital to cover the period between paying contractors or temp staff and being paid by their clients. This often requires external funding to be in place to cover the shortfall in the interim.
Depending on the negotiated, agreed value of the target working capital required in the transaction, the actual amount available in the business at sale may exceed that. In this circumstance the owner is likely able to withdraw that excess amount. In the case of a shortfall in working capital, an owner may need to contribute additional funds. This is usually as an adjustment to price.
In either case, this can have a significant impact on the total value (or anticipated value) of the sale for the seller. In some of HHMC’s projects the value of the working capital withdrawn by the owner has exceed the amount from the profit multiple agreed for the sale.
Tax Considerations
Following these three considerations, each shareholder will have different arrangements in place for tax, and this also impacts the final value of the business sale to the seller. Other factors that may affect the tax position can include owners’ ages and asset position, length of time operating the business, and the tax on sale price v annual dividends.
Tax is another important area for owners to seek external advice during the process.
Recruitment agency owners selling their business need to understand all the components of the potential deal structure to be able to plan the true value of the business, in their particular circumstances.
