What makes a recruitment agency an attractive acquisition opportunity?
Whilst every transaction varies depending on the buyer-seller dynamic, there are some fundamental value drivers which typically affect the multiple achieved in the recruitment & staffing sector. As outlined below, certain attributes identified to be a higher priority in terms of risk will differ from buyer to buyer, however the variables negotiated remain consistent across the board. So what considerations should be given when exploring a staffing agency acquisition?
Strong second-tier management structure with limited reliance on the shareholders
Arguably one of the biggest obstacles to consider is how involved the shareholders are in the day-to-day running of the business. Without an established second-tier management structure, buyers immediately question the sustainability of the business in terms of future growth and maintaining existing earnings following a potential acquisition.
Reliance on the owner is an important factor to consider in all transactions, irrelevant of sector, however a strong indicator in the recruitment industry is the owner’s revenue contributions and direct involvement in client relationships. As a sector with low barriers to entry, particularly in the UK market, the trading of one-man band/micro recruitment agencies is extremely common. The owner acts as the sole biller, with all client relationships and the winning of new business heavily dependent on their involvement. In some cases, the owner may feel that time is better spent billing than training new recruits and this is even notable in agencies with established teams. Office visibility also comes into play, whereby if the owner is present in the business 5 days a week, it is arguable that the existing management team are coordinated by owner involvement.
Permanent vs Temporary vs Contract
When considering the type of agency to buy, another primary consideration is the percentage split in personnel supply between direct & permanent hire, against temporary & contract. Ultimately, a contract offering is presented as more favourable given the visibility on future cash generation and predictability of earnings. With an established contract book in place, the perceived risk is considered lower because unlike permanent recruitment, the order book does not start from scratch each month. Often agencies might start out in permanent recruitment because there is capacity to generate revenue quickly, whereas for contract agencies it is more of a long-term play because of time and cash flow constraints. Whilst the percentage split will always be an important buyer consideration, the below must be appreciated when considering an acquisition of either agency type:
Permanent agency – If considering an agency with a high permanent weighting, it is important to consider the number of fee earners at the firm as ultimately the value of the business are those individuals. For example, a team of 30 fee earners would mitigate some risk of an acquisition because if some employees left there would still remain a strong team of billers. It is also important to consider whether billing volumes are equally distributed between consultants, to further limit risk if strong performers left the business. Other factors to look at from a direct hire viewpoint, would be the average percentage fee taken on candidates placed, as well as whether there is an executive search function to create more visible and recurring earnings.
Contract agency - With a contract agency, the primary value driver is the contract book and determining number of contractors and length/margin of contract. This allows the buyer to ascertain the businesses margin and profitability month by month, with anything from 75+ contractors considered a healthy pipeline. In these types of acquisitions, it’s also important to explore what kind of working capital facility is in place. This is often a big part of the negotiation piece and one that often gets overlooked.
Temporary agency - Like a contract agency, the value of temporary agencies is the number of workers out. Typically, the margin applied is done on an hourly basis resulting in a reduced value per time sheet. This means the volume of personnel supplied needs to be greater than a contract agency, anything above 500 out per a week would attract interest.
Reporting & Internal compliance
How a recruitment agencies valuation is perceived can also depend on the businesses internal reporting, in terms of available business data and compliance with industry regulations. This comes to light in due diligence, where an extensive history of business operation is required by a buyer. One example is showing the breakdown of client revenues and margins and then by specific roles filled and in what geographical location. If this data is made available on a monthly basis, across a 5-year period opposed to a standard 3-year P&L, the buyer will be reassured and feel more informed about what they are actually buying.
In addition, buyers should also consider a company’s adherence to industry regulations. For example, the use of umbrella schemes and the targets holiday pay policy. Both are often an area of contention and something buyers view with serious caution.
Sector focus has long been a consideration in recruitment transactions, with certain sectors naturally more favourable than others depending on macroeconomic factors or industry trends. Arguably, whilst a generalist recruitment firm diversifies its risk by supplying candidates for multiple industries, it may not be as attractive to a buyer if there is no niche.
For example, sectors such as IT & Tech, Healthcare & Life Sciences are a lot more appealing and will receive more attractive multiples compared with light industrial for example. Whilst certain sectors have prevailed in a post-Covid bounce back such as Construction, others including Healthcare, are seemingly more resilient to economic downturn. With this in mind, naturally these agencies will be more sought-after in the M&A landscape.
International presence - US markets
With substantially higher margins and a less competitive market, a US operation is viewed as highly favourable when considering the acquisition of a recruitment agency. The staffing industry in the United States is the largest worldwide and has experienced continuous growth in recent years, reporting a revenue of nearly $177 billion in 2022. Meanwhile the UK market is the third largest globally, generating revenues of $51 billion in 2022.
Despite America’s economy being almost 8 times the size as the UK’s, there still only remains to be half the number of recruitment & staffing agencies operating in the US when compared to the number trading in the UK. This presents a lucrative opportunity for UK owners wishing to gain market share in North America, combined with the fact that fees/margins made across all types of recruitment are notably higher. These factors combined mean agencies with an established US presence will likely drive a higher multiple in deals closed.