Article Written By: Mike Maseda
Acquisition Value Creation and Scale
Mergers and Acquisitions in the PEO space have been a big source of value creation for investors and owners alike. In a fragmented industry, where few platforms have achieved scale, almost all that have scaled have gotten there with contribution from acquisitions. In the industry, size helps to obtain better products, negotiate better terms with suppliers, reduce volatility as insurance pools grow and increase margins in a number of ways. The success of some of these larger PEOs has driven private equity interest into the space, raised valuations and created a consolidation trend. Successful acquisitions require the experience to identify what is essential in each deal and the willingness to be transparent about goals and vision.
Whenever engaging in any acquisition, valuation is always a serious consideration to ensure you pay the right price for an asset. However, PEOs are particularly complex businesses with many attributes to consider, including embedded insurance products. Valuing these insurance products, especially in PEOs that take risk, requires the experience to make sound judgments regarding reserve values and P&L expensing practices. These factors can have a big impact on the value of a target. PEOs are particularly difficult to value accurately if the target is transitioning its client profile relative to its historical book of business. Often times actuaries on both sides will disagree on methodologies and values, requiring some level of compromise to get a deal done. While this and other valuation issues are important, I would like to focus attention on more strategic issues, which in my experience, are bigger determinants of the ultimate success of an acquisition.
A successful acquisition in my mind, is one that achieves the goals of both parties – the seller and the buyer. Ironically, a disproportionate amount of time is typically spent on valuation models and financial assumptions versus clarifying objectives, understanding and aligning interests and getting to know the people. These aspects may appear simple and straight forward when evaluating a deal, but in my experiences, they are the bigger determinants of ultimate value creation. An experienced buyer knows not to get lost in the weeds and focus on these issues.
Some common goals of sellers that I have seen are (1) monetize the business they have built over the last 10-20 years, (2) create a path forward for their employees, (3) have their clients taken care of, and/or (4) have an on-going role with the acquiring company. In some cases, #1 is all that matters, but in others all four may play a role. Buyers also come with varied objectives and visions: (1) start a new platform, (2) complete integration into an existing platform to create value through synergies, (3) partner with a successful operator to make their business better, (4) enter a new market, and/or (5) acquire talent or capabilities.
It is important that potential partners, sellers and buyers, have honest dialogue regarding their goals for a deal. What will the seller’s role be moving forward? What are the plans for the corporate staff, service staff and sales staff? What are the cultures of both companies? How will differences be managed? For example, a seller sells to a strategic buyer that already has a PEO platform. The seller is an entrepreneur and wants to continue in an operating role after the deal. She is strong willed and does not want to compromise in her approach to the business. The buyer has a different perspective on the operating model going forward. In my opinion, it is far better to have honest dialogue about the conflict and devise a plan that both can buy into. If not, conflicts between leadership will arise in the integration phase and likely impact value creation.
Aligning interests is key to effective integration execution, which is critical for achieving value creation objectives. Successful acquisitions are not only about closing the transaction, they are also – and often more importantly – about creating relationships where two parties work together to create value based on a common vision. This is even more important in the case of a buyer desiring to grow through acquisition where reputation is critical to executing on multiple deals.
As an example, some of the objectives I had when acquiring PEOs were (1) target PEOs that had a similar value-propositions. For me that included staying close to white/grey collar businesses, higher average wage client-bases, selling value versus cost savings, and GP/WSE north of $1,200. Not because businesses that did not fit this profile are bad, on the contrary, many are very profitable, but they come with different focus, operating models, cultures regarding service, etc. These attributes would not fit with the platform I was building; (2) target strong regional players that we could partner with and improve upon, giving them better advantages of scale, better master plans, distribution/sales infrastructure and know-how. Achieve best of local/regional proximity to clients and scale of a larger platform. This came from a belief that PEO is best delivered as a regional/local service; and (3) culture focused on high price points and strong service levels, evidenced by high client retention.
Basis of Insight
As the CEO of CoAdvantage for 6 years, we rolled up 7 smaller PEOs to create a 90,000 WSE national platform. As the COO of Vincam/TotalSource for 10 years, we rolled 6 PEOs and created a 160,000 WSE national platform that today is over 500,000 WSEs. It is from these acquisition and integration experiences that I draw the insights above.
PEO is a fantastic industry with many small service providers that deliver an excellent value proposition to their clients. I encourage M&A between like-minded partners to bring more value to our clients, associates and shareholders.