PEO: Before You Call The Investment Banker
Many PEO Owners begin their pre-exit strategy by contacting an Investment Banker to start the arduous journey of compiling financials, quality of earnings (QOE), confidential information memorandum (CIM), etc. in preparation for going to market. There is nothing wrong with this process per se, but you may be leaving money on the table at the time of exit. Choosing the right Investment Banker is important. An Investment Banker will help you maximize your financials through EBITDA add-backs, strategic alliances and courting the right buyers. However, an Investment Banker builds their modeling off your PEO’s historical performance and reasonable projections.
What if you could spend 12 to 18 months prior to contacting an Investment Banker to strategically position your PEO for optimal exit multiples? We call this process your pre-exit strategy. This article will focus on some of the ways you PEO can position itself for maximum benefit at the time of exit. A successful pre-exit strategy will allow you to provide your Investment Banker with an improved position for modeling and projections. Which ultimately will assist in driving your valuation at the time of transaction.
Whether you are selling to a strategic or private equity buyer, get ready for some number crunching. Your financials are the first item that will be reviewed to ascertain the viability of acquiring your PEO. If your financials are desirable, the buyer will then review your model, leadership, culture, business focus, infrastructure, etc. If there is alignment between your PEO and the purchasing PEO or Equity Partner, your company is in a good position to get a desirable offer. That being said, if your financials are anemic, you will either not get top dollar for your PEO or you will have less competing entities wanting to purchase your organization. In the worst case scenario, no one will want to buy your PEO.
For example, when our firm Business Resource Center consults with PEOs, we start with a financial analysis. This analysis provides our team with the insight to ask the right questions. Once we have identified where the weak points are within a PEO, we devise a plan of action to remedy these issues and set the PEO on a path to greater projected income. When a PEO has flat or mediocre historical financials and then presents a pro forma with higher unjustified projections, it is not a PEO that will get top dollar on the market.
Does your PEO have propensity for organic growth and does your track-record prove it? This is a valid question and one that when the answer is yes, it will bode well for your exit. Think of it this way, PEO owners are trying to maximize their ROI at the time of transaction. Acquirers are trying to maximize their ROI post transaction. These are conflicting forces that are trying to accomplish a common aim; a transaction. If your PEO has driven successful organic growth, the acquirer will feel more comfortable with their ability to maximize ROI post transaction. This will allow your PEO to have a better bargaining position to negotiate during the M&A process.
A primary focus of Business Resource Center, Inc. when consulting with a PEO during the pre-exit strategy is sales, go-to-market strategy and channel partners. The ability to successfully and consistently generate positive cash flow is an enticing element of the PEO model. When a PEO is able to outpace its market peers in this area, it becomes a more desirable asset to acquire.
Right Size The Organization
Thinning the heard dramatically right before a sale isn’t fooling anyone. This doesn’t mean that you don’t right size your organization prior to a sale. It does mean however that you are able to clearly illustrate why you’ve made these moves. Your leadership team must be able to convince the buyer that any reduction in force or relocation of talent will not impact the PEO’s ability to service clientele and acquire new business nor affect client retention rates and insurance claims mitigation.
Our firm looks at ratios within your company versus industry peers. We do this process while taking into consideration the nuances of your business model, market scope, technology and talent. During this analysis, we also look at compensation design and provide suggestions for improvement where needed. Understanding how your PEO can function optimally will be important for the subsequent synergies analysis.
Prospective Synergies Analysis
During the pre-exit strategy, why would you want to do a prospective synergies analysis prior to knowing who may acquire you? If you aren’t currently aware of which buyer may acquire your PEO, would a synergies analysis be an exercise in futility? No. While models vary from PEO to PEO, there is commonality among larger players. Through economies of scale, they are able to leverage their capacity and drive greater profit. Conducting a perspective synergies analysis will give your leadership team a framework of knowledge to know which buyers may be best suited for acquiring your PEO. This process will also provide your leadership team with high level insight to speak more appropriately to potential synergies during the courting and due diligence process once you’ve identified potential buyers.
Insurance & Liability Analysis
A large part of buyer hesitancy is due to potential insurance liabilities. By conducting an analysis on your PEOs loss trending and potential liability, you will be able to illustrate if your PEO loss trending is, to an extent, predictable in nature. Removing as much uncertainty as possible in this area is beneficial to maximizing your exit price.
Let’s assume that your PEO is on a high deductible for workers’ compensation. If your loss trending is not volatile, you could be a more desirable asset. If the purchasing PEO is backed by the same carrier but with a higher deductible, the purchaser will realize synergies by migrating your book over to their platform. This is due to the fact that they are likely remitting less premium dollars collected back to the carrier due to a larger book and/or higher deductible. It is essential for the seller’s leadership team to be informed, aligned and have the ability to speak intelligently about the company’s loss trending, risk mitigation strategy and insurance platforms.
Market vs. Company Trending Analysis
Where does your PEO stack up against competition? That is a valid question and one that needs to be answered. Premium acquisition targets go for premium purchase prices. Does that mean your PEO needs to be the largest? Of course not. What it means is that you need to be able to illustrate your value among your competitors to set your PEO apart from others available for purchase.
As you will likely note at this point in the article, there is a method to this process. For example, based on this timeline, you have already conducted your financial analysis to know how to better position your PEO for a sale. Your PEO has already begun to address any holes in your sales strategy so that you can illustrate a positive organic growth trend. You have begun to justifiably right size your organization thus achieving greater efficiency and higher EBITDA. You have a working knowledge of potential synergies that may exist with suitable buyers which will likely make your PEO more desirable. Finally, your leadership team has a deeper understanding of the insurance component of your business.
This is the time to view how you stack up against other comparable PEOs in the marketplace. Ideally, your PEO is trending in a favorable direction which will allow your Investment Banker to position your PEO more favorably at the time of sale. Even if you don’t decide to sell after this process, your PEO is in a more profitable position moving forward. This process could act as the change-agent to reinvigorate your desire to build the business.
Leadership can make or break a deal. If your leadership is looking to remain with the macro entity once purchased, it is especially important that there exists an alignment with vision. If the executive team is to remain post transaction, it will likely be asked to roll over some equity into the larger organization. Therefore, having alignment among your leadership team is important. Also, evaluating and aligning with the leadership team of the purchasing company will be essential to drive optimal results on a go forward basis. Creating increased wealth is dependent on successful leadership. The executive team of the selling PEO should also gain a working knowledge of the M&A process prior to engaging a purchaser, especially if this is the team’s first transaction.
Our firm helps prepare the leadership team and sets appropriate expectations for the process. We also work with executive teams on creating superior communication and alignment of vision which will be important during the M&A process and post transaction when running the entity.
This is an aspect that is surprisingly minimized too often during the M&A process. Culture is a huge factor when looking at assimilation. Creating the right culture in an organization and understanding the acquiring company’s culture as much as possible can help illuminate any red flags during the exploration process.
Even companies whose cultures seem similar can be in for a big surprise post acquisition. Unilever acquiring Ben and Jerry’s is a great example of two seemingly similar cultures that experienced issues post acquisition.
Conducting a culture assessment will help leadership understand their core company culture in order. This will allow the team to speak to the culture more clearly and identify the best acquirer for the organization. If leadership rolls over some equity into the new entity, it is important that cultures align as much as possible to aid in a smooth assimilation.
Even though this may feel like it should be addressed earlier on in the process, it is purposefully positioned at the end. This is due to the fact that we are discussing a different value proposition. While it is important for your executive team to be able to clearly and concisely discuss your company’s value proposition in the prospective clientele sense, that is not what we are covering here.
Beyond the value proposition you illustrate to your clientele, what is your value proposition to prospective buyers? This is a bit of a paradigm shift in your thinking that needs to occur. Look at the prospective buyer as your most important client ever. If they are considering purchasing your PEO, the value that your PEO has to offer needs to be very clear to the acquiring PEO or Equity Partner.
When you can clearly and concisely illustrate the value of acquiring your PEO, you are better positioned to maximize your exit multiples. This transaction will likely be the largest and most lucrative of your career. Take the time to ensure that your PEO is positioned appropriately to capitalize on this opportunity. You cannot be over-prepared but you can be under-prepared, the choice is yours.
Hopefully, after reviewing the information in this article, you can see the value in making implementing a pre-exit strategy prior to hiring an Investment Banker. An Investment Banker will be an asset to you during the selling process but if you provide them with a better PEO to sell, they can deliver superior results. Ultimately, the right preparation allows your stakeholders to maximize profit on the largest transaction of your life.
Author: Rob Comeau is the CEO of Business Resource Center, Inc., a management consulting firm in the areas of mergers & acquisitions, pre-transaction consulting, post-transaction consulting and business consulting. To learn more about Business Resource Center, Inc. please visit their website at www.biz-rc.com. You may contact BRCI at (949) 888-6627 or firstname.lastname@example.org.