Overview

The PEO industry is top heavy. It is estimated that roughly three quarters of industry gross revenues are driven by the top ten players in the industry. With investor interest in the space, we are seeing continual consolidation within the market. This consolidation movement is likely to remain for the foreseeable future.

 

The majority of PEOs are under ten thousand work site employees (WSEs). As we all know, size doesn’t guarantee quality within a PEO. Nevertheless, if a PEO would like to grow, there are steps it can take toward increased revenue and profit. There are advantages to appropriate growth. Increased profit and cash flow from operations, scale, purchasing power, geographic expansion, and resources just to name a few.

 

The first question a PEO owner must ask him/herself is: do I want to grow? It may sound like a rhetorical question but in fact, the question is valid. Many PEO owners have created a very nice living with a PEO under ten thousand WSEs. It is a business that provides for the needs of the owner, their family, and their staff which is an accomplishment to be very proud of.

 

However, if the owner wants more, the journey will demand more from the ownership. So again, the question is: do you want to grow? If the answer is yes, this article will provide insight into key elements and strategy which can be implemented into the PEO infrastructure to stimulate growth.

 

Elemental Review: The Elite Eight

While we could never cover all facets of contributing elements to PEO growth, this article will focus on some of the more important parts of growth. These parts will include: leadership, strategy, value proposition, talent, third-party providers, sales, operations, finances and mergers & acquisitions.

 

To be clear upfront, this will be a longer article than we normally release. Every effort was made to consolidate the information but there is a lot of ground to cover and we don’t want to shortchange you for the sake of a word count limit. As per usual within our article formats, we will tackle the below sections one at a time and then provide a comprehensive wrap-up at the end.

Coverage will include:

1. Leadership
2. Strategy
3. Value Proposition
4. Talent
5. 3^rd Party Providers
6. Sales
7. Operations
8. Finances and M&A

 

Leadership

A company will succeed or fail in large part due to leadership. We have seen this time and again with publicly traded organizations in the spotlight, revered entrepreneurs, innovators, and villains. While leadership is not all that is required to run a successful business, it most certainly has an influence on whether or not the company reaches its potential, is considered mediocre, or falls into scandal. A leader is one person but leadership is not one person. Leadership is a team of professionals with common vision, complimenting capabilities, aligned values, passion for their work, and care for their workforce.

 

Tyrannical leadership does not produce the best possible results. A study was done which was illustrated in the book Return On Character, where the author Fred Kiel contrasts self-serving CEO’s with what they call “virtuoso” CEOs. A virtuoso CEO is one that demonstrates quality character traits. Not only did the employees love working for the virtuoso CEO, but workforce attrition was lower, and profits were dramatically higher. The study illustrated that good leadership benefited the workforce and the bottom-line simultaneously.

 

Identifying the best leadership team may be a challenge at first. Often, relationships are formed within a PEO as it starts out. Some of these relationships translate into a leadership team that may be the right fit to get a PEO started. The question going forward is: are they the right team to move to the next level? Once that question is answered, a PEO may have the right leadership team, or it may have some vacancies it must fill.  To identify if the players are the correct fit, it is advisable to first discuss the role the leadership team will serve.  In smaller PEOs the leadership team may be very active in the day to day operations. As a PEO grows and scales, the leadership team will need to operate in a more strategic and delegating manner. It is the adage, are you working in the business or on the business?

 

The workforce looks to the leadership team to set the tone, vision, and for guidance. A disjointed leadership team causes confusion in the workforce and creates a misaligned business. The result to disjointed leadership is organizational under-performance. This is why organizations like Glassdoor and Forbes grade the leadership within organizations in order to provide insight into the future prosperity of the company.

 

Leadership can develop. People can grow through experience and learning. The key is to identify the growth stages for the PEO and then review the current leadership at each stage. Where does each leader need to grow to perform optimally at each growth stage? Are the correct people in place? Is the communication within the leadership team optimal? Once these questions are answered, the leadership team will have a better idea of what is required from each of them going forward.

 

To learn more about effective leadership, please review the following articles:

 

• 5 tips to improve executive communication
• Learning organization: dialogue and defensive routines
• The CEO & the Entrepreneur
• Essentials of Leadership
• Executives that embrace leadership promote corporate sustainability
• Creating & communicating vision

 

Strategy

Strategy is often a misused term. When people discuss strategy, it is often replaced by a plan of action (POA). However, strategy at its core, is a comprehensive process of evaluation resulting in a determined aim, followed by a formulation of action to achieve desired results and defend against competition. That is a little more detailed than a plan of action.

 

Once the appropriate executive team is in place, the group must determine the organization’s strategic intent. This intent will help guide the actions of the executive team in their decision-making process and provide increased clarity in vision within the team. This vision can then be disseminated to the workforce as appropriate.

 

It is advised that the executive team start with a global strategy and then pare down to segmented strategic initiatives. Global strategy does not mean competing on a global level, although a company may be an international organization. Instead, a global approach is reviewing the organization as a whole. Once a strategy has been determined for the whole of the organization, the team can focus on departmental strategies aimed at achieving the macro or global strategy of the organization. When the team begins with the global strategy, it can more easily determine if the departmental strategies align with the macro initiatives.

 

If the executive team isn’t familiar or experienced in creating strategy, hire an outside consultant to guide the process. Businesses can be successful without purposely creating an in-depth strategy. The best companies in the world cannot. If the executive team desires to be best in class and consistently win against competition, strategic development cannot be ignored. Every company deploys some type of strategy whether they realize it or not. The question is, will your company adhere to a strategy by default or be intentional with how it develops its strategy? The latter will generally yield better results.

 

To learn more about strategy, please review the following articles:

 

• How to build a business model framework
• SWOT or OTSW?
• Creating and driving a successful PEO model

 

Value Proposition

A PEO’s value proposition is the value the PEO delivers to its clientele through its internal and 3^rd party capabilities. It is made up partly by the company’s and partner’s service offering but the value prop should not be confused solely with the service offering itself. A PEO’s value prop is what differentiates the PEO from its competition, governs who the PEO hires, and provides the basis of which the sales force may illustrate as solutions to prospective clientele.

 

In addition to the value proposition design, is the execution and service component. A phenomenally designed value proposition can derail quickly with poor execution. Moreover, if the design is correct and the execution is solid, poor service and customer experience can still derail the intended value. Therefore, a client will generally appreciate the value proposition, as intended, when the design, execution, and customer service work in harmony.

 

Part of the strategy process discussed earlier in this article is determining the PEO’s value proposition. Often, what I have seen in the market, is a startup PEO that replicates a current model (sometimes the PEO that startup owner just left), and then potentially adds some type of addition on to the offering. There is nothing wrong with the generic PEO model. It has been very successful. However, is the generic model what you’re client segmentation will value the most? Or, is there an augmented model that would better suit your client’s needs while simultaneously creating a significant differentiation for your PEO against competition?

 

Whichever variation of the PEO offering is selected, the PEO should ensure it has/will have the capabilities to execute, both internally and with 3^rd party partners. The execution and service components are essential to drive value within the value proposition.

 

Innovative PEOs may have a leg up on their competition. However, don’t innovate for the sake of innovation. Test the market to ensure the innovations are well received by perspective clientele. If there is not a value capture to the innovation, it becomes a financial drag on EBITDA. If the innovation increases profitability, the value proposition is differentiated from competition, and potentially a new profit pool has occurred for the PEO.

 

To learn more about a PEO’s value proposition, please review the following articles:

 

• 4 key elements to a PEO’s value prop
• A closer look at the PEO model
• How does a smaller PEO compete in today’s market

 

Talent

Talent is essential to driving a successful PEO. We live in a world with continuous technological advances. Many of these advances assist businesses in becoming more efficient. Technology is necessary to compete in an industry where competition levels are high. However, talent is arguably more important in the PEO model. Of course, this is solely my opinion, but I am guessing that you are not a robot whom is reading this article. If you are, my apologies robot. For the human readers, identifying the right talent at the right price is essential. This task becomes more difficult when unemployment is at its lowest rate in decades. Also, if the PEO is smaller, it may lack the financial resources to court some of the industry’s top talent.

 

Solution? A PEO can groom internal talent, look outside of the PEO industry for talent, and entice top industry talent with alternate factors other than cash. Grooming internal talent is like a Major League Baseball farm system. It is essential for the future viability of the organization. Like an MLB team, if the farm system is not managed appropriately, it will overpay for veteran talent to compete. However, grooming talent cannot be the only solution. It is a longer-term process aimed at the future but the PEO also must compete today.  I like recruiting outside of the PEO industry. I have personally recruited professionals whom possess the right DNA, drive, inquisitive nature, and attitude to be successful in the PEO industry and then trained them on the industry itself. Often, these “outsiders” become some of the best PEO professionals I’ve worked with. Plus, this gives you a larger pool to fish in for candidates. Finally, a PEO can entice talent with factors in addition or in lieu of higher income. The PEO’s vision can entice candidates, as can equity options, bonus plans, benefits, culture, and advancement opportunities.

 

Once the PEO has the right team, and as it continuously cultivates new talent, it needs to ensure the talent has the capabilities, common vision, and communication to achieve the organization’s desired results. It is also advisable to clearly illustrate pathways for advancement.

 

Finally, cultivating a learning organization is key. When an organization promotes learning within and outside its walls, it creates an ever-advancing workforce. When that model is coupled with purposeful communication to share and explore new ideas, the whole of the organization benefits. The ultimate goal is to create high functioning teams with fluid lines of communication for innovation. If the PEO is able to achieve this balance and promote this culture, the organization and its clientele will benefit as will the bottom-line.

 

To learn more about talent, please review the following articles:

 

• Lifelong learning is a necessity in business
• Symbiosis realized: employee/employer mutual gain
• Posturing and seeking political capital are destructive…
• Workplace Dynamics

 

3^rd Party Providers

I recently wrote an article regarding third-party providers for the September 2018 addition of NAPEO’s PEO Insider. Rather than reemphasize the points laid out in the feature, you may view the article here.

 

Sales

Sales are an important aspect of every organization. The sales engine drives topline growth, a precursor to continuous profit growth. The PEO model has plenty of facets which yield beneficial solutions. A key to successful sales within a PEO is for the business development team to completely understand all facets of the business. Without this base of knowledge, the business development team will not be able to fully illustrate the benefits of the PEO and the subsequent impact on the SMB. Owning this information will allow the business development professional to operate on a consultative level.

 

Consultants spend years learning and developing their expertise. It is the consultant’s experience, knowledgebase and wisdom that gains them new clients. Why should this be any different with PEO sales? If a PEO wants to adhere to consultative sales, the legwork cannot be dismissed.  I love talking with business owners. They always know their business inside and out. That allows the business owner to clearly illustrate the organizations capabilities, innerworkings, and value. Generally, a business owner has no problem conveying what their business can or cannot do. Whether or not a business owner came from sales or some other facet of business, they can speak clearly to the benefits of their organization. That is required in consultative sales.

 

The other aspect a PEO must decide on when it comes to sales is their preferred go-to-market strategy. A PEO can utilize a direct sales approach, a channel approach, or a hybrid of each. Client referrals play into this equation as well. There are pros and cons to each approach that should be weighed carefully when deciding how the PEO will go to market.

 

Aside from the sales force, the marketing and advertising arm of the PEO should emphasize fluid communication with the sales force to ensure continuity in brand and messaging. This information should flow through operations also as operations will be the team executing what has been branded to the market and sold to the client.

 

To learn more about sales, please review the following articles:

 

• PEO Sales 101
• PEO Sales: A successful approach
• The importance of no in sales
• Elite Sales: learned or innate?
• Don’t cannibalize your channel partners
• Forget the 80/20 rule

 

Operations

Operations are essential to the PEO. Whether it be in client deliverables, internal controls, technology, etc. Sound operations are essential to a healthy profit margin. As a PEO grows, some operations remain standard while others shift. To scale a PEO requires a review of operations to identify the most efficient ways of conducting business. As the PEO grows, additional layers of talent may be infused to ensure appropriate control, guidance, and accountability.

 

Operations are somewhat interesting within the PEO model. Meaning, some of the operations are internal while others are handled via a third-party provider. The combination of each make up the whole of the operation. It is different from a verticalization model, in that, with verticalization, you are swimming up or down stream depending on your position. With the PEO model, it is an outsourcing model whereas some of the functions outsourced to the PEO are then outsourced to third-party providers. Examples would be insurance, tech, retirement vehicles, etc. The PEO offers these services but provides much of the service in these areas via a partner.

 

Operational efficiency is contingent upon harmonious departments. Disjointed departments or departmental silos are counterproductive to the PEO model. Some PEOs utilize a departmental approach, while others employ a business unit model. Still others use a client sales and marketing function with backend operating centers. Ultimately, a PEO will fall somewhere within one of these models or deploy a hybrid approach. Whichever model a PEO uses, it should evaluate the efficiency of each model during various growth stages. When reviewing the efficiency of each model, the executive team may want to ask the following questions:

 

• Does the current operating structure yield the best profit margins?
• Does the current operating structure provide the best value prop execution?
• Is the PEOs client retention higher with one structure over another?
• Does the operating structure afford sound controls to mitigate liability?
• Is the operating model positioned to scale?
• Will the operations be congruent with other PEOs for acquisition or to be acquired?

 

There are more questions when reviewing operations but the bottom-line is to ensure the operational structure is inline to maximize efficiency, profit, and model execution, while being able to scale and retain clients. Funky models may yield higher profit margins today at the expense of an exit tomorrow. If the operations are too far form the norm (except for valuable innovation), it will be difficult for a buyer to assimilate the organization into its holding entity. This can diminish some of the valuation upon exit.

 

To learn more about operations, please review the following articles:

 

• Analogical approach to PEO growth stages
• Creating & driving a successful PEO model
• WSE to Internal Ratio
• Establishing & maintaining company culture

 

Finances and Mergers & Acquisitions

Finances

PEO is an excellent model to generate positive cash flow from operations. Adequate working capital is key if a PEO wants to drive organic expansion and/or make acquisitions. When a PEO operates on a risk baring insurance platform, there is liability with profit margins. A PEO can increase profit margins through positive claims history or decrease profit margin through increased claims and claims maturation. It is a risk versus reward scenario.

 

Many PEOs have audited financials which is beneficial if the PEO is seeking capital or looking to exit. Moreover, a PEO should manage their finances in line with their overall global strategy. In other words, if a PEO is looking to expand organically or acquire, it should work toward generating increased cash flow from operations. This could take the form of increased sales, operational efficiency, risk mitigation, price increases, improving client retention, voluntary attrition with poor performing clients, etc. Ideally, all facets are tackled on a regular basis to optimize profit and increase working capital. While a PEO may utilize a loan, LOC, and/or take on an equity partner for organic or acquisition growth, higher working capital will always benefit the cause.

 

Financials are a historic snapshot of a company’s prior performance. Senior leadership should use the past performance (financials) in conjunction with forward thinking decisions to measure the pace in which to move and capital required for such moves.

 

The three primary financial reports I review when consulting with a PEO are:

 

1. Income Statement
2. Balance Sheet
3. Statement of Cash Flows

 

While these three financial reports won’t tell me everything I need to know about the PEO, they provide insight into the questions I will ask the owner. Financials illustrate trends. These trends provide senior leadership and outside consultants with insight into the questions they want to ask about the business. It is advised that senior leadership review the trends within the finances. Are there areas that can be addressed before a negative trend continues too long? Are there areas to capitalize to ensure a positive trend gains momentum and sustains?

 

When consulting, I always make the argument that net profit growth should exceed that of revenue growth. If a company’s revenue growth out paces profit growth, overhead has increased at a greater rate than revenue. The exception to this rule is a reinvestment back into the organization. When profit growth outpaces revenue growth, it is normally indicative of operational efficiencies being realized while revenue growth occurs. There are variables that can impact this equation that don’t guarantee the previous statement but by and large, this generally holds true. Another exception to this rule is sustainability. A company can increase its profit growth over revenue growth but still not be in an ideal situation. This is when the company has a relatively flat top-line while they increase operational efficiencies. The profit will outpace revenue but without top-line growth, there will be a profit ceiling.

 

To learn more about financials, please review the following articles:

 

• Leadership and Financials
• EBITDA add backs

 

Mergers & Acquisitions

Consolidation is a continuing trend within the PEO industry. As previously discussed within this article, the vast majority of revenue in the industry is driven by the top ten players. During a robust economy, capital is generally cheap. Cheap capital is generally a precursor to organic expansion and acquisitions.

 

The number one question I hear when consulting on potential M&A deals is: what is the value of my PEO? Valuation experts are hesitant to provide concrete numbers quickly due to the many variables that play into this equation. Variables such as:

 

• Revenue size
• EBITDA
• Liabilities
• Geography
• Client mix
• Growth trending
• Leadership
• Comps

While there are many more variables that factor into the valuation equation, the above is sufficient to understand why an investment banker won’t be cavalier with throwing out a number. However, high-level, a business owner can gain a range based on a few variables, providing their PEO isn’t fraught with issues. These variables would include size, EBITDA, liabilities, trending.

 

Keep in mind, a seller is trying to maximize their ROI at the time of transaction. A buyer is looking to maximize their ROI post transaction. This is generally why a buyer will require a PEO owner to roll equity and remain involved for a determined amount of time. Theoretically, it incentivizes the PEO owner to continue to build the business in order to increase value for the second liquidity event.

 

Each deal, while it has similarities, has differences. The LOI and purchase agreement can be structured advantageous or detrimental to the seller. The deal structure matters. If the PEO is not familiar with variables in how the deal may be structured, hiring a sell-side advisor is appropriate.

 

Beyond the valuation of the deal, a seller should look at the makeup of the acquirer. Will this partner be in line with the seller’s ethical standards? Does each party have similar views on how to move the business forward? Does the PE bring more than just capital to support the seller? Are expectations on both sides of the house clear? Of course, there is more, but this is a good starting point to begin evaluating an equity partner.

 

Whether or not a PEO is looking to sell, it is advisable to go through the preparation process. Basically, having the exit in mind when running the business. Why? Think of it this way. You walk through your house every day. My guess is, that if you were about to sell your house, you would notice items for repair that you had previously missed when living in the house. This holds true with a business as well. Every business has room for improvement, there are no exceptions. When an executive team functions as if they were going to have an “open house” every week, they pay closer attention to areas that require fixing. This improves the business so that ownership can reap the benefits of increased profitability. It also prepares the organization if/when they do want to sell.

 

To learn more about M&A, please review the following articles:

 

• Private equity in the PEO industry
• Industry statistics
• M&A in the PEO industry
• Leading your PEO through an acquisition
• Bear market approaching?

Wrap Up

In this article we reviewed eight elements that can lead to PEO growth.

1. Leadership
2. Strategy
3. Value Proposition
4. Talent
5. 3^rd Party Providers
6. Sales
7. Operations
8. Finances and M&A

 

When a PEO excels in each of the above areas, it positions itself for growth in the market. A PEO that masters these important functions, with the ability to adapt with the market, can capitalize on opportunities more quickly than competition. Ultimately, these areas will also increase the valuation of your business. It may seem daunting or time consuming to tackle all these areas of improvement at once. That is true. It takes time and work to improve each area. However, if each day has a focus of improving just a little bit at a time, the cumulative effect will be beneficial to the PEO.

 

To learn more about how business improvements increase valuation, please see the below articles:

 

• PEO Valuation: Sales & Scale
• PEO Valuation: Operation & Technology
• PEO Valuation: Liability, Legality, & Loss Ratios
• PEO Valuation: Talent & Value Proposition
• PEO Valuation: Leadership & Financials

 

If you made it this far in the article, you’re a trooper. This was a long feature so hopefully it was a good use of your time and the takeaways were worth the read. Good luck out there!

 

Author: Rob Comeau is the CEO of Business Resource Center, Inc., a business consulting and M&A advisory firm to the PEO industry.