Understanding external variables may help guide you in your exit strategy for your PEO business.
WHAT IS YOUR EXIT STRATEGY?
Overview:
What is your exit strategy? Within the industry as a whole, PEOs as well as PEO Owners are at different stages within their evolutionary life cycle. Some are just starting out while others are potentially winding down.
It is important to note that the timing for this cycle doesn’t always coincide with the most lucrative time to begin your exit strategy. External variables can impact the exit strategy of a PEO owner. Don’t ignore these factors when you’re focused on the internal build.
Examples:
Take construction for example. Let’s assume that you owned a construction company that was booming in the early 2000’s with all of the building that was taking place. The prime time to have sold a construction company would have been roughly around 2006, though that may not have coincided with the owner’s exit strategy. If the owner, in the early 2000’s decided that they planned on selling in 2009, had they not made an adjustment to sell at the height of the market (2006), they would have taken a significant hit on the valuation due to the 2008 housing bubble.
Let’s take another industry for a spin. If you owned a financial services or mortgage company in the early 2000’s, the same type of cyclical damage could have been done to your valuation as the contractor. The takeaway from this is that with market volatility during economic instability, you may want to consider striking while the iron’s hot, even if it isn’t exactly in sync with the timing of your exit strategy.
Variable Impact:
The residual nature of the PEO model provides some comfort with predictability of revenues. However, there are variables that impact the a buyers perception for growth predictability which subsequently can hurt your valuation and lessen the EBITDA multiples afforded.
Let’s take a moment to explore a couple of these.
Economy: The economy today is humming along in the stock market, though some believe (myself included) that we may be in a state of artificial inflation. If this proves to be true, an economic downturn may be forthcoming. A downward trending economy will impact even the most efficiently run PEOs.
- Same Store Sales: Whether or not you believe your PEO is recession proof, your clients are not. When an economic downturn occurs, your clients are impacted, some more than others. This means that as they perform a reduction in force, be it hours or headcount, the result impacts your bottom-line. If your PEO achieves a 15% new business growth but your existing clientele experience a 10% reduction in force, your net gain is diminished to 5%. How do you think buyers view this when evaluating your company vs. the 15% net growth during prosperous economic times?
- New Business Revenue: a slower economy means tighter wallets. While you and I know that your PEO may drive cost efficiencies within your prospective clientele, you may find it more difficult to secure new business during an economic slide. Businesses are less inclined to invest in a partnership that may pay long term savings dividends if they are too concerned about the short term financial viability of their organization.
- Gross Margin Dollars: To an extent in a capitalistic market, competition sets the pricing precedence; good, bad or indifferent. Lesser PEOS and/or sales professionals, whom are trying to hold on, may drive the pricing bar lower to obtain new market share in the hopes they will retain this business come the next economic upturn. This can impact the gross margin percentage your PEO is earning which by extension will reduce your GP, EBITDA and Net Profit.
Regulations:
- ACA: It finally seems like the ACA volatility is calming down a bit. However, it is important to note that regulations that may not be clearly defined such as MEWAs can impact the ability for a PEO to drive cost efficiency within large group plans.
- Workers’ Compensation: these regulations are subject to change and as a result, changes can impact a PEO’s ability to operate self-insured programs. California is a good example of disallowing PEOs and Staffing companies from fully self-insuring as recently as 1 year ago.
- Taxes: We’ve had some good movement on this front with the SBEA (small business efficiency act) and the creation for the voluntary CPEOs. That helps more clearly define the PEO relationship. This evolutionary gain was largely driven forward through the advocacy efforts of NAPEO (www.napeo.org). You have to keep in mind that with regulations, they may evolve and as a result, this creates unforeseeable factors to consider.
Market Consolidation:
- Growth: Your PEO may be growing, but so are the largest players. With increased size generally comes economies of scale and the ability to provide a more robust offering to a PEO’s clientele. PEOs and investors recognize this and therefore are willing to pay to build larger organizations. Too often I’ve noted PEOs that have hovered in size without much substantial growth. I don’t currently foresee this changing and if anything, as the larger players get larger, some of the smaller and mid-sized PEOs may begin to notice a decline in business.
- Competition: The market is not only consolidating but it is evolving with high tech platforms and ancillary offerings that are driving a bigger impact to PEO clients. As clients become more educated and aware of the PEO space, buyer sophistication increases. If your PEO is not driving superior results with superior marketability, the name brands have a leg up on the marketplace.
Final Thoughts:
This article isn’t a scare tactic. It is written to remind PEO owners of the external variables that can impact your business. Most owners are focused on building, growing and maturing their PEO business, offering and personnel. This is understandably where your focus should be. However, don’t ignore the fact that external circumstances can partially diminish the value of your organization on the M&A market.
It is recommended that you explore your options, whether the timing is exactly in line with your exit strategy or not. This way you’ll understand what today’s market is yielding versus where the market is if/when you decide to sell. The ideal scenario is that your PEO is outperforming the industry, the economy is booming and both of those align with your exit timing. Aside from that situation, you may want to explore your options while the market is yielding high EBITDA multiples.
You may have the option to start another PEO in the future (details and timing vary depending on your contract with the buyer) to take advantage of a future market upsides. Except this time you’ll be able to do so being well funded by cashing out on your previous venture during a strong market.
Rob Comeau is the CEO of Business Resource Center, Inc. a management consulting firm that specializes in the PEO industry. BRCI is engaged with a portfolio of Private Equity and PEO buyers. To confidentially learn more about potentially selling your PEO, please contact Rob at rob.comeau@biz-rc.com or visit us on the web at www.biz-rc.com.
All of the information contained within this article is considered opinion in nature. There are many variables and unknown certainties that can impact the economy, the PEO industry and regulatory bodies and this article should not be construed as a prediction for forthcoming events and changes.