As I speak to lots of recruiters who want to build their own recruitment company, after all my profession is investing in startup recruitment businesses, I get a fair few whose goal from day one is to build to sell. Is this really a smart move?
As with most questions like this it depends who you ask. It also depends on circumstance. For example, if you have a substantial amount of cash and the plan is to grow big quickly with a rock-solid plan, the necessary expertise and a very clear future event such as AIM listing then yes, this can be a very good idea. However, as my contact is generally with aspiring business owners with only sufficient cash to go down the more organic route, i.e. mostly funding growth with cash from profit, it’s my opinion the answer is yes AND no. I explain as my blog goes on why my answer is both.
Why do you want to sell?
In the conversation I have with recruiters who want to build to sell, I ask why? It may seem like a dumb question to some ‘to be rich’. However not everyone’s ambition is fuelled by the desire to be wealthy. I, for one, was more motivated by the satisfaction I would get from the achievement of building something from nothing to a size someone wanted to pay me in excess of 7 figures for, so if this is the reason then I would say yes, definitely it’s a good idea. But if it’s purely to cash in a large sum to retire off or have a fleet of supercars and a boat moored off the South of France, then I would say the answer is yes AND no.
How much are recruitment businesses worth?
In my forthcoming blog ‘How to value a recruitment business’ I will go into more detail on how recruitment businesses are valued. However, I can tell you now it’s hard to put a value on a recruitment business. But for the purpose of my point, we can use the industry average of 4 X EBITDA for permanent recruitment businesses and 8 X EBITDA for contract businesses. EBITDA is earnings before interest, taxes, depreciation, and amortization, which in simple terms mostly means profit. For those unaware of how businesses are valued this is often a surprise, they assume they’d be worth much more. I would add that if you do get an unsolicited approach from a buyer who wants your business for a specific strategic reason these can go up, but in general the above is a good guide.
What is the reason recruitment businesses aren’t valued by more?
The answer to this is a blog in itself but there are 2 big reasons. Firstly, a recruitment business isn’t very sophisticated so if someone has enough money to buy one, they’ve probably got enough expertise to build one themselves.
Secondly, risk. As recruitment businesses don’t have any clever patents on what they make, or something of real tangible value that’s very hard to replicate, then a buyer is really buying the brand and workforce and the risk is in the latter, i.e. the staff. Staff can come and go, hence the risk. We all know the ‘you’re only as good as your last month’ risk in being a recruiter, well the risk in buying a business is also ‘you’re only as good as your last month’ especially if those recruiters decide to leave ‘en masse’. I’ve seen businesses taken over where once a few of the long-standing employees leave, the remaining team get nervous and move too. Boom, business gone.
Why building a business to sell is a bad idea
When you sell a business, unless you have already exited the business so it runs entirely without you, it is virtually always the case that the new owner will demand an earn out in the deal. An earn out is where the deal consists of some of the cost of the sale being paid up front and the rest either over the period of the earn out or at the end of this period, and any money after the initial sum is linked to the business hitting the projected numbers agreed on sale. In practice this means you could be selling the business for 4 X profit but staying on with the business working for 2 years, which really means you get 2 times profit, and this additional 2 can reduce or even evaporate if the business doesn’t hit the numbers projected. Plus, after building the business yourself and being your own boss for so long how would it feel suddenly working for someone else and have to stand by with no power if said new owner makes some bad calls that cause the business to fall apart, or you see staff you care about leaving because they don’t like the new owner?
So why cash in for 2 years’ profit when, if the business runs by itself, then holding on to it can mean 6, 10, 20 years’ profit if the team you left running it do a good job and the business carries on trading well. They could even take annual profits up. Often the owner manager can actually hold the business back! The smart move would be to tie in some of your key staff with shares, maybe employ a very good Non-Exec to help develop the new board and sit back and take the profit every year. That’s a much better return than any pension fund!
Why building a business to sell is a good idea
If you read my blog on 8 ways to increase value when growing your recuritment business, I go through the factors that add value to a business. Some of the areas I cover are:-
These are all smart aspects to have in your business as it grows. Why? Because they make your business more a of a money-making machine that isn’t so reliant on your employees, which in turn makes it so much more resilient, easier to grow, retain staff and exit or semi-exit when you feel the time is right.
So, if you build a business to sell you are really using a great blueprint to build a business built on very strong foundations that will be easy to scale up, have great longevity and carry on as your cash cow. PLUS, if you do get an unsolicited approach to buy your business out of the blue, it’ll be worth that much more.
In my opinion, build your business as if you are looking to sell in the future and you will build a better stronger business. This is the method I use with the businesses I invest in and partner with. Of course, the overall decisions on the direction of the businesses I help set up and grow lie with the owner manager(s). However, as this very simple strategy is such common sense all the business owners I support follow this method, which contributes to them building a resilient business that will become even easier to grow as these aspects fall into place.
Written by Rhys Jones Managing Director – Davidson Gray.
Rhys sold out of his previous recruitment businesses in 2012 to focus solely on helping recruiters set up and build recruitment businesses. Follow Rhys on LinkedIn or contact him direct for help with your start-up recruitment business or for coaching to grow an existing one.