Lewis Gray, Associate at Arrowpoint Advisory shares his thoughts on why recruitment businesses might want to recruit some private equity.
It's no secret that recruitment firms have been riding a growth wave over the past couple of years. Technology and social media may have transformed the ways in which the market operates but people still buy from people, and people still buy into people. That is not going to change. As any economy improves, so too will its recruitment sector.
This is a high-octane, entrepreneurial industry. Its low barriers to entry reward the ambitious entrepreneur. It's a sector that boasts a cohort of high-growth firms that were founded in the difficult times of 2008 and 2009 but which are now making operating profits of up to £5 million. Few other mature business sectors can throw up such startling growth.
It's a good time for the founders of such firms to look at their next big strategic move. For some, this may be the opportunity for an outright exit; for others, it's the chance to bring in external investors and stoke up your financial firepower.
The active private equity players
It's more than likely that private equity will be involved. While some private equity houses - such as Baird, Graphite, Inflexion and Sovereign, seem to have developed something of a specialism in the area over the years, it's fair to say that pretty much every single mid-market private equity house has had a human capital/recruitment business in their portfolio at some point. Private equity really does "get" the recruitment sector - and its appetite to invest in recruitment firms is keen.
What attracts investors?
So what is going to help a recruitment firm attract particular attention from private equity investors? Private equity likes the sector's proven ability to increase profits. But it is also sharply aware that this profitability is closely linked to the economic cycle. So investors will want to see sustainable and growing revenue streams in the business.
Private equity really starts to get interested when a recruitment firm's (Earnings Before Interest, Taxes, Depreciation and Amortization) is above £3 million. They prefer earnings from contract/temp placements than permanent jobs; the quality of the recurring revenues is smoother and less lumpy than the profits gained from placing someone in a permanent role. In considering these opportunities, a useful benchmark is a 75/25 contract/permanent revenue split.
Of course it is vital to have the right management team in place. The depth, capability and quality of the management team is at the heart of a successful recruitment firm. This is a tough, unrelenting business; every week starts with motivating a team to focus on its goals and hit its targets. That requires really strong management and processes. So the private equity investor will need to be comfortable with your management team and growth plan.
They will also need to be persuaded of the credibility of contingency plans. They want to know how the management might protect a particular market position in the event of a downturn. This is a volatile business; investors back teams with demonstrable agility.
Sector strength counts. Investors want you to have a distinctive market presence. But from their perspective there's limited upside if that presence is in a single, mature market. A firm that can also demonstrate that it has expanded into another country or region in which there's good growth will really capture attention.
The last criterion is, perhaps, the most important. It may be tempting to broaden your service offering but the appetite among investors will be for those outfits with a strong, definable focus. In recruitment, it pays to be a specialist.