Staffing Industry Spotlight: Brian Kennedy, M&A Advisor at R.A. Cohen

Staffing Industry Spotlight is an interview series with staffing leaders who are shaping the staffing industry. The series is brought to you by Ascen, an all-in-one employer of record and back office platform for staffing agencies. In this installment, we spoke with Brian Kennedy, M&A Advisor at R.A. Cohen, who talks with us about M&A in the staffing industry. Brian shares insights on staffing agency valuation, sale structure and process, and issues surrounding staffing exits.

Francis:

Brian, thank you so much for being at the Spotlight Series. First off, we'd love to hear about who you are and what you do.

Brian Kennedy:

Well, I'm Brian Kennedy. I'm 64 years old. I've been in the staffing industry, I don't know, 43 years or so. I came in 1981. I came in working for somebody else. I ran a perm placement desk in IT. It wasn't called that back then, but we'll leave it at that for now. And then worked my way through the ranks.

Finally caught on under the magic contract and temp placement about four or five years into the business. And there's been no looking back. Over that 40-some odd years, the last 12 have been spent on M&A and consulting work, operational and strategic consulting. Other than that, I was in the trenches.

I've owned a couple of firms. I've had a couple of exits as well. One was a dream and one was a nightmare. So I figured some of that on-the-road experience, if you will, would translate well over into the M&A space for staffing company owners, particularly in the lower middle market where we spend most of our time.

Investment bankers have a place, particularly with the very large deals, but even the best of them, if they haven't been in the staffing industry, some of the nuances may escape them and those nuances can make a big difference in getting the right transaction done.

Francis:

How did you end up in the M&A side of the business? That's quite a jump from an operator to an M&A. How did that happen?

Brian Kennedy:

So Bob Cohen, our founder, he founded the company in 1991. He was originally from New York, but he transplanted here to Toronto where I was, and I was a youngster in the industry at the time. I joined the industry association up here, the equivalent of the ASA and joined the board.

Bob was on the board and he took me under his wing and he mentored me for many years. I didn't realize he was doing that until much later. And then we parted company. He did his thing, I was doing my thing for a while. Then in 2012, he called me and asked me if I'd be interested in coming into the M&A space and having gone through two exits, one being great and the other not so much, it seemed intriguing.

What Bob didn't tell me, he was actually suffering from terminal cancer at that point in time, and he was really looking for a partner for Sam so Sam wouldn't be left on his own. Bob and I, we had a long-standing relationship and I'm so grateful that he thought of me and gave me the shot to come here. And that was in 2012. And here we are in 2024.

Francis:

You mentioned the lower middle market. What is that range of sales and what kind of firms are those?

Brian Kennedy:

So, revenue can be a tricky metric to use when describing firms because you've got direct hire-intensive firms where the revenue is going to be lower, but it's almost all margin. And then, of course, you've got temp and contract firms where much of that revenue goes out in the form of cost of goods.

But if we were to use a revenue measurement on a temporary or contract business, that lower middle market probably ranges between 10 million in revenue on the low end, maybe up to 200 million on the high end. Maybe a more suitable measurement in terms of encapsulating that marketplace is EBITDA or net profit after interest access depreciation of amortization.

And there we're probably looking at anything from $500,000 of EBITDA up to 15, $16 million. Beyond that, we're starting to talk about much larger companies and they will tend to use the resources of a large investment bank.

Francis:

EBITDA multiples, we'll dive into that more in a little bit. What do you all look for in a staffing firm that's going to be selling?

Brian Kennedy:

So there are 10 or 12 major criteria that are used in valuing any kind of a company, at least any kind of a staffing company. And that's the methodology that we've used, it's a fair market approach. We are known for valuing a little bit more on the conservative side.

We're a sell side engagement firm, so we don't want to tell somebody their business is going to be worth 20 million if we know it's only going to be worth 15 million. But we'll look at the different criteria. Gross margin performance is a key criteria. The quality of that gross margin, the consistency, the sustainability. For example in IT, kind of a tale of two cities, we see the MSP centric, the VMS centric firms often operating on margins of 13, 14, 15%.

Whereas direct sourcing-type IT staffing companies, where they're working with the companies directly, maybe even doing statement of work, can achieve margins of 20, 25, even 30%. And those create two very different categories from an evaluation perspective within that IT staffing niche on its own. So, I think that there are a lot of different factors to consider, but EBITDA tends to be the number around which a multiple is applied in most valuations.

Francis:

What are the other criteria?

Brian Kennedy:

Gross margin, performance profitability, and then we've got management team. What's the management depth if the owner, particularly in a smaller company, is intrinsic to the business? In other words, if he or she isn't there, the business suffers, that's a problem.

So we're looking for companies that have developed a toe hole, that have developed a safety net and have a team of managers in there that can run the business when the owner or owners are not on board. And particularly, a buyer is going to look at that in terms of do I need to replace this owner? What were they doing and how expensive is that going to be?

So a well-developed management team is key. Client concentration is another big issue. If you've got one client that's 25, 40, 60% of revenue, it's not necessarily going to change the valuation or the multiple that you achieve. What is going to have a direct impact on and a dramatic impact is on how that deal is structured. How much cash at close versus how is the rest of the money going to be paid out and under what conditions. Earn-outs, interest-bearing notes, some combination thereof, who knows?

But client concentration certainly plays a major role in that. Bricks and mortar used to be a thing. The number of branch offices and certainly for staffing businesses that still have that retail walk-up component like industrial where you're still trying to bring candidates in off the street for interviews and that sort of thing. Bricks and mortar is still important, but it has faded in terms of its importance with the advent of remote work becoming more popular through COVID.

Other than that, obviously, the buyers like to see good clients, clients that are sustainable. Again, related to the concentration issue, I think most clients would rather see a whole bunch of medium-sized clients rather than a few elephants just because of the sustainability and the security factor that's associated with that.

I'm happy to send you an article that we publish each year. It's actually a report card that people can use to self-evaluate, and it gives the 10 or 12 criteria, give some different answers, and then you can score yourself and see where you fall in the grid that we provide that shows what we think the multiples are in each sector and for each bandwidth in terms of size.

Francis:

That's probably very helpful for folks who are just starting to explore this sale process. You mentioned client concentration, and I've heard different answers from different bankers. Some say buyers will discount the revenue of a highly concentrated client by a large amount. Say you had a client worth 40% of your revenue, then the associated EBITDA would be discounted, say, 80%. But it sounds like you are saying really only affects the structure.

How are staffing transactions in the lower middle market structured?

Brian Kennedy:

We don't see a lot of stock entering into the equation in that lower middle market space. There's this concept called rolling equity where an owner of a firm may choose to sell a majority interest of the firm to, for example, a private equity company, but retain a piece, go along for the ride for another three or four years and have that proverbial second bite of the apple when the private equity company, as this example, includes exits from the investment.

So that doesn't happen a whole lot in the lower middle market and often, owners in the lower middle market are older and may not be interested in rolling equity and going along for another four or five years. The reason they're talking to us is that they finally reached a point where they're figuring, now's the time for me to get out, now's the time for me to go and do something else, or at least be able to put my feet up and figure out what I'm going to do next.

So, coming back to the other parts of the question, though, cash deals are rare. All-cash deals are very rare, and when there is an all-cash deal, the valuation is almost always going to be dramatically discounted. It represents the buyer taking on all of the risk, whether there's client concentration or not. You don't know if those clients are going to stick around. You've got to make sure in due diligence that the contracts are even transferable or re-assignable.

But even if they are, doesn't mean that they're going to. So that's obviously consideration and not to mention the all important human assets inside the company, the recruiters, the salespeople. That's almost as valuable as the database and the list of clients itself, especially in a marketplace where it's hard to find great frontline staffing people.

So again, there's risk to the buyer. If they come in, they introduce a different culture, a different methodology in terms of their management style and whatnot, all of a sudden you can see some people heading for the exits and that really undermines the value of the acquisition in the first place, at least in our minds.

So there are some cash deals that occur, but they are rare. Most deals, I would say if we were to average it out, we've done 200 transactions in the space. And I would say if we were to average it out, I would imagine the average transaction is about 60% of the target price paid in cash at close, with the remaining 40% on average balanced between notes and earners.

Now on the topic of notes, they are unsecured, so they're not risk-free. They can be secured, but it's expensive and usually a turn-off and can sour the whole mood of the deal, if you will. So there is some risk associated with accepting a note, because you have to be sure that the person who's offering that note is going to be liquid and able to pay when the note matures.

Notes in our transactions run anywhere from a year to three years typically, they usually pay interest often on a quarterly basis along the way, and then we'll pay out a principal amount at the end of each term or at the end of each year. But there are exceptions. We sold a business, $13 million business with one customer. The customer was Walmart, like the 300-pound gorilla.

Now, that was 650,000 cash at close, but then a six-year earn-out. And for every hour that a worker worked for Walmart, the seller got $2.

Francis:

Wow.

Brian Kennedy:

They were booking 500, 600, 700,000 hours a year there. I'm happy to say that now it's eight years later, that staffing company still exists. They're still thriving and they still have Walmart as a customer and some other customers too.

Francis:

I've never heard of a single customer sale.

Brian Kennedy:

They were renting a CDL truck drivers, we call them easy-beesies here, but that's all they were doing. So it was a really interesting experience and Walmart, was involved in every negotiation with every prospective buyer because they had to obviously approve the handoff of the company.

So that was more of a staffing partner than a staffing agency, I think. And it's a nuance, but again, one that maybe would escape the typical investment bankers.

Francis:

It’s great that you were able to get a structure that worked for the buyer for that deal.

Brian Kennedy:

Now, you know Francis, this all sounds very nice, but the truth of the matter is earn-outs are ubiquitous and have been certainly since the beginning of COVID, and they were prevalent before COVID as well. A lot of people bristle at the concept of an earn-out. They think it's very risky and it's often a zero-sum game, one wins and one loses. It doesn't have to be.

We propose that they're now properly designed I.E. revolving around a gross margin target, which is easy to find to define and not open to reinterpretation when it comes time to see if we hit the target or not. That can work. And let's face it, gross margin is what runs staffing businesses and what puts money on the bottom line.

So if you can get a buyer and a seller aligned after the transaction closes, both going for the same thing, more gross margin, it's typically a pretty safe setting for the two to work together and make sure that the earn-out is actually achieved. And that's an overly simplistic description, but most of our deals have earn-outs in them and most of those earn-outs are earned.

Francis:

So there's the cash component. They have a cash, the note and the earn-out all like a cocktail of structure?

Brian Kennedy:

Absolutely. Now, a seller may be required to leave working capital behind, which is usually some of their AR. Thank you for that. Depends on the quality of their DSO, another valuation point.

And in some cases, an offer will come along where the seller gets to keep their entire balance sheet so they get their cash, they get all of the AR that they create up until closing. It's collected by the new owner and remitted to them when they get it, but they're also responsible for settling the liabilities and the debts on the balance sheet.

And by the way, in the lower middle market, most transactions are asset purchases, not stock purchases. So that's a big difference. So consideration for the seller from a tax perspective, and it's a consideration for both parties in terms of our representations and warranties and indemnification perspective. It's just easier and cleaner to get those deals done. But the devil's always in the details.

Francis:

Do you see it in some sectors where there are more stock sales and in other sectors there are more asset sales?

Brian Kennedy:

I can't say that I've really noticed that. No, I haven't noticed that correlation.

Francis:

So systematically in that end of the market, it's more asset sales. So, talking about multiples, this is the question everyone has. This obviously changes from year to year. What kind of multiples are out there for staffing firms doing 1 million to 15 million EBITDA?

Also, what affects those multiples?

Brian Kennedy:

So growth has been a real wild card obviously from 2020 until now. 2020 was a write-off for almost everybody. 2021 was pretty damn good. 2022 was fantastic. 2023 was horrible. And 2024 was only a mild improvement for most over 2023. So the great hope now is 2025.

I don't know if the normalization is really done yet. We are starting to see some subtle changes in buyer behavior in terms of the attention that they're paying to past performance maybe isn't quite as intense as it was because I think everybody understands that either this is the new normal or we're not normal yet, one of the two. And I don't know anybody that's got an absolute answer to that question.

So overall performance over a long period of time certainly supports valuation. But for the most part, the valuations are still largely focused around the last 12 months of performance. That background information helps as a supporting cast to help indicate whether or not that performance is likely to be repeated, improved upon, or may not hit again.

So it tends to be more contextual, I think, rather than having a direct impact on the multiples itself. Now you've got a lot of different kinds of staffing there, white collar, blue collar, high wage, low wage, high skill, low skill, different workers' comp as you would well know being in your business and valuations in each of those sectors varies quite significantly, as that article I'll send you afterwards will show you.

And it does create a matrix. So not only do you have the rows, which are the different types of staffing firms, but you've got the columns which are sizes. And certainly, if we take a look at one that most people can relate to, and that's light industrial companies in that $15 million range right now, all other things being equal are probably somewhere in the three and a half to four times adjusted EBITDA.

Not including their balance sheet, including the liquidity that might exist on that balance sheet. If you take that $15 million revenue firm and you bump that up to let's say 50 million in terms of light industrial revenue now, that multiple goes from a three and a half to four, to probably a four to five.

And again, where it falls in that range largely depends on the deal structure, how much cash versus how the rest is being treated. More cash at close and less risk on the back end for the seller is going to equal a lower valuation every single time and vice versa is true.

And then if you go from there, light industrial up to the hundred million or larger, a significant firm, again, other still being good in terms of gross margin management depth, not too much client concentration, not too much perm business in this particular example, then we're probably looking at a five to a six as opposed to a four to a five. So you can see how it incrementally goes up.

The increments are very different and more dramatic in other sectors though. If we take healthcare, it's the real shiny one the last few years. There are some healthcare staffing companies that are and have been transacting at tens and twelves and even a 14 X. First of all, these are massive companies and they attract the interest of publicly traded staffing companies who tend to pay premiums.

Secondly, they have really been able to put in those kinds of valuation scenarios, something together that is unique, something that really stands out, no blemishes at all. And in fact, some added features. Could be a piece of technology that they've built or commissioned for their business that has applied in candidate impact, could be their client list, they might have a few really choice clients on there. But they have to be far better than average to get up into eights, tens twelves or 14x’s.

If they're average in healthcare staffing, we're probably looking across all the different bands and sizes. And remember, there are lots of different kinds of healthcare staffing out there as well. But on average, we're probably looking at that five- to seven-type of multiple IT staffing.

As I mentioned earlier, you've got the low volume, high margin stuff, which might be more statement of work. And then you've got the high volume low margin stuff, which is largely MSP. They're going to trade at different multiples, potentially remarkably different multiples because you're attracting two very different buyers.

You don't find many buyers in IT that are heavily weighted in both the MSP market and the direct sourcing market. It's structurally not very intuitive. So it's a little bit all over the map, Francis, and certainly the matrix that I'll send you will help you to see where we think these multiples are right now and we refresh that every year. So our next edition of 2025 will be in December.

Francis:

You mentioned adjusted EBITDA. What does adjusted EBITDA mean?

Brian Kennedy:

So there's a few things. It does tend to become a negotiation point in most transactions. We have to be sensible and relatively conservative in terms of what we try to get adjusted back. But in principle, there's a couple of things. One-time business expenses that are not expected to reoccur. Maybe you settled an EEOC claim, maybe you did some leasehold improvements, something along those lines. It's a one-time thing, not going to be doing that again for a long time.

So whatever expenses show up on your profit and loss statement, assuming it's an accrual-based profit and loss statement or income statement, those expenses would get added back to the actual net income. Obviously, EBITDA is earnings before interest, taxes, depreciation, and amortization. So we want to add back interest, taxes, depreciation and amortization.

When it comes to the owner and expenses associated with the owner, this is where it gets a bit blurry. If the owner is doing something in the business and taking a paycheck and showing up on that income statement, we need to evaluate what they're doing, do they need to be replaced? And if they do need to be replaced on the premise that they're leaving, how much is it going to cost to replace them?

And if it costs $150,000 to put somebody in that job and the owner is taking $200,000 off the income statement, we'd have a $50,000 adjustment. But if the owner is taking a dollar because they're taking their money other ways, maybe distributions off the balance sheet or whatever, we're actually going to need to adjust that net income downwards. We're going to need to reduce it by 149,999 bucks in order to have credibility.

And look, we're not just trying to throw everything in the kitchen sink into the adjustment list. So it really is excess compensation, which can also include key man life insurance, the very owner's auto deals and things along those lines. Other than that, there's not really much that qualifies as a legitimate adjustment. We've got those statutory ones and then the one-time business expenses and excess owner compensation. In a nutshell, that's about it.

Francis:

There are different buyers in the staffing space: private equity and strategics. Are the buyers split between strategics and private equity, or are you seeing one more than the other? Also, do their motivations and behaviors differ?

Brian Kennedy:

So we'll put family offices in with private equity and lump them together because they’re similar, although they are different family offices, tend to have more of a hold and grow mindset, whereas private equity might have a grow and flip mindset more often.

But you're right, private equity is very active, and family offices are very active in the space and have been for years, or it's interesting that their threshold of interest has lowered. When I came into the industry 10 or 11 years ago, it had to be at least a couple of million dollars of EBITDA to get any private equity company curious.

Now $500,000 of EBITDA, but scratching the right itch as far as the niche is concerned, particularly if the private equity company or only in cases where the private equity company already has a staffing platform in their portfolio, then certainly, these $500,000 EBITDA and up type targets can be great, add-ons for them.

But for those private equity and family offices that are new to staffing, they don't have an active staffing platform in their company, they have to be really careful. They can't go small to begin with. They have to get something that's big enough to be able to absorb other bolt-ons as they go. Something that's got that really well-established management team, a strong strategic direction, all the technical underpinnings, totally compliant and that sort of thing.

So private equity will continue to be a force to be reckoned with, there's no doubt. And they're not that different from strategics in terms of their behavior and how they approach a deal. And I think where they might differ from strategic mostly is in terms of the length of their view, how far out do they look?

There's another constituent though that has entered into the mix over the course of the last five years. And these are the talent marketplace platforms, the digital platforms, the wonolos and the swipe jobs and the shift Pixies and the many others. And there's some really good ones and some that aren't so good.

But these tech companies have realized that their cost of customer acquisition metric, an important one when you're looking to raise money in the tech space, can actually be driven way down by buying staffing companies. Because you can buy a million candidates in a database or even a hundred thousand candidates in a database and you've lowered your cost of customer acquisition significantly, and that's going to matter in your next round of financing if you're going to the Silicon Valley Vulture Capitalists.

I think there's been some interesting developments there, but of course, here we get into some of the stuff that you are dealing with all the time. 1099, is it okay or not? Most of us would say it's probably not a very good idea. We are somewhat concerned sometimes that these technology companies don't realize.

You're getting into the people business and there's a lot of regulatory and compliance responsibility that comes with that. Not to mention just the moral responsibility for the fact that you're not making glass bottles or cardboard boxes. You're dealing with people and that's important.

And that's a mind shift for a lot of tech companies that they absolutely have to go through before they learn to balance the technology side of their business with the people side of the business that they're trying to buy.

Francis:

That is a very good point. So, there are different buyers and different motivations. Talking back about the staffing companies, at what point do they engage somebody like you if they're looking to sell?

Brian Kennedy:

So in terms of timing, most people start a little late because they think the process is going to be fast and fast is less than a year, and it's often not less than a year, it's often a year or more. By the time you really deal with all the aspects of your company that need attention in order to be ready to go to market, by the time you get all of those market materials and you go through a due diligence with us to be ready to go to market, that's a couple of months usually just on its own at minimum.

And then you've got the process of getting out there discreetly. We don't mass market anything. We don't have a window where we've got companies on display. So it's hand-to-hand combat, and that takes time to do it properly. It's a curated type of transaction if you will.

So I'm not sure if that answered the question, but I think our general approach has been this, Francis, we've offered owners of staffing companies an opportunity. We'll sign an NDA, give us some data that we'll specify what we need and we'll give you our opinion of what your value is currently, and we won't be able to help ourselves. We'll also point out the things that we think you need to start doing or stop doing.

And in many cases, this forges a bit of a relationship that we want to foster. Sometimes these relationships will transcend over eight or nine years where the owner says, "Wow, geez, that's not what I was expecting. That's a lot less than I was expecting." After they get over their indignation, then they get back to work, and then they come and do another evaluation six months or a year later, and that can become an annual exercise.

We've had examples where people have done that for seven or eight years and then finally come back to us and said, "Now I'm ready." Or, "Now I'm going to get my number." Or, "Now I'm really crazy. Just get me out of here." So it's a long relationship process. Bottom line, it can be done quickly.

If something happens in your life and you've got to get out from underneath your business, it can be done. But chances are you're not going to see the same kind of optimized return that you would see had you had time to really polish the business, fix the blemishes, and clearly investigate the marketplace.

Francis:

Well, Brian, those are wise words from an obvious veteran in the space. Thank you so much for being on the series.

Brian Kennedy:

Thank you. I appreciate your time, Francis.