Osborne Clarke has advised on six UK deals in the sector since the summer, with three currently "on the go". The completed deals were:
- The sale of a majority stake in Orion Electrotech to Japanese listed company Technopro Holdings, Inc.;
- The sale of healthcare and education recruiter (including brands like Monarch Education and Team 24) by private equity-owned Affinity Workforce Solutions to CRG;
- The investment by private equity company ECI Partners in MThree, an IT consultancy using a staffing model;
- The investment in professional recruiters Dartmouth Partners by private equity company Literacy Capital PLC;
- A private equity investment in a healthcare consultancy using a staffing model; and
- The sale (by management buy-out) of the staffing division of a major construction company.
The news headlines continue to be dominated by Brexit and how long a transition period will last. And staffing companies have recently been granted their own transition period: the recent budget announcement postponed IR35 changes in the private sector until April 2020. You can read here our views on what this may look like – it is clear that the IR35 developments will have a major impact on large parts of the UK staffing sector over the next two years.
The question is, how are these two issues, and other factors, affecting the M&A landscape for recruitment and staffing companies?
It seems to us, based on recent experience, that these are six of the more interesting developments that are affecting deals at the moment.
1. Notwithstanding Brexit and the possible impact that may have on hiring, recruitment and staffing companies that have a strong position in niche markets continue to attract interest, as ever. However a slight shift might be that UK companies with a continental European or other international presence seem to be relatively more attractive to acquirers/investors now. "No doubt this is partly as a hedge against Brexit" says workforce solutions sector partner Kevin Barrow. "We are certainly seeing a lot of UK based staffing and recruitment companies start to ramp up their international capabilities especially in Germany, Belgium, the Netherlands and, above all, the USA. Another Brexit related factor is that the decline in the value of sterling has made UK companies cheaper for overseas acquirers. Whilst this may not be enough to attract investors and buyers from the traditional buyer community in the US (who appear to have a fantastic home market to tap into and for the most part do not really see the need to grow their operations in uncertain overseas markets like the UK) we feel that some potential acquirers from other countries may see opportunities in the UK market."
2. What about the impact of tax and regulatory changes like IR35 on UK staffing company valuations? Corporate partner Matthew Bodfield says: "Trade buyers are aware of the proposals, and will have their own views on how this might affect the market and potential outcomes of this regulation. Institutional investors and overseas buyers may have less of a precise understanding of what the impact of the proposed reforms may be, but their awareness of them (and their advisers' awareness of them) has been heightened due to the recent announcement, and this has also focussed attention on some of the aggressive schemes offered by some umbrella companies and possible risk for staffing companies who use those schemes. We are seeing these points come up in due diligence (or later in the process) as a significant issue that buyers and investors are seeking comfort on. An organised seller should prepare a tailored analysis of the impact of the IR35 reforms on the future profitability of the IR35, and should have tidied up supply chain risk relating to umbrellas and other intermediaries. A failure to be ready for questions about these things may prevent or delay a deal or at least reduce the amount paid up front.
"Kevin Barrow adds: "We see these proposed rules as just one element of a more aggressive regulatory environment for the industry in the future, and predict that this will lead to hirers seeking more sophisticated suppliers of staffing and recruitment in order to mitigate any perceived risk. That suggests a continued appetite for consolidation in the recruitment sector in the mid-term, as increased compliance cost can be better absorbed across larger scale businesses. Some sellers will be benefit from this, and will be seen by investors/buyers as future gorillas in their markets. We will have to wait and see how the implementation of IR35 and other changes in the law plays out, but the changes may in fact turn out to be good news for potential sellers who appear to be on top of the issues."
3. What other issues are affecting transactions at the moment? Well there is some more good news about the impact of regulation on corporate value. Workforce solutions sector and employment partner Anna Elliott points out: "Whilst GDPR is considered more of a hindrance than a help by employers, those who have got their house in order can use it as a very effective tool for preventing recruitment consultants leaving and taking customer/candidate data with them. Institutional investors have generally been concerned with the tendency in the recruitment sector for key staff to leave post-deal, taking business and goodwill with them. That risk can now be significantly reduced post-GDPR provided that employment contracts, restrictive covenants and GDPR policies for staff (including social media use policies) are all updated, aligned and effectively enforced to exploit fully the opportunity given to employers by GDPR".
4. Another development is the increased involvement of many staffing companies in "statement of work" (SOW) style supplies, such that they in part operate as consultancies or outsourcing companies. There is an awareness that to do SOW properly (and avoid risks, and ensure it falls outside recruitment regulation and, incidentally, IR35) staffing companies really need to do a bit more than "staffing plus". Staffing expert Frances Lewis explains: "SOW needs a new mindset and approach, with a different approach to selling and probably a lot of legal support. But if it is done well a staffing company's addressable market, and margins, can increase as will the multiples of EBITDA on exit. We have seen a growing number of staffing companies develop and win new market share as consultancies in the last year, and we expect this trend to continue not least because exits involving companies who have gone to market as consultancies seem likely, based on recent deals we have done, to attract much higher multiples."
5. At the moment loans are available on very attractive rates. Matthew Bodfield comments: "Many owners of privately owned companies have looked at using loans (rather than, for example, a full sell out to private equity) to raise a bit of cash to fund expansion, with some of that cash being used to buy out some or all of the longer-standing shareholders in the business, for some of whom partial de-risking may seem a good option at the moment. We have advised on a number of these deals."
6. Those staffing companies which rely heavily on workers from across the EU are obviously thinking about what impact Brexit may have on their access to those workers. The Withdrawal Agreement currently proposes a transition period until late 2020. That deal may not be agreed and in any event the end of the transition period may not be not long off, so relevant businesses will need to show that they have plans about how they can replace relevant workers and/or bring in migrant workers after Brexit/transition. Organised sellers should prepare a tailored analysis of the impact of Brexit immigration changes on future profitability, and should be building flexibility into their supply agreements to allow for any price changes that may be necessary.
Osborne Clarke’s workforce solutions team is considered a go-to practice for many companies in the sector, working with global businesses, fast-growth start-ups and market challengers. The team advises at every stage of company development across all corporate issues, from equity and debt fundraisings to M&A, IPOs and joint ventures. We are currently helping many companies get into good shape so that the developments mentioned in this briefing do not impact sale or investment plans. Please let us know if you need assistance with any of these issues.