We provide the latest trends and insights into what's happening across the sector
2021 AUTUMN EDITION
While other sectors are steadying, recruitment is thriving. Driven by reactivation of the job market and the 'big quit,' this pattern is clear across all sectors. And, it's translating into M&A. To guide you through this, Keely Woodley and Carl Parker look at the key deals from Q3, and explain recent trends.
This activity is great for the sector, but it does mean that a robust financial model is vital for individual companies to benefit from it. In the second part of our Q3 review David Mountjoy explains the key issues you need to look after: from forecasting to churn, and invoice financing.
These are the core insights you need to take from recruitment in Q3. To get all the detail, read our review.
With UK job vacancies at a record high, skills and talent is a hot topic. Recruitment businesses across all sectors have told us they’ve never been busier, and this on-the-ground activity has been mirrored by healthy deal volumes. Here are the key highlights from our 2021 Recruitment Insights report.
The year to September 2021 was strong for UK recruitment M&A, with 80 deals completed. This makes it the third-best performing comparative period in the past decade.
Delayed transactions were picked up again, leading to a particularly busy Q4 2020 (27 deals). Following the changes to Entrepreneurs’ Relief in March 2020, there was the threat of an increase in capital gains tax in the March 2021 Budget. This also boosted activity in Q1 2021, and although adverse changes to the tax environment for entrepreneurs are currently on hold, rightly shareholders are still nervous of future changes.
Public market confidence signifies that the recruitment sector is expected to grow. Comparing quoted company multiples against last twelve months (LTM) and next twelve months (NTM) trading shows they were closely aligned in recent years at c.8-c.9x. This changed at end of Q3 2021, as LTM multiples grew to c.13x whereas NTM multiples remained at c.9-c10x. This was as share prices recovered more quickly compared to LTM COVID-19-hit trading results. However, we expect LTM/NTM multiples to normalise over the next 12 months as trading catches up with current valuations.
Public market confidence also bodes well for the valuation of private companies in the sector, particularly in specialist sectors servicing skills-short markets of IT, digital transformation, engineering and life sciences.
The above figures back up anecdotal evidence from our clients, who tell us that the market remains buoyant. So how did the sector manage to bounce back so quickly?
In early 2020, lockdown placed large numbers of UK businesses into a holding pattern. The government introduced measures to protect employment, and job vacancies dropped from 701,000 in Q1 2020 to 304,000 in Q2 2020. Deal volumes followed suit, decreasing from 20 to 10.
In the year to September 2021, the reverse was true. Deal numbers strengthened as job vacancies increased, creating demand for recruitment and talent solution services.
The number of job vacancies in July to September 2021 reached a record high of 1.1 million, according to the latest ONS figures.
To understand what’s driving deal activity, it is important to understand what’s driving the uptick in job vacancies.
UK manual labour shortages hit the front page in October due to the HGV driver crisis. A shortage of foreign workers following Brexit has exacerbated vacancies across a number of blue-collar sectors.
Professional sectors are also experiencing skills shortages. Data from the Association of Professional Staffing Companies (APSCo) shows that recruitment revenues for both permanent and contract placements were up 2% and 16% respectively in September 2021 from August 2021 (source: APSCo report).
In addition, UK recruiters are keeping an eye on data from the US that shows people leaving their jobs at a higher rate than before the pandemic. The so-called ‘Big Quit’ isn’t just the reserve of professionals wanting a better work-life balance after a period of working from home. Rather it is being driven by low-paid workers upgrading to better opportunities in a market that favours job seekers.
Increased financial investor activity was another key driver of deal volume in the year to September 2021, accounting for 46.3% of deals. This is nearly a 20-point increase on the 28.6% average in the five years before the pandemic (2015-2019).
This is partly because private equity still has record amounts of dry powder – $2.286 trillion in August 2021, according to S&P. This made it well positioned to seize opportunities while the market was depressed, and also make acquisitions driven by the expected change in capital gains tax earlier in the year.
More fundamentally, however, the pandemic has meant that business at large has had to accelerate the pace of change in their organisations to remain relevant to an online in-person hybrid world. Talent that drives this change is in short supply and investors want to place a 'bet' on those sectors that are most skills short to benefit from those underlying fundamentals.
While UK recruitment M&A remains dominated by domestic deals (UK firms buying other UK companies), cross-border activity remained stable at 13.8% of all deals in the 12 months to September 2021.
North American interest in UK firms remained high. In Q4 2020, for example, US-based Premier Healthcare Professionals (PHP) acquired the London-based international nurse recruiting business Field Health Ltd, which operates under the Adevia Health brand. At the time, PHP commented that the deal would provide a solution to help US hospitals with their critical nurse staffing needs.
In Q1 2021, US-based CEO advisory firm Teneo acquired Ridgeway Partners, a London-based executive search firm. Interestingly, Ridgeway Partners has strong diversity and inclusion (D&I) credentials (see ‘three big trends to watch’, below).
Anecdotally, we’ve seen particular interest in the UK and Ireland from countries such as Japan, where the domestic growth is flat. They are looking for higher returns for faster-growing markets, such as the UK.
In Q4 2020, Outsourcing Inc, the third-largest staffing firm in Japan, announced that it has agreed to acquire Irish recruitment firm CPL Resources. The move is expected to help Outsourcing Inc expand its scale in the European market.
Sector specialism continued to drive M&A activity in the 12 months to September 2021 accounting for 65% of transactions.
The pandemic had a clear influence on the attractiveness of different sub-sectors. Unsurprisingly, IT, healthcare and logistics respectively accounted for a higher percentage of deals than sectors such as financial services and energy.
Digital, IT and technology accounted for 17% of deals in the year to September 2021, against a 10-year average (2011-2020) of 15.5%.
The move to work from home shone a stark light on the efficacy of companies’ IT systems, creating demand for more specialists. And many roles here could be hired in and performed remotely.
This geographical freedom was a driver in a deal we advised on – K2 Partnering Solutions’ Q3 2021 acquisition of international recruiter Marlin Green, which places highly-skilled niche technology consultants into Europe.
Technical recruitment specialist Morson also sought to capitalise on the growth in the technology sector through its Q3 2021 acquisition of Cornwallis Elt. The deal enhances Morson’s scale and specialism in technology, digital and transformation experts. Bringing London-based Cornwallis Elt into the group also enables Morson to further expand and strengthen its geographic footprint in this particular sector.
Healthcare was one of the most active sectors for recruitment M&A in the year to September 2021, accounting for 17% of deals. The combination of Brexit and the sector’s reliance on an overseas workforce exacerbated existing staff shortages. The King’s Fund charity estimates there is a shortage of 84,000 full-time equivalent staff in the NHS alone.
The UK lorry driver shortage and resulting supply chain issues were a loud and public demonstration of the sub-sector’s importance.
Transactions involving supply chain and logistics accounted for 5.7% of deal volume in the year to September 2021, across both blue-collar and professional staffing.
Transactions include Challenge-trg Group’s acquisition of temporary labour expert PMP Recruitment.
TPA Capital also backed this sector with an investment in Bis Henderson, a leading provider of supply chain professional services.
Executive search transactions continued to make an impact on recruitment M&A activity, accounting for 17.5% of deals in the year to September 2021 (up from 12% for the same period a year prior).
Key transactions include Elysian Capital’s acquisition of Eton Bridge Partners, a high-quality talent solutions firm, which was ranked the number-one provider of executive interims by the Institute of Interim Management (IIM) survey.
Building out CEO advisory capabilities was also a key driver behind CVC-backed Teneo’s acquisition of Ridgeway Partners in January 2021 (and subsequent acquisitions by Teneo outside of the UK).
We expect international buyers to really invigorate this area of the M&A landscape as functional and sector specialism, rather than a generalist approach to Executive search, becomes ever more prevalent. In particular, the rise of those providers who specialise in placements for private equity-backed businesses is driving significant cross-border recruitment activity, which will in turn become an area of keen focus for those consolidators in the Executive search arena.
More holistic talent solutions providers that can offer companies trained employees will be well placed to meet the demands of the skills shortage. This is certainly what Challenge-trg set out to do with the acquisition of HGV driver training specialist Phoenix Training and logistics recruitment specialist TRG Logistics. These deals enabled Challenge-trg to extend its end-to-end solutions to the logistics, warehousing and distribution sectors.
Traditional ways of working have been upended by the pandemic: some candidates reluctantly commute while others want the buzz of city life. APSCo has warned that employers will need to be more creative to attract talent amid skills shortages. Recruiters will get increasingly involved with the communities from which they are hiring to learn what their candidates want. This might involve hosting online communities or retreating to a super-specialism. International recruiter Marlin Green, for example, focuses on contracts for system applications and products (SAP), big data and business change.
SmartRecruiters’ State of Diversity Hiring Report 2021 found that many companies are still only paying lip service to ED&I. For example, 50% had no strategy in place for setting and calibrating diversity hiring goals. As ED&I becomes increasingly important to employees and candidates, recruitment, training and coaching firms that can help drive change will be in much demand. A company already leading in this area is Audeliss Executive Search, which seeks to “level the playing field for diverse leaders in executive and board appointments”.
We expect that societal pressure will encourage these considerations to become the norm rather than the exception in hiring decisions.
We are also expecting the RPO model to take more prominence in corporate talent acquisition strategies as the cost of large-scale specialist recruitment becomes untenable. Winners in this area will be those businesses who can deliver deep sector specialist talent solutions at scale, rather than generalist RPO providers who do not have the requisite depth of expertise.
There has never been a more exciting time to be part of the recruitment sector, as exhibited by these trends.
Source of M&A data: Data compiled from a variety of generalist M&A databases (Mergermarket, Zephyr, Capital IQ) and the specialist press and trade journals.
The recruitment sector remains active in the current transaction market and the number of financial models in the sector I've worked on has hit double figures. But while there’s no one-size-fits-all approach for recruitment businesses I'm seeing the same modelling challenges crop up again and again. Here are five key things to consider when designing a financial model for a recruitment or staffing company.
Most recruitment models are driven by the number of consultants – the basic premise being that adding more heads leads to more revenue.
Building a forecast up by individually-named consultants gives a lot of granularity and is the right approach for a one-year budget. But it can have drawbacks for a longer-term forecast. If you want to show some sort of employee churn in the future, which of your current valued team members do you exclude? If you’re forecasting rapid growth, do you really want to type in person-by-person assumptions for every new hire you’re expecting over the next five years?
An alternative (and more common) approach is to group consultants by category (eg, by desk, experience level, office or some combination of these). Then you can use higher-level assumptions for the number of heads and average performance in each category. This approach is much more flexible as it allows for a quicker scenario analysis (“What if I add five heads here?” or “What if this key hire falls through?”). The downside is that you do lose some of the granularity, which may be important if you have a diverse workforce with a wide range of experience.
These approaches will work for both temporary and permanent recruitment businesses. The only difference is that net fee income (NFI) in a temp-focused business may need to be grossed up to calculate the sales and temp costs for working capital purposes.
A key dynamic of recruitment businesses is ramp-up: how long does it take a new joiner to get up to speed, start delivering revenues and build their network?
This could be reflected as a simple lag in performance (eg. wait three months until any sales are forecast to come from a new joiner). Or it could be something more sophisticated using a percentage ramp-up profile over the first few months of their employment (12 months is standard; I’ve even seen a 36-month ramp-up used in one case). This can be a complicated area to model from an Excel perspective, but that’s why we’re here to help.
For some recruitment businesses with a high turnover of junior staff, employee churn is important to consider. You may make the reasonable assumption that you would simply recruit to replace to keep your headcount at the same level. But the performance ramp-up for new joiners inevitably means that churn will have an impact on your forecast performance.
There are various ways that churn could be reflected in a model. A simple churn percentage assumption only really works for very large teams – applying a 1% churn rate per month isn’t that meaningful if you only have a desk of eight people to start with.
For smaller teams a better approach is to make a rough estimate of individual leavers in specific months (reviewers of the model will recognise this is a prudent assumption). Alternatively, you could keep headcount unadjusted but slightly reduce your NFI-per-head assumptions to compensate.
Sales commission is often one of the most significant costs in recruitment businesses. It can also be very difficult to forecast accurately depending on how you’ve built up your revenue forecast. If forecasts are built up at a person-by-person level, it’s quite straightforward to calculate their individual reward based on various commission bands and thresholds.
But if the forecasts are built up by desk or team this is much more challenging. The model won’t recognise if your revenue has been spread equally across the team, or all has been earned by one star biller, which would lead to different commission amounts. If you wanted to still use a tiered calculation, you’d need to apply it at a group level, based on average performance within the group.
Or you could sidestep this complexity entirely. If your historic track record shows that you reliably pay out 10% of NFI as commission, regardless of overall NFI or sales team makeup, it could be a valid approach to model commission as a simple percentage of NFI. This will let you focus your Excel and forecasting efforts on areas that will make a more material difference to your forecasts. We always look to keep the approach as simple as possible.
Many recruitment businesses use invoice financing to accelerate their cash receipts. It’s vital that debtors are modelled in enough granularity for this. This is especially important if some sectors or regions have very different debtor days, or aren’t eligible to be financed at all.
Once again there are a couple of different approaches to calculating the financed amount. The simplest approach is to assume that the facility is fully drawn against all eligible debtors. But a more advanced method is to calculate the required facility usage each month based on the other cash flows in the business.
The five considerations I've outlined are just a flavour of the key issues that you’d need to consider when developing a financial model for a recruitment company. There’s no 'right answer' here, and it’s important that your model matches the way you think about the business.
Ultimately, designing a financial model is all about getting the right balance between detail, flexibility and usability. There needs to be:
Contact David Mountjoy to find out more about financial modelling.