Recruiting Business Valuation: Is 3x SDE a Good Deal?

0:00Welcome to Acquisitions Anonymous. Today's episode was a great one. There were four of us, which tends to make the episodes even better. And we had a special guest today who came in with a ton of industry knowledge and brought a deal that we took a look at, and we all had a consensus view on it. So stick around to the end for that. Here is the episode. We'll set Acquisitions Anonymous. Hello, another episode of Acquisitions Anonymous. We don't have 100 % beard anymore. I'm thumbs downing on just the plus inventory alone. Hey, everyone. It's Bill. And I want to tell you about maybe the most exciting sponsor we've had in a long time on the pod.

0:37It's called Capital Pad. And it is the thing that I wish existed when I started my journey of operating and investing in small businesses. So Capital Pad is a marketplace for acquisition entrepreneurs. That is people who want to buy a business and need capital to list their deals and solicit capital from other people who want to invest in acquisition deals. So if you want to back somebody buying a small business, CapitalPad is the place to do it. And if you want to buy a business and need capital, you can go on CapitalPad to be introduced to investors. So the really great thing too from the investor side is that CapitalPad takes care of all of the details that can get hairy with small business acquisitions.

1:23They handle standardized terms, standardized governance, standardized distributions, all up front in black and white. Basically, Capital Pad professionalizes investing in small businesses and the returns can be really, really good. I'm so stoked they exist. It's founded by my friend Travis, who is a phenomenal entrepreneur in his own right. So if this sounds like something that's appealing to you, if you want to buy a small business and need capital, or if you want to invest in small businesses, go check out CapitalPad.com and tell them that Acquisitions Anonymous sent you. I clicked record. Oh, we're doing it.

2:00Okay. Now, we can't talk about Vida Bravo because we can't let the secret out.

2:09Well, Ty, welcome. Ty's our special guest co-host today. And believe it or not, Mills makes him guest of the day because he brought a deal, which we'll get to in a second. You always get like three gold stars for bringing a fun deal. So, but Ty, before we get started, tell our listeners sort of who you are and why you are qualified to talk about small business. Like, why are you in this world? You know, what's your experience? Yeah, I run Search. Search is a boutique executive search business. So we've been around for about six years and we recruit primarily operators. I refer to operators as CEOs, general managers, presidents, sometimes COOs, but someone to be kind of have P &L responsibility for a business.

2:55I would say half the time we work with founders who don't want to run their company anymore. They don't want to sell their company. They don't want to run their company. They want someone else to do it. So we'll recruit their successor. And then the other 50 % of the time we work on behalf of investors, kind of like lower middle market investors, sub a hundred million revenue. Typically companies are typically profitable. and it started out, we started out doing a lot of internet-based businesses, SaaS companies, and e-commerce, you know, working, recruiting a lot of executives for these types of companies.

3:25But word of mouth got out and industries have changed. We recruited a CEO for a chain of daycares in New Jersey. We recruited a CEO for an orthopedic brace company. We recruited an executive for a soil analysis company for, right now we're working on a CPG meat company. So it's changed a lot. And that's, you know, so part of like, what my world is, is just interfacing with founders and entrepreneurs and investors of businesses all over the world, doing really, really interesting niche stuff. And I get to hear a lot about the good and the bad of bunch of different business models and stuff. So I'm excited to share a little bit about what we found today.

4:09So what I'm hearing is you are the dream bringer. So this is like when people buy a business and they're like, oh, I'm just going to put in an operator, like this mystical operator. You find the mystical operator. I wouldn't say it as succinctly as you just did, but yeah, I think you might've just developed my new brand. Are you my new brand guy? There you go. I am the brand guy. I came up with the name for the podcast. That's why they got me here. I'm the brand guy. So Ty, are you guys, in terms of your business model, do you do more just straight up recruiting, kind of direct hire stuff? So fee per success fee, or do you guys do retain search or do you vacillate between the two of them?

4:50Where do you guys live in that spectrum? Yeah, good question. We're retained. So we take part of our payment upfront and basically that's a big sign of a commitment that you're, you know, a lot of people, I think that the Twitterverse likes to talk about just hire an operator, just delegate, um, a lot easier said than done. And so we want to make sure people are, are willing to back that up. So we do, we do charge a retainer upfront. Um, and, uh, and that's kind of it. I mean, it's, it's, it's pretty straightforward. We go and we find this person, we, we ask for a specific set of skills, experiences, competencies that we want this person to have because they do exist.

5:33Like whatever, kind of any type of person you want to run your business, they do exist. And it's just a matter of being really, really diligent about what those skills are, what those experiences are so that we can then go find them. And that's kind of the main core of what we do. We go find very specific people to run really cool businesses. I have so many questions about this, and we will get to the deal eventually. But how are the comp packages typically, so because alignment is so important, right? So I'm not talking about quantum of comp. I'm talking about structure of comp, right? Like what have you seen that sort of works best when designing comp for a high-level executive who's going to run a business that you own?

6:22You know, interestingly enough, I gave the talk at HoldcoConf this year. And what I said was the numbers don't really matter. You can't talk to your buddy and be like, how much do you pay your CEO? Because it's not you as an owner are going to have different motivations than your buddy. And your business model is going to be different. And the type of candidate you find is going to be different. And so the total number is not nearly as important as the structure. I have a full deck. I could talk about this for hours, Bill. But basically, you want to align on four main things. Depending on your business model, the economics of your business model, depending on the candidate's risk profile as well, you might recruit somebody who's a proven CEO.

7:06They've done it once or twice. And if your goal is to sell this thing and that guy knows that, then he's going to be like, great, give me$1.50 salary and I want a bunch of equity on the back end. or if you recruit somebody who's 33 and has a young family and really needs cash then you're going to you know weigh that part heavier than than you know potential event stuff so that kind of ties into your own goal if you're just trying to cash flow this then you don't need to include any equity but you could design it so that this person is incentivized based on like quarterly EBITDA growth which is a really common thing we see and then also like there's a time horizon sort of influence, right?

7:46If you're trying to get this done quickly, if you're, if you're not trying to get it done quickly at all. So it just kind of depends. There's like four or five different variables for what you're trying to achieve that will then allow you to design the comp that you want. So it's not a very simple answer, but we have lots and lots of data of all the places we made, of course, and no two are the same, which is really good. But is it typically like your buckets are functionally cash comp, annual bonus, you know, kind of call it short there's like base cash comp there's performance-based cash comp and then there's typically like performance-based long-term comp yes equity and equity like comp right like those are your buckets yeah yeah now yeah generally yes yes they make it easy yeah okay i could i could go all day but i do want to you brought a deal that i think might draw out some more of these these questions so who's reading it who's ready i'll do it all right you want to do it mills or Sure.

8:40Yeah. All right. It's, uh, it's biz by sell, which is, um, our most sought after sponsor. They really want to sponsor us, but they haven't told us that yet, but we feel, we can feel it. Um, it's a reputable high margin executive recruiting company, which I can't wait for you. Not Tide's company. Not Tide's company, but I can't wait for you to just, you know, blow our minds with this. It's in Lake country, Illinois, and it's relocatable. They're asking$1 ,135 ,000 And the SDE, which they're saying cash flow and SDE are the same thing here. There's no EBITDA disclosed, but$365 ,000 in SDE on$1 ,085 ,000 in gross revenue.

9:25So it's about 36-ish percent net margin, and they're asking roughly three times SDE. SDE. And the description is, it's an established executive recruiting firm specializing in high value, permanent placements within the printing, packaging, and paper industries. The company is known for its refined approach to sourcing top-tier passive candidates, utilizing a combination of proprietary databases and industry-leading tools such as LinkedIn Recruiter, Zoom Info, and Source Whale. I can't wait for you to talk more about this, but those don't seem very proprietary. But The business has consistently generated around$1.2 million in annual revenue with peak years reaching$1.4 million.

10:08Client relationships are structured through a mix of retained agreements, which is 45 % with upfront payments, and contingent placements is 55 % of the business with average placement fees of roughly$35 ,000. Clients pay promptly, typically within 10 days, and more than 80 ongoing partnerships are maintained through high-quality service and trust. Team has five experienced recruiters and a dedicated research professional. Two senior recruiters have over 15 years' experience and maintain extensive networks, while the research director manages candidate sourcing, providing 50 to 100 qualified prospects per search.

10:48That seems like a lot, but maybe not a good thing. The current owner is responsible for business development, generating approximately 60 % of client engagements. Wow. And 36 % of total revenue, while the remainder of the team handles both client servicing and new business efforts. Internal operations are fully systematized with structured weekly meetings, 401k plan with a 6 % match, strong mentorship program for new staff. Firm CRM has 200 ,000 candidate profiles and 125 ,000 company contacts. They say it's entirely relocatable, can be operated remotely or from a small office. Seller is open to remaining involved for up to 18 months for a seamless ownership transition.

11:32with strategic leadership and additional hires. The firm has significant growth potential with revenue projections between two and four million. Rare chance to acquire a reputable niche-focused executive search firm with recurring revenue, exceptional client retention, strong industry reputation. So they have seven employees listed here, six full-time, one part-time. Michael, we scroll down a little bit more. And yeah, they just leased some property in Lake County, Illinois. that's it that's what that's what we got what do you think ty lower mind here all right lake county is a little different than lake country not to call you out mills i know we just oh my bad did i oh okay lake county yes yeah lake country sounds a lot better it sounds romantic wherever lake country illinois is like i want to know i've been to the lake country in england which is yeah right right i probably did picture that as i was saying it so something tells me this is not like that.

12:27Well, there are a lot of lakes up there in the border between Illinois and Wisconsin. So that's exactly where this is. In fact, I think I might've found this company, but I'll leave that to you later. We try not to do that, Ty. People get mad at us when we do that, when we announce it on the air. We'll have the editor edit that part out. Well, it's okay that you find them. We just don't want to dox them. Yeah, we just don't dox it. It's helpful to find them. We routinely will find them. We just don't, we don't tell anybody. We don't tell anybody who it is. So that's it. So you're fine. So a couple of things that kind of immediately stand out to me are there's some interesting things and some maybe concerns.

13:02The 45 % of their business that's retained, like I come from the retained world. It is way more lucrative than contingent. And let me explain the difference between contingent and retained. Michael needs a CEO. Michael hires Ty. Ty says, okay, you need to give me part of your fee. part of i'm taking part of this for you up front to show that you guys are committed to making this hire great michael pays it uh when we find the ceo that the rest of that fee becomes due everyone walks everyone's happy uh on the contingent side michael wants a ceo michael hires ty but he says as soon as you find me a ceo and we hire him then i'll pay you your full fee okay so contingent recruiting is typically done for like lower level positions i would say and so immediately that tells you that there even is a split.

13:49It's quite rare, honestly, to find recruiting firms, search firms, executive search firms that do both of these. So that's just a little bit odd to me. But there is some retained. Okay. Let's say 45 % of the revenue is retained. That's decent. I would say clients paying within 10 days, that's pretty good. Is a$35 ,000 average fee low? So that's, it is, but let's think about the context here because this is a printing and packaging and paper industry business. I don't imagine those salaries, even for a VP of sales or whatever, are that high relative to other industries you might see. So that is, it is lower than I would expect, but let's keep that in mind.

14:35And the second part is the contingent fees that they do collect, that they are successful with, inevitably are going to be lower than those retained ones. So it's going to skew that average fee down a little bit there. And they could be, it does say high value, but they could be placing everybody from VP of sales to on-the-phone salespeople in this industry. I would think, Ty, if they're specifically focused on one industry, printing, packaging, and paper, you're probably kind of a little bit more full stack, like full org structure, versus if you're just doing CEOs, it might be a little bit more transferable.

15:14I would think so. And that actually brings up another really interesting point, which is we would have to understand the off-limits agreements they have. So if they have 80, what do they say? 80. 80 ongoing partnerships. Okay. So that's 80 clients that they've worked with. I don't know the size of this industry, but if, if you're, if you've got 80 relationships with companies that you've worked with, you probably cannot recruit out of them. At least you shouldn't ethically. You shouldn't write. If they're paying you, then you shouldn't recruit out of them also. So that like significantly narrows down the pool of people that you could be recruiting from assuming you want to recruit people from like with industry experience right so that part's really interesting uh i would need to like understand a lot more about the quality of these ongoing 80 relationships you know are they someone that worked with them four years ago or they have they all been done the last 12 months that part's unclear to me i think the biggest thing i would really understand is like this division between contingent and retained because the other thing about retained is when you take on a retained project, you're getting some income.

16:30Most of the time, you're probably going to get the full fee, but 100 % of the time, you're going to get some revenue. On the contingent side, they say 55 % of their deals are contingent. Well, how many of those are actually paid this company? We don't know. What's their close rate, basically? They If they don't close any, the pipeline's worthless. That's a ton of wasted time by their recruiters. That's why recruiting firms are often set up to be purely contingent, where they're going to do a six to eight week sprint, and they're going to get this person. If not, peace out. They're going to work on another thing.

17:08And retain is more like three, four, five months. This strikes me as one of those services where the better you are, the more you move up market. Right? Like in terms of like comp for the hired position, like if you're really good, you are not placing like data entry folks in like the payroll department. If you are really, really good at what you're doing in terms of having a clear expectation from the person about what that role needs and then finding the exact person for that role, you would move up. You would move up market in terms of comp. unless you figured something out. Like there's probably a guy who does data analyst recruiting who crushes and he does way better than we do, you know, but there's probably like one of them.

17:50So I don't want to necessarily throw shade on contingent, but typically, yeah, like that's a, it's a, it's a lower margin business. It's a lower successful rate. There are people who do it really well and they focus on like one specific function and that's like makes them the, you know, the G at it. But, but I would agree with you. So we had, in our business, we were constantly placing people in our warehouse. And so we had a search firm that sort of helped us do that. It was contingent, but there was such a regular flow. We'd hire one a quarter on repeat. So they were okay with contingency and they just got paid every time.

18:31So does that tip or was that an anomaly, Ty? I mean, like, could it be that these guys are half contingent, but it's like quasi contingent because it's repeat business? I would say a protection around being contingent is if you if the recruiter puts an exclusivity clause in there. Right. Because what's stopping you, Bill, from talking to 17 other contingent recruiters to just find you the one person? You're only going to pay one of the 17 recruiters that you hire. right yeah you might as well get 17 guys working on it and pick the best one right right at the c level that's you don't want that you don't want 17 or who you know banging down your door calling the same candidates it's just it gets messy it's terrible for the brand but i but for that level position it might make sense so i don't know i don't know did you guys have an exclusive agreement with them uh we probably did yeah because they kept coming through and like these weren't pretty they weren't super high level candidates and they had a big pool and they kind of specialized in it.

19:27No, I mean, those could be really great recruiting partners. Like I said, for those types of jobs, even without exclusivity, if they've just solved this problem for you and you trust them and they can do a turnkey real quick, then like that's definitely a solution to, you know, some of your people needs for sure. So it kind of highlights though, you've got to diligence each of the clients of this recruiting firm to kind of understand what is the nature. You know, I would imagine like the best, if you could come up with like the platonically great executive recruiting firm, right? They would have very, I would think, Ty, tell me I'm wrong here, but I would think they would have long-term relationships with clients that keep coming back to them and that have kind of repeat placement needs.

20:11And you would just keep placing, you know, the same types of roles over and over and you just keep ringing the register on the same clients because they don't have to. Like a private equity firm or a venture firm who. exactly who's like always placing ceos and you're just like their go-to yeah yeah yeah definitely there's a little nuance to that i mean there's like yeah there's nothing but like the nuance around that is if you've recruited two or three executives for the same company they probably shouldn't need your services for another couple of years assuming you you get them good people right or you know unless they have open positions but for like a fund for sure where they where they're always kind of going, you know, new deals coming in and out.

20:52That's, uh, that's definitely a, you know, it's part of our strategy. Yep. So is this a, this doesn't seem like a very large business in general, in the executive search world. Is this large, small, like, no, it's a small. Okay. Well, there's, there's probably five to 10 very large companies. Maybe three of them are publicly traded that primarily do executive search. They're recruiting Pepsi's CFO and they like to beat on their chest. And I think they probably do good work, but they're also publicly traded. So now they have to think about new revenue lines and new services and assessments and all this other stuff.

21:34But these guys are small. These guys are small. Are you ready to take a leap into business ownership, but you don't know where to start? Well, look no further than Acquisition Lab, the premier resource for entrepreneurs seeking to buy their dream business. founded by Harvard MBA and acquisition expert, Walker Deibel. The lab is your fast track to success in the search diligence and acquisition process with hands-on support, world-class resources, and a community of like-minded entrepreneurs. Acquisition lab gives you the tools and confidence to navigate every step of the journey. And we're proud to call Walker and Chelsea, the lab's director, longtime friends of the podcast.

22:05They're passionate about helping entrepreneurs like you take the next big step. So don't wait to make your business ownership dream or reality, visit acquisitionlab.com today to learn more and schedule your free consultation. And when you do, be sure to tell them the Acquisitions Anonymous podcast sent you. What is the barrier to entry from somebody kind of coming in and competing with this business? Like what's to stop, say, somebody with your skill set from coming in and competing against this guy and taking his clients and stuff? The key is the relationships. I mean, this is a professional services business, right?

22:37And as we see here, I don't know how long I mean I do know but I'll say I don't know how long these guys have been in business and so like everyone in fact I built a product I built basically an info product to like teach people how to start the recruiting business and the recruiting part is very teachable that's like here's how you do it here's how you filter candidates here's how you ask the questions here's how you present them blah blah blah but the business development part is really hard because these sales cycles take six to 48 months. I mean, they take a long time. This is an expensive thing you're selling.

23:20Right. And so like brand in the industry is very, very valuable. That's why I suspect these guys have been around a long time and that's why they get people coming back to them. They're known as the recruiters in the printing and packaging space. Now, what's interesting, Michael, is that the owner is responsible for business development, generating approximately 60 % client engagements and 36 % of total revenue. So that's better than 100 % of client engagements, right? When you're buying a services firm, like typically the person at the top is like the guy or the gal who's been developing business and has relationships.

23:59And that's what you're buying. You're not necessarily buying any IP or anything. I guess they do have a CRM here, which could be valuable. Um, so my question is like, where do these, this other 40 % of client engagements, where do they come from? And further, you know, the, the, the current owner takes or is responsible for 36 % of revenue. That means that his team who's executing the searches does such a good job that their clients come back to them and say, you know, we want to do a little bit more work. That's really interesting to me. To me, that means that he's not the sole rainmaker. And more than that, his team is executing really, really well, and their clients are coming back for more.

24:42That's a pretty good signal, I think. Which also is kind of like the small local mom-and-pop HVAC business problem, where your lead revenue generators could also be your biggest competitors if the transition doesn't go well. where like if these recruiters, these five experienced recruiters or the two senior in particular, if they're like, oh, well, the seller promised me they were going to sell me the business and then I feel slighted in the process. I'm just going to go out on my own. There's not, I mean, maybe there's some non-competes in place. Maybe there's non-solicits. Maybe there's some things, but it feels like, especially with it being niched down so much in the industry, like I could come in, have all the legal protections in the world, and if the fit isn't right and those people leave, I've got a really, really uphill battle to try and claw back any of the goodwill that was really stuck with these people.

25:39yeah i i would pretty i would go pretty strong on both a non-compete and a non-solicit if i were to do this meaning we don't want that we you know we don't want this seller to just start up his own shop and go after the same set of clients um or do the same exact thing and i might even put that on some of the you know some of these other recruiters these two senior recruiters who are probably like leading some of the business development as well I think there's probably there's probably a world where we could put could like create some sort of bonus pool for these recruiters to stick around because they do have some value right like some pretty significant value I think and so we'd want to make sure to like treat them right but also make sure that you know they don't walk out the door with it because if they walk out the door when the deal closes then we're looking at 0 % of business development from anybody left you know And it's why I really don't like, I mean, and I'm going to say businesses like this type, but you, I don't know that much about your business.

26:44I know a little bit and I'm going to assume yours is different, but it's why I don't like businesses like this because I'm at such a disadvantage in a professional services environment when I am not the practitioner of those services. like for the same reason that I wouldn't buy a specialty law firm or something like that. Like I just, it's not, it's not my core competence and I can't fill in the gap that may or may not be created with a founder leaving or, you know, key revenue generators leaving. It just, it scares me. I think it creates this kind of like virtuous cycle of insiders staying in the business and inside the industry.

27:22but it makes me wonder like usually there's so much value in a niche and niching down it's kind of the double-edged sword here where like the niche is helpful in terms of their their competence and their familiarity with the industry but like you said there may also be kind of a perverse thing at play where because they're so specialized they may have like a lot of saturation in the market and then you end up with a limited pool like an outsider could come in and get a candidate that you placed who's a great candidate that you now can't like cross solicit. Yeah. I know of, uh, I know of two guys who, who started a firm, uh, search firm, great, great business, did really well, exited to one of the kind of big five, uh, and the, the acquirer didn't put very much restrictions on them.

28:11And after their earn out period, they went and started the same thing. And now that company is almost as big as the company that bought their first company. uh ty how would i grow this business if i bought it it's a good question i probably would want to look at the the depth of these relationships to understand like where you are you know how much revenue are we getting from each of these clients how else can we serve them can we if if if these clients are asking for searches or for hires that we can't do can we develop a partnership and you send them to a fully contingent shop or something and take small little affiliate fees.