How do you finance the purchase of a staffing company?

The money moves the wrong way

A staffing company pays before it is paid. Its temporary workers are on its payroll and are paid every week, whether or not the customer has paid for their hours. Customers pay on net terms, and large customers buying through a vendor-management program often pay slower than that. The company is always carrying several weeks of wages, payroll taxes and insurance it has not collected.

In plain numbers: a company with weekly payroll of 100 whose customers pay about six weeks after invoice has roughly 600 of wages tied up in receivables at any moment, plus the employer taxes on them. If sales grow by a third, the float grows by a third. Growth consumes cash in staffing before it produces any, which is why a buyer who finances only the price, and not the float, can own a growing company that runs short of cash.

A lender financing a staffing acquisition is answering two questions. Will earnings after closing cover the debt used to buy the business? And where does next Friday's payroll come from, the day after closing and every week the business grows? At this size the answers come from different lenders or different facilities, and they have to be agreed together. A company this size has usually outgrown SBA financing, whose 7(a) loans go up to $5 million.

In staffing, the purchase loan and the payroll revolver are two halves of one financing. Lenders want to see both before they commit to either.

How a staffing company earns, and the lines lenders value differently

Revenue is the bill rate times the hours worked. Real earnings are the spread between the bill rate and the fully loaded cost of the worker: pay plus employer payroll taxes, unemployment insurance and workers' compensation. A worker billed at 30 an hour and paid 20, with 3 of taxes and insurance on top, leaves 7 of gross profit per hour to pay recruiters, offices and the debt. Lenders read gross profit per hour and gross margin by customer before revenue, because revenue in staffing can double while gross profit stands still.

Temp-to-hire conversion charges sit between the two: welcome, but not something a lender counts on repeating. Where EBITDA leans on permanent placement, expect a more conservative loan than the headline figure suggests. How lenders adjust the figure is in EBITDA add-backs and quality of earnings for acquisition loans.

The revolver and the term loan

The payroll float is funded with an asset-based revolver against receivables. Asset-based lenders typically advance 80% to 90% of eligible receivables; invoices more than 90 days past invoice are typically ineligible, and borrowing bases commonly cap any single customer at 20% to 25% of eligible receivables, so a concentrated company gets less payroll funding than its invoices suggest. Lenders usually take control of collections through a lockbox and require a borrowing base certificate on a set schedule; see how a borrowing base works and cash dominion and lockboxes.

Where the revolver and term loan come from different lenders, their split of the collateral is set in an intercreditor agreement; see ABL and term loan split liens. Many staffing companies factor their invoices before a sale. The factor is paid off at closing and replaced with the revolver; how a borrowing base works explains how it is sized. For how the revolver works on closing day, see using a revolver in an acquisition.

What actually transfers to a new owner

Little on a staffing company's balance sheet is worth much except receivables. The buyer pays for relationships, and each has to survive the change of owner.

• Customer agreements. Master services agreements often require consent to assign, and vendor-management programs may require re-approval as a supplier after a change of control. See change-of-control consents.
• Recruiters and account managers. Customer relationships often belong to the person who answers the phone. Lenders look for retention arrangements and non-solicitation agreements with the staff who hold the largest accounts, and rollover equity for founders who still sell.
• The worker pool. The candidate database and workers on assignment are the company's inventory, and must move without a gap in pay or employment paperwork.
• Licenses and registrations. Some states license employment agencies or day-labor services, and healthcare staffing carries credentialing obligations.
• Workers' comp and unemployment history. Rating rules usually carry the seller's claims experience to a new owner continuing the same operations, and many states transfer the unemployment-tax rating to a successor.

That last point surprises buyers. An asset purchase protects against many of the seller's liabilities, such as old wage claims, but it does not reset the insurance and unemployment rates the business pays next year, and those rates drive gross margin.

The risks lenders price

Customer concentration. Staffing companies often grow by winning a few large accounts, and one can end with a single call. Lenders measure gross profit by customer and ask what happens to coverage if the largest leaves; see customer concentration in acquisitions.

Payroll taxes. A staffing company withholds tax from thousands of paychecks. If the seller ever fell behind on deposits, a federal tax lien can sit ahead of the lender. Lenders ask for quarterly payroll tax filings and proof of deposits, and an ABL lender often reserves against payroll taxes in the borrowing base. Any balance is resolved before closing.

Workers' compensation. In light industrial staffing, the premium and the claims tail can decide whether the business makes money. Lenders read several years of loss runs, the experience modifier, open claims and reserves, and whether the program is guaranteed-cost, high-deductible or self-insured. A high-deductible program with open claims is a liability the buyer inherits in cash, and often needs collateral posted with the insurer.

Classification and the cycle. Wage-hour claims, misclassified workers and joint-employer disputes are the industry's litigation risks. And temporary staffing is one of the first costs companies cut in a slowdown. Lenders look at how gross profit behaved through the last soft patch, and whether the debt still clears if hours fall for a year.

What goes in the file

The revolver starts from an AR aging by customer with days outstanding, an AP aging, the balance sheet, the P&L, a year-to-date P&L, and the debt schedule with existing liens, often with bank statements and two to three years of tax returns. The acquisition adds the target's latest full year of figures for every company being bought, never an older year, and the letter of intent. A staffing company adds:

• Revenue, hours and gross profit by customer for each year and year to date.
• Quarterly payroll tax filings and proof of deposits.
• Workers' compensation loss runs, the experience modifier and the current policy; unemployment rate notices.
• Customer contracts and vendor-management agreements, with assignment terms.
• A roster of recruiters and account managers, with the accounts each holds.
• Any factoring or receivables agreement, and its payoff.

Senior bankers run every Midas Partners engagement. Once the documents are in, Midas Partners builds the financing model, lender presentation, blind teaser and underwriting memo in a day; by hand the same package takes at least a week. Software does the analyst work and a senior banker checks every page. Of the 1,800+ lenders in the book, 235 write asset-based loans and lines and 1,148 write term and private credit, so the revolver and the term loan can be placed together. Lenders that fit see a blind teaser first; the client approves each by name.