Whether you’d like to enjoy the fruits of your labor or tackle a new challenge, making sure that your staffing firm will thrive after you leave is the key to courting buyers and consummating a lucrative deal.

A slow-recovering economy continues to create a cautious merger and acquisition environment, according to RBS Citizens’ Middle Market M&A Outlook 2014. As a result, every aspect of the trans- action must be defended to survive the rigorous scrutiny of the due diligence process.

“Your valuation hinges on your ability to show that you’re a capable  financial operator who has grown a profitable business by developing client relationships and making prudent investments in people and technology,” says Dave Phillips, director, Childs Advisory Partners.

There’s not a moment to lose. Positioning your staffing firm for a successful sale by reducing the buyer’s perception of risk can take some time.

Strengthen Customer and Business Mix

After reviewing your financial statements and pro forma forecast, a prospective buyer will conduct a customer-base analysis, which looks at customer behaviors and trends over the last three to five years to predict future sales.

Naturally, they want to see sequential growth, a steady stream of new customers, robust margins and diverse clientele. But they’re also looking for cross-selling opportunities and whether key clients are tethered by agreements or long-term relation- ships with the staff. And they’ll discount the asking price if they find companies with shaky credit or a history of workers’ compensation claims.

“A prospective buyer will consider the longevity and profitability of every single customer,” says Steve Crisham, managing director, Generational Equity. “Higher margins equate to less risk and usually higher EBITDA, so they bolster valuation.”

As you remodel your book of business, strive for positive attributes that enhance value like being a preferred vendor or working with marquee clients in desirable industries and having the lion’s share of revenue in contingent staffing instead of direct placement.

Even if you’re marketing your firm as a niche supplier, buyers will balk if 40 percent or more of your business comes from a single customer. Minimize customer concentrations to maximize value.

“A high concentration of VMS clients or offshoring services may signal that you’re the Wal-Mart of the staffing industry to a prospective buyer,” notes Brooke Hollis, president of Hollis Associates Acquisition Advisors LLC.

“It behooves you to replace unprofitable customers because the cash generated by the business is the biggest driver of the sales price,” he adds.

Although high margins enhance valuation, they must be sustainable. A spate of recent rate increases or sudden influx of new clients will raise a red flag with buyers.

Use qualitative industry metrics and analytics to validate your position as a value-added supplier, Crisham suggests. And counter fears of post-transaction margin erosion or client defections by articulating a specific pricing methodology that can be sustained after you leave.

“You bolster a buyer’s confidence when you have a clearly defined, repeatable process that will help him increase rates and maintain cash flow after the transaction,” he says.

Fine-Tune Financials

“Owners who plan to sell need to clean up their act because accountants will go through their finnancial statements with a fine tooth comb,” warns Bruce Benator, managing partner with Williams Benator & Libby LLP.

“There’s no statute of limitations if you fail to file income tax returns in every state where you supply contingent workers,” he says. Further, misclassifying W-2 contingents as 1099 or corp.-to-corp. contractors or mischaracterizing contingent payroll as per diem expenses are deal killers.

Other issues that affect a firm’s valuation include unresolved lawsuits, unrenewable leases and inadequate reserves for bad debt, lawsuits or claims, poor record keeping and using cash instead of accrual accounting.

Transaction attorneys and accountants like to see financial statements prepared using generally accepted accounting principles (GAAP) that have been independently audited and attested by a CPA. Smaller firms should consider a new financial reporting framework often referred to as “GAAP Lite” and a less costly review by an independent auditor.

SG&A that is too high or too low compared to industry norms will raise buyers’ suspicions. They fear the seller may have inflated profits by curtailing investments in big ticket items like technology or that reducing hefty bonuses or commissions may incite turnover.

To see where you stand, compare your gross margin and adjusted EBITDA levels with those of public companies. Consider closing or consolidating unprofitable branches to boost returns and bring your SG&A in line with competitors. And be sure to highlight compensation plans or services that drive higher margins when presenting your staffing firm to potential buyers.

Finally, it may be worth it to restructure to a corporate form that facilitates an asset sale like a subchapter S corporation or limited liability company (LLC). You’ll need to start the process well before a sale but some business entities minimize the risk of double taxation for the seller, Hollis says. There may be other benefits as well, but it’s best to check with an attorney.

Orderly Transition

Because revenue in service industries hinges on trust and relationships, buyers fear that employees and clients will abandon ship after an acquisition, leaving them with debt and insufficient cash to yield a reasonable rate of return

The best way to prove that your firm can thrive without you is to groom a successor and transition your day-to-day responsibilities to the new leader a year or two before your firm hits the market. That way, a buyer can rest easy knowing that the most difficult part of the journey has already taken place.

Alternatively, offer to stay involved for a period of time after the sale. Suggest performance clauses, a partial earn-out or maintain an equity interest to convince buyers that your new status won’t stifle your drive or competitive spirit.

“Be honest about your reasons for selling,” says Hollis. “Otherwise, buyers will wonder whether they’re inheriting a problem instead of an opportunity.”

Offer equity or retention bonuses to rainmakers and ease the transition by assigning them to key clients. In exchange, ask employees to sign reason- ably enforceable non-competes and be transparent about your timeline to keep competitors from pilfering vulnerable employees left twisting in the wind.

Redundant systems, detailed procedure manuals and a formal transition plan can ease the fears of wary buyers by creating a roadmap for future success.

“Staffing owners with military experience tend to get top dollar when they sell, because they track and document everything,” Crisham says. “They leave little doubt about how the business was built and why it will continue so they usually close the deal.”

Moreover, clearly defined systems and policies distribute knowledge across multiple individuals and serve as a hedge against the departure of key employees, helping to minimize a buyer’s perception of risk. Staffing firms that conduct business by the seat of their pants often stumble when transitioning to a new owner.

“The best way to enhance your valuation is by creating a company that you’d want to buy,” says Phillips. “Only when your firm is buffed out and ready to go are you ready to start the search for the ideal buyer.”