PEO industry adjusts to life under the SBEA with robust M&A activity

By Brad Buttermore
Managing Director and CFO

The Professional Employer Organization (PEO) industry experienced major consolidations late last year, as the sector reached a turning point following the December 2014 passage of the Small Business Efficiency Act (SBEA).

The SBEA legislation continues to move forward with what seems to be a firm commitment from the IRS for a July 1, 2016, implementation date. As we have discussed before, the legislation creates a voluntary certification program for PEOs within the IRS, giving certified PEOs a statutory right to collect and remit federal employment taxes, among other things. One benefit, often referred to as legal certainty, diminishes real or perceived risks of working with a PEO from the universe of prospective clients. This may be a driving force for investors, especially private equity funds that have made significant investments in the industry.

The increasing regulatory environment and the nation’s improving economy have fueled demand for PEO services, and the small to mid-market PEO sector has discovered it needs to add some market heft to compete in today’s new regulatory marketplace.

Here’s a look at just a few of the M&A deals that occurred during the second half of 2015 — deals likely driven at least in part by the SBEA:

  • Tenex Capital Management’s acquisition of PEMCO – a private equity group made a platform investment in this PEO operator.
  • HROI’s acquisition of Fortune Financial – Clarion Capital Partners, a private equity firm with past experience in the PEO industry (SOI), backed industry operators re-entering the market and establishing a new platform for future growth.
  • Oasis Outsourcing’s acquisition of A1HR and Doherty Employer Services – both significant strategic purchases for growth by this well established PEO platform.
  • Assurity Life Insurance’s acquisition of a majority interest in Resourcing Edge – a Texas-based PEO. The investment provided cash for shareholders and new capital for growth through more acquisitions.
  • Morgan Stanley Global Private Equity’s investment in CoAdvantage – a company formed via many private equity-backed acquisitions over the past few years. While the investment likely provided a payout for early investors, it also strengthened the balance sheet for future growth plans, including acquisitions, and drew yet another significant capital provider into the industry.

As evidenced by the sector’s robust M&A activity, the stage is set for focused efforts to expand market share that we believe will continue to drive M&A activity in 2016. With several platform investments now in place, we believe lofty valuations will begin to diminish slightly, but remain relatively high by historical measurements.

A 2015 NAPEO study calculated the size of the PEO industry at $136 billion to $156 billion, based on gross revenue. Nationally, there are between 780 and 980 PEOs, with Florida and Texas having the most.

These PEOs provide services to 2.7 million to 3.4 million worksite employees for 156,000 to 180,000 clients, and employ between 21,000 and 27,000 internal employees, according to NAPEO.

This is significant growth for a young industry that only took hold about three decades ago. In each of the last 30 years, the industry has added, on average, roughly 100,000 worksite employees and 6,000 net new clients, NAPEO says.

Capital Alliance Corporation is an investment banking firm with an extensive international reach and a 40-year history of providing trustworthy advice to private company shareholders who want to sell their businesses. Our team has deep operational and M&A experience across broad human capital management (HCM) and technology sectors.