In a Q&A with Matt Vaadi, the speaker outlines the primary factors that increase the valuation of payroll and software businesses when they are sold. The discussion emphasizes that the client base is the most critical element, with a focus on the composition of industries and the size of clients. The market is divided into four groups, and the speaker highlights Group 2 (employers with 5‑50 employees) as the sweet spot, representing over 96% of U.S. small businesses. Valuation drivers include: (1) high‑quality, stable clients; (2) strong sales growth, effective sales processes, and high client retention, measured through KPIs such as cost per check; (3) operational efficiency and economies of scale; and (4) proprietary technology. These factors feed into the valuation matrices used by M&A and private‑equity firms to place a company in a high‑value box.
Chapters
But if it— for those people who do know and are licensing software and are growing a meaningful payroll business, what are some of the things that you see that drive the value up for a payroll company when it does come time to exit?
Well, that's a good question, Matt, from the point of view that, that people understand what they're building and where the value is. So the obvious is clients, good clients, and the type of client that you have. Today, from a due diligence point of view, we're very careful in terms of looking at the client base to understand what markets, what industries are represented in that client base. So there's one factor from a client point of view. The other factor has to do with what, what group those clients exist in. We've defined the market generally, the business market, the economy into 4 groups. Group 1 being very small clients, call it 1 to 5 employees. Group 2 being employers, let's say from 5 to maybe 50 to 75 employees. Group 3, middle-sized companies, might represent anywhere from, let's say, 75 employees to maybe 500 employees. And then the enterprise size of Group 4 would be what you would see as a national accounts. Now, when you look at the economy generally, over 96% of the small businesses in the United States live in Group 2. So, that's a focus group. When I look at somebody's business and I find that they're all over the board, small clients, middle-sized clients, big clients. I'm going to analyze that, that client base very, very carefully because from our point of view, one of our successes has been focus. We are very focused in Group 2. That's where we live. If a client outgrows us, we don't try to change the software up or find the fix to keep that client. In many cases, we help them move on if they've outgrown us. But in that small business market space of 5 to 50 employees, most clients for the most part are stable. They're not growing. Companies that are able to get over $5 million and then get over $10 million in revenue are rare. That's very rarefied air. And it's also representative of our industry as well, something I might talk about a little bit as we move along here. But so obviously number one in value is clients. Number 2 would be sales growth. What type of sales processes and what type of history from a growth point of view does the, does the business have? Are they able to also retain clients, or is there a lot of turnover? So we look very closely at retention levels, and that basically may speak to are they a full-service provider, or are they a low-cost, low-service provider? So as part of that mix, we're going to look at the revenue, and we're going to analyze from a key performance indicator— KPIs— what does that revenue look like? Cost per check. If it's low, they're basically indicating that they may be a low-cost provider, which also probably equates to a low-service provider, which then might tell us that they have a low retention. So the sales process, though, becomes very important. And if it, if it's really good, it's another notch from a value point of view. Then you go to operations. How efficient are they? What type of operational processes do they have? And are those operational processes in a sense providing great economies of scale and efficiency. If they are, there's another click that'll, that'll add value. Uh, the fourth area is technology. If they have a proprietary technology, that adds value. Check all of those boxes and now you have a company that, that is at the extreme high of value. And if you look at some of the M&A people out there, some of the PE firms, the venture firms, there's a matrix that exists that'll basically put you into a box of value. And it's all related to those factors I just gave you.
