Looking for a fast-growth service business with a proven niche? This profile of a payroll-processing company includes the price, the valuation methodology, an evaluation of the company's prospects, and pros and cons.
The Business: Looking for a fast-growth service business with a proven niche and the potential to relocate? Punch this into your calculator: an eight-year-old payroll-processing company whose customized software enables it to bring affordable services to often overlooked small-business customers. With a client base of about 500 companies, this business jump-started its growth about a year ago. That's when it first offered to customers its biggest asset: proprietary technology for transmitting payroll information. The system allows customers to send data the way that big corporations do -- by using a modem. (Although the company doesn't charge customers for its software, the resulting efficiency improvements have raised its payroll-processing revenues per minute -- a key internal metric -- from $6 a minute to a staggering $3,200 a minute.) The current owner realizes he lacks the marketing expertise to help his company achieve its hypergrowth potential, but his seven staffers are ready to stay on.
Price: $2.1 million (financing terms available from seller)
Outlook: Check this out: The demand for payroll-processing services has become so huge that ADP, the publicly traded company that dominates this industry, rings up $5 billion in annual sales. This company doesn't have that kind of growth potential, but there's plenty of room for expansion if a new owner can figure out how to better market its comprehensive payroll services to the fragmented small-business community. One approach worth pursuing is the current owner's recent efforts to form alliances with accounting firms that concentrate on this client niche. The more customers that sign up, the more profitable this company becomes, since it earns interest on escrowed payroll taxes from customers.
Price Rationale: While this company's prospects add up nicely, there's simply no rationale for a deal this overpriced. A good payroll-processing company should be valued somewhere between a bookkeeping business (50% of annual sales) and an accounting firm (100% of annual revenues, plus assets). With all this company's pluses, it probably makes sense to assess it closer to the accounting industry model, which could suggest a price tag as high as $1.5 million (if we rely on the seller's assessment that the company's software could cost a competitor about $1 million to replicate). Double-check that calculation, though. Existing payroll-processing companies looking to hop into the small-business market might be able to modify their software for less money than the seller is estimating. One final point: accounting firm deals usually include earn-out guarantees, so it makes sense to insist on one here.
Pros: Valuable technology, fast-growing product demand, and an appealing (and largely unmined) customer niche could help you earn the biggest paycheck of all.
Cons: Pay too much and you might wind up on the unemployment line.
*Before interest, taxes, owner's compensation, software development costs, and depreciation. **Projected.