By Bradley S. Buttermore
Managing Director and Chief Financial Officer

The professional employer organization (PEO) industry likely will see a period of consolidation as industry dynamics change on the heels of the recent passage of the Small Business Efficiency Act (SBEA).

The nation’s larger players are eyeing regional PEOs as potential acquisition targets as they seek to add scale. These large players — some backed by private equity funds or publicly traded firms — are flush with capital and willing to pay top dollar for regional PEOs.

Regional players, sensing opportunity, are seeking to add to the number of “lives” they represent — making themselves more attractive to potential suitors. Other regional players are looking at merging with like-sized PEOs to bulk up.

It is possible this period of consolidation will be fairly short-lived, perhaps about a year or 18 months in length. Once the largest players achieve a presence in most regions of the country, they will turn their focus to organic growth.

This M&A activity comes as the industry awaits the implementation of the SBEA, a new law that the PEO’s largest trade group — the National Association of Professional Employer Organizations (NAPEO) — strongly supported.

The SBEA, passed in late 2014, recognizes PEOs under federal tax law and will establish a set of tax code rules under which they will operate. The SBEA also establishes a voluntary program for PEOs to be certified by the IRS for the collection and payment of federal workplace taxes. The tax code rules and the certification program won’t be implemented until 2016.

NAPEO believes the SBEA will provide a new level of legitimacy and acceptance of the PEO industry while adding certainty to the process of collecting and remitting workplace taxes. Another PEO trade group, Professional Administrative Co-Employers (PACE), strongly opposed the new law, citing concerns about governmental regulation, new liabilities and costs.

Smaller PEOs likely will be left out of the M&A activity as they simply won’t have enough lives to draw interest from the larger players. Whether these smaller players can continue to operate profitably under the new regulation remains to be seen. Certainly, many will find a way to do so, but it’s also likely some of these smaller PEOs will struggle with growth if they cannot find a merger partner.

We anticipate that about 30 regional PEOs, each representing roughly 15,000-30,000 lives, could be strong acquisition targets over the next 12 to 18 months.

This is an exciting time for the PEO industry as M&A activity heats up. Stay tuned to the Capital Alliance blog to learn the latest news and analysis of the sector.