Positioning Your IT Services Firm for a Successful Exit
I often speak with CEOs and business owners in the IT services space who are beginning to think about an eventual exit plan but are still a few years out from starting that process. And the question I am often asked is “What are buyers looking for, and how can I best prepare for a sale?”
Many executives are myopic in their thinking, believing that simply driving top line revenue and EBITDA growth is the best path to a fruitful exit. And while that to a large degree is accurate, those two metrics are a starting point. When evaluating a potential acquisition there are numerous variables buyers will look at. And the reality is, there is no perfect opportunity. But the more boxes a company checks, the higher the chances of a successful sale.
Variables that buyers look at when evaluating an acquisition opportunity can be placed into two buckets; primary factors, which are viewed as highly important by most all buyers and will serve as the foundation for a company’s value. And secondary factors which, while still important, are variables that carry varying degrees of importance across different buyers and are viewed as nice to haves. So, when we look at answering the question of how executives and business owners in the IT services space, can effectively position their firm for an eventual exit optimizing these variables becomes very important.
The Four Primary Factors
EBITDA: In the IT services space EBITDA and a multiple of a company’s EBITDA will serve as the basis for formulating a valuation. Many business owners will look to some of the qualitative attributes and qualities their business can offer buyers as playing a role in valuation. And those attributes should and will have a positive impact with the right buyer. But ultimately valuation will be based off of EBITDA and the strategic value a company can offer a buyer will drive a higher multiple.
Positive Growth: The ability to maintain steady and consistent growth over time is very important. And almost equally important is the ability maintain an EBITDA figure that grows in unison with top line revenue. It’s needs to be understood that year-over-year growth by no means needs to be meteoric. But modest and consistent growth over a 3-4 period is what most buyers will want to see.
Customer Concentration: In the IT Services space acquirers are essentially buying 3 things; your team, your IP (assuming you have some) and your customer base. And organizations whose revenue is overly dependent on a small number of customers pose a sizeable amount of risk in a buyer’s eye. Almost all services firms servicing the mid-market and enterprise space are in a scenario where their top 3-4customers constitute a significant portion of total revenue. However, it creates a significant amount of risk when those customers comprise 40% + of a company’s total revenue.
Strategic Value: At the end of the day would be buyers have to see a strategic value when evaluating an acquisition target. If there is no perceived strategic value all of the other variables really don’t matter, there simply is no fit. Do you have expertise and talent that supports a bleeding edge technology? (providing line of business solutions and expertise that leverage newer, in demand technologies will go a long way in offering strategic value) Is there deep subject matter expertise and IP? Have you built a strong customer base and a reputation in a particular market? There are many ways to offer potential acquirers’ great strategic value. But it’s the ability to find the organizations that will see that value that will determine whether or not you realize a successful outcome. And as intermediaries the interesting thing we see is, often times the best strategic fits are found in the least likely of places.
Secondary Factors
Gross Margin: A strong gross profit margin is of course a great indicator of a company’s ability to scale. Buyers will typically look at a 40% gross margin as a baseline and anything in the range of 50% + as highly favorable.
Expansion Revenue: What opportunities does your current customer base present to drive additional revenue through cross sell / upsell opportunities? When you have a higher percentage of customers that fall into the enterprise category these accounts typically present the ability to significantly increase revenue by selling complimentary services and solutions or expanding into more departments within the account. Many buyers I talk to will want to see a good representation of accounts that offer the size, purchasing power, and potential to become million-dollar accounts over time.
Retention Rate: Many IT services firms, of course derive some or all of their revenue from project-based work. And while those client relationships typically aren’t long-term contractually booked relationships. Demonstrating the ability to maintain those relationships over time through repeat work and projects is important to buyers. Ideally a savvy services firm will move to a model that is less reliant on project-based work and begin to offer a managed services model with longer-term contractually booked recurring revenue. While the classic managed services model has been in existence for quite some time, many are moving towards models that provide as a service offering delivered as a holistic solution tackling a business challenge. IT services firms that can build up a sizeable revenue base from recurring revenue will not only attract a larger pool of interested buyers, but they will also increase their valuation.
Intellectual Property: When looking at the role intellectual property plays in a services business many will automatically think of processes, methodologies, maturity models, etc. For IT services firms more valuable than that is the ability to build IP through internally developed technology. Internally developed technology used to support clients and client projects not only provides a level of differentiation, but it also creates a scenario where a company can create a more efficient delivery model thus increasing their gross margins. Furthermore, if used the right way it will enhance value for the client and justify long-term subscription agreements.
At the end of the day the decision buyers face on whether or not to purchase an IT services firm or any professional services firm, for that matter comes down to perceived risk. The inherent nature of a professional services model poses numerous risks for acquirers because there are no guarantees. In what is largely a project-based model, there are no guarantees that your largest clients will continue to work with you. And there are no guarantees that senior team members who maintain a lot of those client relationships and are the ones bringing in new business will stay onboard post acquisition.
As expected, there is usually little to no tangible assets that can be had when acquiring an IT services firm. The acquirer is essentially buying your team, client contracts, and client relationships, and that’s usually it. So the more that can be done to mitigate these risks by; creating strong IP, building a well-balanced customer base, demonstrating a strong retention rate, and generating recurring revenue, the less perceived risk there will be in a buyer’s eyes. Just like any other investment your IT services firm will be a looked at in the lens of risk versus reward. The only question is, how well is your organization positioned to demonstrate less risk and more upside potential to substantiate the value you want?
About The Author
Matt Tortora brings over fifteen years of business ownership, sales leadership, and consulting experience in both technology and professional services. He has founded three companies and held strategic leadership positions at growth stage technology companies. Most notably, Matt was the co-founder and CEO of a Chicago based software company which he successfully grew and sold to a strategic acquirer. Matt is based in Chicago, Illinois.
Learn more about Matt here.
The article “Positioning Your IT Services Firm for a Successful Exit” was originally published on www.BMIMergers.com/
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