Technology services firms: the hidden gems of the software M&A world

Software ventures get a lot of attention in the merger and acquisition (M&A) world. They often command strong multiples and generate sticky headlines. In contrast, many businesses that co-exist in the same markets – the technology services businesses which offer application consult, design, build and implementation services, often with intellectual property (IP) built on top of a leading software platform – don’t get the same kind of M&A profile.

By getting their market narrative right and showing where they excel, technology services businesses can create more practical wealth for their owners than their SaaS counterparts, even if their ultimate valuations are less heady.  In general, they don’t experience the same shareholder dilution to fund the build of their core product. With lower capital intensity (and therefore increased cash conversion), owners can also take cash distributions along the way more easily. While a SaaS business may sell at a higher valuation multiple, the founders will generally enjoy a smaller share of the spoils.  

So how can technology services businesses in an M&A sweet spot of, say, £5m-£30m revenue build value for shareholders and make themselves even more attractive to future acquirers and investors?

Here are some of the key things to build on.

Where technology services businesses need to focus

The route to maximising shareholder value and a strong sale price lies in offering qualities similar to the ones that make pure-play software businesses so attractive. These include factors such as IP capture, scalability, proven and replicable customer value creation, and recurring revenues, which we’ll explore in turn.

Definable intellectual property

This can take the form of software, including configurations and integrations (‘software’ IP) and also sales and service delivery methodologies and architectures (‘how to’ IP). IP illustrates value capture and supports scalability, which are both key factors in business valuation.

When it comes to software IP, solutions may not be fully productised in a SaaS sense, but even as a ‘service accelerator’ the IP can be properly documented and made easy to implement, so that an acquirer can easily assimilate it. The ability to showcase tried and tested IP and efficient scaling into enterprise clients can be crucial as a way of de-risking in the eyes of acquirers and investors.

Scalability

This is about enabling the business to grow efficiently, with minimum friction, and most importantly, without over-reliance on a handful of senior talent or visionary founders, always a major discount factor when selling. It can be created in a technology services business in many ways. A key route is to leverage IP to deliver efficient sales and solution delivery. Scalability can also come from strong channel and service delivery partnerships that give access to clients and expert resources without incurring the time and cost of recruitment. Another route is to have contractual models and a portfolio of highly complementary solutions that support efficient upsell and cross-sell in the customer base.

Repeatable value delivery

These are of course the foundation of any business, but are particularly important for technology services businesses which may not have, by design, highly repeatable solutions. Case examples that clearly demonstrate the customer’s challenge, the value designed for them and the results achieved can give an acquirer or investor a high degree of confidence in the value of the business. This is particularly the case where benefits can be directly quantified and the customer can be externally referenced.

Recurring revenues

Increasingly, investors and trade buyers are willing to take a flexible view on the definition of recurring revenue and long-term retained clients. Even recurring project revenue can still count towards all important quality of earnings.

Software-based IP, even when not fully productised, can still be positioned as recurring IP license charges which are explicitly contracted by the customer. It can also be integrated into multi-year contracts to create a financial dynamic very similar to pure SaaS, with a commensurate positive impact on business valuation.

A further factor here is to consider an element of usage-based pricing in the commercial offer. Again, this can serve to create a rich seam of scalable, recurring revenue.

Other ways to drive financial value

With these foundations in place, technology services businesses seeking to sell or secure investment can boost their value and reduce the challenges and risks associated with service-based acquisitions.

But there are other things they can be doing too.

Be clear on your IP strategy

It’s not always necessary to have the finished article ahead of a sale or investment process. Many businesses will take on private equity investment or seek an acquirer to help accelerate IP development. There are ways of structuring an M&A deal to capture the future value of these assets, but critically, the thinking behind the asset needs to be fleshed out. Yes, a transaction can be completed without this clarity, but it will mean leaving significant value on the table and potentially challenging conversations in the future if there are misunderstandings around the future promise.

Set the ratio of internal to external staff appropriately

Some technology service businesses over-rely on contractors to retain flexibility and support scalability. However, it’s important to have a core team of permanent employees, especially for senior roles, to signal a sense of continuity to the acquirer. Combined with repeatable processes and proven approaches to skills transfer, this communicates strong confidence in the business and its long-term prospects.

Develop value-add partnerships

These can take the form of channel, technology and delivery partnerships. Properly constructed, they can support scalability and growth, and contribute positively to a well-functioning sales and delivery engine. But, as with clients, it’s important to avoid over-reliance on any single partner and the scenario where a potential acquirer may be conflicted by, or prevented from, working with one or more of these parties.

Who will buy your technology services business?

If you’ve put all of this into action, there’ll be plenty of open doors to explore. Acquirers may be interested in your capabilities, your IP assets, your customer base or all of these. Candidates might include leading management consultancies, specialist tech consultancies, technology outsourcers, business process outsourcers and private equity.

Many private equity firms struggle with pure software businesses with limited cashflow, and as such, most scale-ups are left to specialist venture funders. If positioned correctly with the right fundamentals in place, technology services businesses which can combine strong growth, high quality of earnings and good profits have proven to be some of the most sought-after businesses in the market.

Getting out the shadow of SaaS

Too often, technology services businesses might feel they are living in the shadow of their noisier SaaS cousins. But they have much value to offer potential acquirers and, with the right approach and positioning, can command solid exit valuations that properly reflect the value they have built and captured. Perhaps in the final analysis, even eclipsing the SaaS business that capture most of the limelight.

Martin Ward

Post by Martin Ward

Partner at Waypoint Partners

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