Solution providers considering selling their businesses, or purchasing competitors, got some M&A tips Monday from IT industry advises who told them it’s a seller's market with valuations on the rise.
Mike Harvath and Reed Warren of Revenue Rocket Consulting Group spoke in a breakout session at the 2015 XChange Solution Provider conference about how companies can gauge when it's the right time to buy or sell, the factors that determine their attractiveness and potential valuations, and the pitfalls that often plague deals.
The XChange conference, taking place in Dallas this week, is hosted by The Channel Company, publisher of CRN.
Harvath, Revenue Rocket's president and CEO, said there are many rules bandied about for determining the multiples of various financial figures that suggest appropriate market value, but ultimately it comes down to the bottom line.
"It's important to remember that all valuation metrics are built around one thing, and that's profitability," Harvath told the group.
IT is a $4.4 trillion industry and a hotbed of M&A action, he said.
The industry is somewhat unique in that "almost all entrepreneurs start their business thinking they will sell it at some point," Harvath said.
About half of Rocket Revenue's business comes from consulting IT companies on M&A strategy, Harvath told the group. The company he founded 15 years ago has worked with more than 400 firms, and estimates it is involved in between 5 percent and 10 percent of all North American transactions less than $50 million each year.
"The market is getting much more selective about how it works with folks like you," he told the group.
Buyers want specialists -- they gauge a solution provider's depth in a particular industry, and assign more favorable multipliers to those with legitimate areas of expertise.
According to a report from U.K. analyst Equiteq, 86 percent of the industry is planning to grow through acquisition. In short, it's a seller's market.
"We've seen multiples creep up," Harvath said, a trend he expects to continue at least two more years.
But that doesn't mean buyers are rushing into deals willy-nilly.
They're looking for certain attributes, including a trending history of growth and financial stability, good penetration of specific verticals, and intellectual property that can be leveraged, according to Reed, Revenue Rocket's vice president.
NEXT: How To Know When You're Ready
But how do buyers know when it's time to start shopping?
"You're ready, typically, when you're a $5 million firm or larger," Harvath said, adding as a rule-of-thumb a company can afford to buy one about half its size.
A firm looking to make an acquisition should have in place a clear organic growth strategy it can articulate to sellers. It also should be growing at least 10 percent faster than the market as a whole (which means north of 20 percent today), hold little or no long-term debt, and be in position to take some risk.
Buyers, when identifying a target for acquisition, should first and foremost search out a good strategic fit. If a potential acquisition meshes with the buyer's overall strategy, then it should be evaluated as to whether it is a good cultural and financial fit, Harvath advised.
On the flip side, those looking to sell should make sure they're not running their business simply to advance that goal. That strategy of creating optics that can raise a valuation -- such as running on a skeleton crew to increase short-term profits -- is usually obvious to buyers and typically causes more damage than profit, Harvath said.
Buyers today are typically looking to acquire companies that have 30 percent or more in a recurring revenue model, the two presenters told the group.
"Also, make yourself obsolete," Harvath advised CEOs. That means make sure there's been a knowledge transfer, and the business can run smoothly without its current leaders.
"One of the things buyers want to know is if they extract you from the equation, is this whole thing going to fall apart?" he said.
He emphasized that multiples based on revenue or EBITDA (earnings before interest, taxes, depreciation and amortization) are simply comparative benchmarks.
"It's about profitability, not revenue or length of contracts," he said.
Kumar Nandigam, CEO of Tekpros, a solution provider based in Dallas, has been in business for a decade, but hasn't yet thought much on the session's topic. He told CRN he attended Monday's session because he thinks in a couple of years he might be ready to consider some form of a deal with another solution provider.
For that reason, the ballpark numbers put forward by the Revenue Rocket presenters, and the key points they offered to keep in mind when preparing for a merger, were helpful, Nandigam said.
"I wanted to learn the process," Nandigam told CRN. "Prior to this I was never thinking about M&A when running the business. It seems to me I should at least know the process."
After years in business, he said, it's natural "to put that on the wall as one of your goals to achieve."
Harvath and Warren ran through the stages of an acquisition, which progress in a familiar sequence: identifying a company to try to purchase, negotiating a letter of intent, reaching a definitive agreement, and finally completing the post-merger integration.
On Tuesday, they will present another breakout session sharing insights into navigating post-merger integrations, the stage at which 65 percent to 70 percent of deals go bad, Harvath said.
For additional information regarding Florida business sales, acquisitions and valuations, please contact Eric J. Gall at Eric@EdisonAvenue.com or 239.738.6227. Also, visit our Edison Avenue website at www.EdisonAvenue.com or my personal website at www.BuySellFLbiz.com.
