Real World Perspective on Acquiring an IT Services Company1 Mar, 2014 By: Mitch Morgan; Chris Ryne, Growth Achievement Partners (GAP)
Many dealers seek to acquire a company that is currently in the network services business to gain critical mass quickly. It can be a great strategy. We have helped a number of companies successfully analyze, negotiate, acquire, and integrate IT Services companies into their dealerships to accelerate entry into the business. If this is a direction you are considering, our experience can provide you an overview of important considerations:
Business Review: Is this the right type of business? The reality is that only about 30% of the Network Services companies in the market have fully transitioned into the Managed Services Model. The business should fit into the "go forward" business model.
Valuation and Negotiation: The valuation components and approach are different for this market. Your traditional yardsticks for measuring acquisition value for traditional MFP/MPS companies won't work here. The growth trajectory, the strategic nature of the business, and acquisition market factors yield different valuation measures and transaction structure.
Integration: Culture and Leadership are key integration issues. Customer base and personnel is what you are buying. In short, the assets go home at night. Additionally, you want the leadership to stay, and you need them to be an important part of your leadership team.
Acceleration: A good Managed Services business should be on a healthy growth curve. Typical growth percentages that we see are 15% to 30% per year. A proper acceleration strategy should provide an additional growth of 1.5x the projected growth. As an example, if the business is projecting 20% growth, your target should be 30%, based on a successful sales integration approach.
The Business Model: Critical to Assessing Acquisitions
When Growth Achievement Partners and Continuum built and released the Business Model for Managed Services earlier this year, we didn't fully recognize the benefit it would bring dealers when assessing and valuing Managed Services businesses. The model is a composite financial model that assumes 100 Managed Services contracts. When done right, this amount of contracts gets a dealer pretty close to the revenue target outlined above. By plugging the acquisition candidates’ financials into the model, it is easy to see where improvement needs to be made. The model includes Income Statement components, but goes much deeper into areas such as contracts and account expansion, margin and mix, headcount and productivity, and service types. By comparing the target company with the composite of "what good looks like" it is easy to see strengths, weaknesses, and trends. Additionally, we have built a model component that provides a valuation template, taking these issues into consideration.
Culture and Team Fit
In our past we participated in and then led the acquisition and integration of 35 technology services companies into a national office equipment provider, the integration of those companies into the bullpen, and then ultimately into the expectations, quotas, and compensation plans of everyone involved. We were able to see first-hand how cultural integration impacts success. It is likely that the target company has a strong technical foundation with a limited sales and marketing orientation. On the face of it bringing together technical resources with a sales driven organization looks like the perfect marriage. However, this is not a natural fit for either side. Attention needs to be given to bringing disparate cultures together to create this synergy.
Personnel: Is there a vCIO in there?
In many ways the presence of quality virtual CIO (vCIO) is the most important factor in the growth of this business. The vCIO is a trusted adviser to your clients and plays a critical role in the selling and delivery of Managed Services. In our experience, this role is critical to the success of the program. In short, this individual provides a "technology road-map" to your clients, acting as a consultant to the process. When considering an acquisition, ask yourself if employees of the company you are considering can lead a conversation with a business owner of small-to-medium sized business on applying technology to support the company business goals. Often it is difficult to get inside the business and interview potential vCIO's before the deal is structured. However, there is a common behavioral profile for these individuals and some consistency to the background that successful vCIO's have, so seek them out during the vetting process to identify if they are part of the business today.
Does the existing client base fit the target market you are seeking for these services? We tell our clients the target market is 10 to 100 users, with 20 to 50 as the sweet spot. Some smaller network services companies have a large portion of their client base below this threshold. In addition, when reviewing an acquisition, dealers should ensure that the existing pricing to the client fits with the revenue and margin requirements that the dealer is seeking. (See model discussion above). In short, does their service pricing (for hourly as well as recurring services) fit with where it needs to be for your business? It is often difficult to raise the price following acquisition, but it can be done over time with proper planning.
Management capabilities and appetite for growth
Many IT services companies are relatively small, "lifestyle businesses". A typical network services company will have less than 50 active accounts. The owner and management team often do not have a history of driving strategic growth within the business. These businesses often command a premium value, especially if they have successfully transitioned to being a Managed Service provider. It is not uncommon to see valuation based on top-line recurring revenue. The way to achieve a positive return on invested capital is to significantly grow the business. But what is the capability and desire of the management team to achieve this level of growth? Additionally, in spite of the fact that the majority of the staff is highly technical, they often do not have client engagement processes in place to facilitate the growth you are seeking. Building an end-to-end process from initial sales appointment all the way through on-going account reviews will help you to achieve the growth you are seeking. As described, this growth is needed to pay for the acquisition.
We believe that the right acquisition, with the right management focus, cultural integration and implementation of business processes for growth is a great formula for success for dealers seeking accelerated growth into this attractive market. For many dealers it is the right answer. We have participated in a number of transactions that have resulted in a positive outcome for all parties. By paying attention to the initial components outlined in this article (before and after the transaction) your opportunity for success will be greatly improved.
Mitch Morgan and Chris Ryne are co-principals of Growth Achievement Partners, a well-recognized strategic sales and operational consultancy in the office industry and managed services space. They are presenters at the ITEX Expo held March 11-13 at the Rio in Las Vegas. Show agenda at www.itexshow.com / www.growthachievementpartners.com