Meeting the changing demands of tech M&A
Digital transformation continues to drive M&A activity in the tech sector but demand is shifting, with a new wave of cross-border interest and an increased focus on securing the highest-quality talent.
London-based advisory firm Venture Corporate Finance, which specialises in selling companies in the IT, tech and Telco sectors, has seen a significant increase in international buyers seeking to enter the UK market over the past year.
“Private equity-backed trade buyers often look to buy businesses that offer like-for-like services,” says Venture’s Managing Director Gary Smith. “What we are seeing now, particularly with European buyers, are people who don't have those services entering the marketplace to add new capabilities into their portfolio of companies.”
While lower exchange rates may mean better value for overseas buyers, the main drivers are strategic and geographical expansion. Adding a presence in the UK has also become more important since Brexit.
IT companies have long been popular M&A targets because of their innovative technologies, fast growth potential, loyal customer bases and global footprints.
Dealsuite’s research shows an average of 13 interested parties per offered IT Services firm and 12.2 per Software Development firm in the UK in the first half of this year versus an average of 7.5 for the overall market.
The fragmented nature of the sector has also made it ripe for consolidation, with many small and medium-sized companies competing for market share and plenty of scope to achieve economies of scale through acquisition.
The talent war
Tech firms boast some of the most talented and skilled workers in the economy and the ability to add these new skill sets to established businesses has often formed an important part of M&A decision-making, particularly in new and evolving areas such as AI and cloud computing. In a sector for which demand is constantly growing, competition for talent is becoming even more fierce, making human capital one of the highest priorities in recent deals.
“Buyers used to be very focused on customers and contracts, and aggressive with making synergies in the business,” explains Smith. “There's been a real shift in mentality in terms of the need to add quality people to the business, particularly as the labour market has become tight - hiring and retaining the right people is expensive so it’s become a key part of the transaction.”
Restrictions put in place during the Covid pandemic accelerated digital transformation as companies and organisations had to quickly adapt to remote working and online business models. From video calling to IT infrastructure and cybersecurity, many different tech companies benefited from the surge in demand.
“In the last four or five years we’ve seen a rise in profitability for a lot of these different services, which increases the value of people's businesses,” says Smith. “This then allows owners to make a positive decision about exiting.”
The global pandemic afforded owners a chance to reflect and develop a new work/life balance, which also prompted sales. With so many good quality businesses coming onto the market, and with multiple buyers bidding for the same types of businesses, it has been a highly competitive and buoyant marketplace.
All these factors have led companies in the tech sector to achieve multiples and structures never seen before. According to Dealsuite’s M&A Monitor, the IT Services and Software Development sectors reached some of the highest EBITDA multiples in the UK&I, with an EBITDA multiple of 8.1 for the Software Development sector and a multiple of 7.7 for the IT Services sector.
Covid also supercharged the move towards online deal-making, one that the tech sector has, unsurprisingly, been quick to embrace.
“The way transactions are managed and the speed at which they are completed, particularly in the mid-market, has changed because the ability to meet through digital communication is much easier and quicker, it has sped up the whole processing time,” explains Smith.
Venture Corporate Finance has completed transactions where the buyer and the seller have never met face to face, which previously would have been rare and may still be unusual in some sectors, he adds.
A changing landscape
As the cost of borrowing increases and the prospect of political change looms in 2024, the balance of power may be recalibrating as buyers begin to look at lower-risk options.
“Businesses that would have been acquired two or three years ago are being reviewed in a lot more detail now when it comes to ongoing performance,” says Smith. “People are asking, is this growth sustainable?”
While the tech sector may not be as buoyant as it has been over the past few years, Venture Corporate Finance remains highly active. Casting the net wider for potential buyers is a crucial reason for this. When selling an IT business, the company always has a strong database of ‘known’ and ‘slightly unknown’ buyers but it is often that extra 25% - the ‘unknown’ – that makes the difference, explains Smith:
“Dealsuite adds the unknown - people outside the industry, people who may be European, who we may not have heard of before -they extend our reach to bring new buyers into the ring.”