When talking to founders of services companies, many are surprised to discover that services companies can be acquired. Their next question is to understand "Why are tech services companies acquired?", "What is the value proposition for the buyer?" This brief article shares the common reasons for an acquisition of a tech services company.
The best acquirers are strategic acquirers. They have a specific business need that acquiring your services company lets them kickstart.
Adding new capabilities is the most important reason for acquiring emerging technology services. The "Innovator's Dilemma" goes into deep detail on why businesses struggle to innovate and how one of the easiest and most common methods for keeping up to date is to acquire a company in the space. Adding a new capability includes:
Staff that can deliver
Processes for successful deliveries
Training processes and practices to train new staff
Sellers who understand the space
Platform partner relationships
When a buyer acquires a new capability, their interest is in that capability. Anything outside of that capability would likely overlap with the existing capabilities of the acquirer and not be valuable to them. A buyer trying to add a new capability would likely receive the highest value. They don't base the value on the income from your company but rather on the potential of selling your services to their portfolio of companies.
A strategic acquirer may gain access to markets they did not have access to before. Using the definition of a market from the book "Crossing The Chasm," a market is:
a set of actual or potential customers
for a given set of products or services
who have a common set of needs or wants, and
who reference each other when making a buying decision.
A market can be defined in many ways, but here are some examples of criteria that would make you an acquisition target:
Geographic regions - especially if you enter a new country, you may face stiff competition.
Verticals - You can expedite your bowling alley strategy through acquisition.
Business type - Government or private sector, company size, and GTM market strategy are examples of other criteria that make them an acquisition target.
Services Capabilities In A Product Company
The line between product and services is blurrier than we like to think. Every product company needs a services wing to service their most profitable large enterprise customers. Some may choose to acquire a services company to bring this capability in-house.
Private equity (PE) firms are investment firms, but their investment profile and strategy differ significantly from venture capital firms most familiar to technologists. They invest in medium-risk, medium-return companies. They usually take a controlling stake, bring in their operational capabilities, grow the companies, and sell them at a higher return.
Investment And Growth
PE firms are interested in taking companies they can grow. They will intend to sell it at a later point. When purchasing, they will adhere to the investment maxim of "Buy low, sell high."
One of the criteria in the equity value of a tech services company is the size. A larger company can command a higher multiple. To attain this quickly, many PE firms buy multiple companies to roll them into larger companies. They use their operational capabilities to build structures to scale the combined company.
Partnership With Founders
Many PE firms allow founders to take some "chips off the table" while maintaining a stake in the company. It enables the founders to derisk their personal life while maintaining a vested interest in the company. This strategy gives the PE firm very motivated operators to grow their investments.
There are some other types of buyers you may see.
Some companies acquire tech services companies to hire a team with desired capabilities rapidly. The acquirer is not necessarily a tech services company. The incentive is to get a functioning team complete with leadership. Please note that this form of acquisition represents a destruction of value if done by a product company.
This strategy is more common with smaller companies. Taking a company from zero to one differs from scaling a company with an existing customer base and reputation. Some entrepreneurs with the operational ability to grow a company may want to purchase an already running company rather than start one from scratch.
A competitor may want to acquire as a part of a consolidation play. Acquiring removes a competitor from their customer acquisition. This strategy is highly effective for emerging tech services companies working on technologies with a shortage of talent and services providers in the marketplace.
What This Means For Your Tech Services Company
Most people asking us this question want to know their long-term options for running a services company. Many founders of tech services companies may have renewed enthusiasm after understanding the "end game" of their journey. This article also helps you know how to align yourself towards the outcome of an exit. In our "Demystifying ETS Valuations" series, we explore the topic further on the valuation of your emerging tech services company. We highly recommend reading the series and keeping the key ideas in mind as you grow your tech services business.