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It's the age-old question in business. What's the best way to build an organization of high value? It may involve adding a new line of business, building out a vertical market, or buying up a rival IT services firm. Either way, you're going to need capital to do it. But what should an owner do to get his or her hands on that cash?
CompTIA assembled a trio of financial experts to share their thoughts and insight on that dilemma at ChannelCon. Moderated by Frank Coker, CEO of CoreConnex, the panel dove into several issues related to funding and IT business valuation, including ways to better position your IT firm as an M&A target.
Mike Marcolina, Managing Director at Wells Fargo Capital Finance, Channel Finance Division, says the technology community has become very attractive to investors. That's good news for those interested in borrowing to expand their businesses ‒ or to sell them. "Services are generally a higher value when you can show an increasing recurring stream of income. Investors and lenders favor firms that are moving towards longer duration contracts with a firmer customer commitment. Those activities decrease risk and increase valuation."
The introduction of managed and cloud services changed the pricing equation. In the past, IT firms derived their value from inventory, real estate, vehicles, and services contracts, with the owner's continued involvement in the business typically considered a positive. That gave you borrowing leverage. Today, it's all about recurring revenue and customer commitment. Inventories are substantially lower (around 10% of attendees admitted carrying any), while contracts and intellectual properties have become the largest assets for most IT services firms. Potential investors may not care if an owner stays involved as long as the company's processes are fully optimized and automated.
What do lenders and potential M&A partners want most? "Investors want predictable business growth," says Coker. "When I do valuations, the number of contracts is secondary. I want to know if they are current and if the company is retaining clients and able to get a consistent revenue stream from those customers."
The panelists alluded to two points. First, many IT professionals don't have a firm handle on their most crucial business metrics, and second, few seem to understand the true market value of their firms. Ryan Wash, Executive Vice President of Partners Solutions at Pax8 asked the audience if they were ever approached by someone interested in buying their company, and a fair number of hands shot up. "The demand is there. If you're ready to sell, what is a realistic price?"
"Of course, the multiples vary depending on cloud product and other services the business offers," emphasizes Walsh. "Investors want to know the power of the company's recurring revenue stream. Though there's a lot of discussion around valuation drivers, many providers don't even know their own customer acquisition costs." What did the panelists advise? Learn the KPIs that investors and lenders value most and improve those areas of the business.
Coker also suggested that banks may not be the best place to go for funding their business expansion. "You need a capital fund for growth. The disadvantages of borrowing, especially at the high-interest rates associated with short-term loans, put many IT firms on a slippery slope."
Investors bring their own risks, too. "If you don't hit certain milestones in most VC contracts, they can take control of your business," adds Coker. "That's why I'm a fan of bootstrapping the company, using your own recurring revenue to grow."