Despite current global headwinds, investment in technology – whether that be to improve operational efficiency or to develop new products and services – continues to be critical for businesses to remain competitive and drive future growth. 

Consequently, we are seeing strong demand for both product and service technology businesses operating across a broad range of markets. In this article, we share our insights on recent trends and key areas for consideration from a mergers and acquisitions perspective.

Where there is a proven product/market fit and an effective management team, technology businesses can be attractive to investors and corporates due to their capital light and scalable nature, offering the potential to rapidly disrupt and grow into their chosen markets. Other attractions are that many companies in the industry enjoy upfront customer payment terms and high levels of recurring income.

Our Corporate Finance team has significant experience across the sector, having recently advised on a number of investments, acquisitions and disposals. Involvement in these transactions has provided us with detailed insight into the potential investors/purchasers in the market, metrics and pricing, and the types of deal structures being offered. A selection of trends that we are seeing include:

Metrics & pricing

Typical metrics for businesses with a Software as a Service (“SaaS”) or subscription delivery model include:

• Annual recurring revenue;
• Gross margin;
• Customer lifetime value;
• Customer acquisition cost;
• Customer churn; and
• Net revenue retention

Outside of SaaS companies, the most common pricing metric is Adjusted EBITDA, which reflects the normalised ongoing cost base of the target business.

When forming a view on pricing, purchasers will focus on the above metrics, particularly the quantum and security of recurring revenues and the breakdown and underlying profitability of each revenue stream. They will also be keen to understand and assess the reasonableness of forecast financial information, including how forward assumptions compare to historical data points and the wider market outlook.

Each company will have unique characteristics that influence its valuation, but as a broad rule of thumb for growing businesses we are seeing SaaS transactions complete at revenue multiples up to the mid-single digit range and non-SaaS deals closing at high single-digit Adjusted EBITDA multiples. That said, higher multiples have been noted for businesses of greater scale and/or operating into markets with particularly attractive dynamics.

Treatment of deferred income

The delivery model of many technology businesses is such that they receive payment from customers in advance of delivering the products or services they are obliged to provide, thereby creating a deferred income liability on their balance sheet. The treatment of deferred income, either as debt or working capital, is an area of frequent and often material debate during price discussions.

It is a complex area, and in our experience the negotiating position adopted typically depends on whether you are the purchaser or the seller. As the purchaser you may argue that the business has not yet “earned” the cash under the seller’s ownership, and as it will be required to deliver the product or service to the customer it should be treated as debt-like. On the other hand, if the level of deferred income is relatively consistent across the year, the seller may view it is as a normal feature of their operating model that should be treated as working capital.

Where the treatment of deferred income will have a material impact on the purchase price, we recommend that both sides discuss this as early as possible to avoid challenges at a later stage.

Transaction structure

The structure and timing of proceeds should also be a key consideration for sellers. Purchasers will typically look for a portion of proceeds to be deferred for a period of time post-completion as a mechanism to protect the value of the business (from a product/service and/or customer relationship perspective). Generally speaking, and where the product/service is commercially proven with an established customer base, we are seeing 75-90% of proceeds being paid upfront on completion, with the remainder being subject to earnout or deferral based on, for example, achieving revenue or profit targets over a period of one to three years post-deal.

Culture

Whilst not exclusive to the technology sector, cultural alignment and integration is a key area that requires careful consideration to maintain and grow the value of an acquisition. For example, where a large corporate acquires an owner-managed software business with 10-20 employees, many of whom may come from a start-up type environment, thought should be given to the retention and incentivisation of staff and how best to mitigate the risk of a “cultural clash” that leads to key people leaving the business post-completion. Each scenario will be different, but possible solutions may include an earnout/deferral deal structure (if the individual is a shareholder), share options in the larger business, day-to-day operational autonomy or a wider role in the enlarged group.

Get in touch

The Johnston Carmichael Corporate Finance team has recently advised on the following transactions across the technology sector:

• Sale of Clevermed to System C;
• Sale of AGR Automation to Convergix Automation Solutions;
• Acquisition of Consilium UK by Kick ICT;
• Acquisition of Airship Services by Zonal Retail; and
• Investment into MUSO by Puma Private Equity

If you would like to discuss a potential investment, acquisition or disposal please contact myself, Alan Hamilton, or Campbell Cummings.