Balancing Risk & Reward in IT-Services M&A

There is nothing that is without risk! In this episode we are diving into the big risks (and rewards) that come with working an M&A process. M&A always feels like a bet. Hosts Mike Harvath, Matt Lockhart & Ryan Barnett explain how top-quartile IT-services firms stack the odds:
• quantify risk, then plan for success—not failure
• engineer deal structures (earn-outs, equity rolls) that protect both sides
• keep culture-integration front & center
• why buying customers can beat marketing for them

Listen to Shoot the Moon on Apple Podcasts or Spotify.

Buy, sell, or grow your tech-enabled services firm with Revenue Rocket.

Mike Harvath   0:12
Hello and welcome to this week’s shoot The Moon Podcast broadcasting live and direct from revenue rocket world headquarters in Bloomington, MN.
For those of you that TuneIn regularly and you know, grabbing a rocket is the world’s premier M and a advisor and growth strategy consultant to IT services firms with me today are my partner’s Matt Lockhart and Ryan Barnett. Welcome guys.

Matt Lockhart   0:40
Thanks Mike. Thanks Mike.
It’s by the time that we release this, which I know will be shortly, but the days are gonna be getting shorter. It I can’t even believe it. We’re we’re, like, moving into the heart of summer. Time is, time is flying and I think that’s because we’re busy as can be and looking to have.
The culmination of a couple of successful transactions here. This month. So that’s exciting and I think we’ve got an exciting topic today too.Ryan.

Ryan Barnett   1:19
Yeah, I’m. I’m excited for this as well. So essentially, we focus on mergers and acquisition with the IT services world and one of the things that’s in absolutely every deal, even superseding the IT services world is a risk versus reward scenario and mergers acquisition. Today I want to really look at how leaders in it Serv.
Companies you can really evaluate big swings in M&A and how to plan for really successful failure. Mike. Matt, I I know that both of you have been through a lot.
Transactions and each time there is an element, we have to look at.
A buyer of a company is ultimately going to take on the company that they’re buying and there is risk that is associated with running that. But the win for having that company should supersede that risk. So Mike, why don’t you get us started?
Now, what’s the upside of M&A when everything starts to go right?
You know, why are we doing M&A in the first place?

Mike Harvath   2:18
Yep, good question, Ryan. So, you know, at the end of the day you should have a 1 + 3 or four or five when you look at an M&A transaction.
You know the synergies from that transaction go to line around strategy, culture and financial fit to create a company that’s better than the, you know, the whole needs to be better than the sum of the parts.
So to speak. And I think, you know, often times we overlook that right when we’re looking at a transaction, we sometimes start to begin to look at what could go wrong versus what could go right. In our experience, more goes right than goes wrong.
And you know, all people take a little risk to get that done. But I think in short, you know your reason you do M&A is that there’s just more synergies together and more opportunities together than there are apart.

Ryan Barnett   3:23
So Matt if I turn that question over to you and just kind of expand a little bit on why we’re doing M and a, you know, what does success look like in M&A? What does it really take to to get a deal done and and and help get to the next step of actually running that combined company?

Matt Lockhart   3:42
Yeah, you know to to sort of build upon what what Mike was saying. Well and 1st off, right Every firm that is in just about every firm that is in the top quartile In their space is acquisitive, right? So the most leading firms in IT services in SaaS and manufacturing, you name it all, have an acquisitive mindset and so I think that that’s important to note.
To understand that the very best are continuously looking. For opportunities to make their firm better through acquisition and you know, I think and we’ve talked about this before, that ongoing acquisitive strategy is is aligned to the overall business strategy of increasing capability in creasing market share and or the addressable target market in bringing on great team members, be it executive team members or you know, down the down the line, if you will. So there’s a, you know, there’s a a ton of reasons That top firms are continuously acquiring.
But and also because they’ve got this ongoing acquisitive mindset. They are also looking at themselves and how do they do better in assessing the opportunities, assessing the risks related to the opportunities and and really keeping that growth mindset of how do they, how do they take on new firms and bring them in.
To then reach at that force multiplication of, you know 1 + 1 equals, you know, 4-5 or six as opposed to, you know, 1 + 1 equals 2 1/2.

Ryan Barnett   5:53
I’m glad you brought up that fixed growth fixed mindset versus a growth mindset.
We did quite a fixed, but the growth mindset is there and this is in life just to have the opportunity to be malleable and to grow into the challenges that you have compared to kind of deal with the fixed mindset of of underestimating your ability or underestimating the capacity I think that growth mindset starts to be critical in in M&A to to find where synergies exist.
Just to understand the risk mitigation strategies and to come up with great plans to to help mitigate some of the risk.

Matt Lockhart   6:32
Yeah, Ryan, and you know, think of the alternative, which is a fixed mindset related to M and A where You are only, you know, looking at risk and or you are being too conservative in your assessment of your ability to, you know, to bring firms on now, yeah, obviously that’s not to say if the strategy doesn’t align or the cultures are completely opposite then it’s then it’s really not a good fit, but you know typically that in well in every scenario, there’s gonna need to be adjustments. There’s gonna need to be change that occurs once the acquisition is complete and and really going into the assessment of your ability to do that is is all about having that growth mindset versus you’re looking at what might be a a smaller risk.
Scanned and you’re like, well, yeah, it’s just not gonna work because, you know, there is that small risk that appears.

Ryan Barnett   7:43
That’s it’s a great point, Matt. Mike, if I kind of think about this and and we start talking about the mindset and you know I’m curious how, how do the top acquires plan for success without really being blind to risk. So in a different way or or you know what are some key levers or kind of deal structures that someone can take to help reduce, reduce that bets or reduce that risk?

Mike Harvath   8:10
Well, I think what’s important is you know the best acquirers look at and understand what the risks are, what the downside risks are in a deal. Now, when you’re looking at quality of earnings and diligence and analysis, you know the actuarials and the guys doing quality of ear. Are exactly that, they’re weighing in on the quality of those earnings and assessing potential risks in the deal.
And potential risks in the post transaction.
Ultimately, what is a likelihood?
But that these revenues and profits will continue post transaction. I think it’s easy to get blinded a little bit by you know contractual risk or continuity risk of customers or employees and getting too focused on that.
And beginning to say, well, if this happens, then that happens.
And if this happens, then that happens and ultimately, you know, in some ways you can focus on that and talk your way out of a deal. The best acquirers don’t do that.
They tend to do that analysis and understand that risk and quantify that risk, which you certainly should but they plan for success and they look at well, based on the acquisition and this opportunity, does this get us into a new market that we can cross sell and upsell?
How do we ultimately create a win win here for this customer, right?
Take the customer view. What messaging should be done to these key customers?
How do we store them up and give them new opportunities together, not only for our business?
Now the collective business and the customer business, but how do we again create a 1 + 1 = 3? Versus what if we lose this?
hat if we lose that?
Because ultimately, if you get too far down that rabbit hole of, you know, planning for failure, you’ll talk your way out. Almost every deal, right?
I mean, it’s a there’s certainly risk of failure, but there’s risk of failure in your existing customers too.
Just as easily any of your customers on your current list could give you notice and terminate, and you know you’re you’re certainly, you know, maybe you are, but you know generally I would say that most clients are doing their best.
Our clients are doing their best for their clients and focusing on, you know, planning for success in general and and and they achieve that success.
It’s oftentimes they get down a little bit of a rabbit hole.
And an M&A deal. And they start to bond this trap of planning too much planning.
And focus on failure versus success. I think the best to get more to the question, Ryan, the best acquirers tend to focus more time on understanding the downside risk, but planning for success. And when they do that, they get to the right place of balancing risk and re.

Ryan Barnett   11:01
That’s a it’s a. That’s a great summary. Mike and Matt I’m kind of curious if I flip over to the the other side of the table and when a seller’s selling their business and that business closes at some point the seller says OK.
This is this is a kind of your problem now in some levels.
I mean, what are what are good ways that to to bridge it bridge. I think that’s an extreme statement but. What are ways that sellers can get in perhaps?
The perspective of a buyer like maybe it’s a client concentration and the seller has to agree to an earnout or now what are some ways that a sell? What things can sellers do to better understand that buyer risk?

Matt Lockhart   11:47
Well, First off, you erase this mindset of it’s not my problem anymore.
And you replace that with how you know can I assist the buyer in understanding what may be A natural risk.
You know you use the example of client concentration, you know, so maybe there is.
You know one or two particular customers that that make up.
You know, kind of over market percentage of the overall revenue so.
A first. Recognize that from an outside perspective, from a buyer’s perspective, that that is truly risk. Now you you as the seller and and the one with the knowledge of the relationship.
May not see it as much of A risk, but you know sort of being open and understanding that that’s not the perspective of the buyer. And so how you know with that mentality, can you assist the buyer to understand what the real risk is?
How you’ve managed that customer and and managed that risk to your own business?
And you know, really get them into understanding the relationship and the need of your firm to continue on with that with that customer or customers, right.
And so, you know, First off it’s it’s, you know really being open and and recognizing that there is a you know on paper a a potential risk. How can you help to mitigate it and then being open potentially to an associated structure related to that risk and That you can have participation to ensure continuity. You know with that customer. But that’s just one example. I think that it it First off is is you can’t you know sort of put your head in the sand and say that a it’s not going to be my problem. Anymore, because if you do, you’re not going to get a deal done.
And B you know, through constructively being open and working with a potential buyer on how both you and the buyer can mitigate those risks is is the healthy way?
To you know, moving forward with, you know, with a potential transaction, you know assuming that that, that good strategy fit is in place assuming that that good culture fit is in place.
That there’s means to do, but it’s through collaboration and openness and transparency that you, I think, will find the best engagement as well as.
Arriving at at the best deal structure for for both parties.

Ryan Barnett   15:04
Yeah, there I believe there there are absolute risk mitigation strategies you can use. And so in a letter of intent, you’re going to see you’re going to be able to see that presented, for example, earnouts or or sell earnouts tied to a caller or a seller or a.
Certain threshold you’ve got to hit for revenue. I think there’s some just straight things you can do in agreements to help you get over some of that risk.
It’s it’s and I think those are all great examples, Matt.
Mike, if I think about buyers and we work with a lot of buyers every day and on nearly every company that we call into says, hey, I would love to do more deals.
I’d love to buy that managed service provider down the street.
Mike, I’m curious when you think about a CEO who’s actively kind of wired for M&A compared to someone who perhaps should not pursue M&A. You know what are some traits about that ceo i mean are they emotionally resilient? Are they obsessed with details? Do they just have operational trust and what? What’s profile of the CEO is needed to be successful in understanding this risk versus reward scenario?

Mike Harvath   16:21
Well, I think it starts with a vision for what they’re trying to build, right? That CEO needs to have clarity about what they’re trying to build, whether that be in through inorganic or organic methods or both, right?
And understanding more clearly how being doing deals on the buy side can support that vision. That that’s where that starts. If you don’t have clarity about that AKA, you’re just looking at doing deals for the sake of doing deals. You’re going to quickly run off course as to what’s important, Does the deal align and check the boxes for you again? Back to strategically, culturally and financially, What is the right level of risk for you to take pursuant to building the firm that you envision?
And you know how? How does ultimately this particular deal, but more broadly, how does buy side M and a support that and then what level of risk are you willing to take, right?
You know, I think operating risk is one thing I think.
You know, and and you should be prepared to take operating risk.
Right. If you’re going to do M and A when I say operating risk, I mean that you’re going to be able to maintain the relationships with the customers that are coming over, that you’re going to be able to service them appropriately once the deal is done or Aug.
That service to a new level, which the customer would appreciate and you’re able to really create a true 1 + 1 = 3 or four or five. That that’s just a given. Need to believe that that exists.
You need to be able to take on the financial risk of making the investment right, either through funding it from proceeds on your balance sheet or taking on some debt or or equity financing or combinations of all the above. You know you have to have a a stomach for that, right? And ultimately know how you will be able to do that and you sort of have to have this growth mindset that we talked about earlier, which is, you know, you truly do believe that. But you can achieve your strategy through this tactic, right?
Because blind side M and A is simply a tactic to helping you achieve your ultimate goal, which you should certainly have clarity about before moving into buy side M&A.

Ryan Barnett   18:51
It’s like magic. If I switch to here and say, you know there’s been some great deals that are in place. Do you know of any or can you share any red flags that might scream kind of walk away from a deal even if the numbers look good?

Matt Lockhart   19:12
Yeah, I mean it it all it all does.
Sort of harken back to, you know, the 3/5 that we talk about.
I think that the one that often times culture is is overlooked trying.
And So what would be an example that you know, it’s something that if you have questions about culture and and it rises to the rank. You have a seller that every seller has the right to say. Look, I’m gonna be retiring after a sale, OK? But if they do not want to have an an applicable, you know, transitionary period where the seller is assisting in bringing the new team members on board, if the seller.
If if the buyer has identified, you know, opportunities within the seller’s management team.
To you know, utilize some of his executives, but utilize them in a new way, and they need to be, you know, brought brought along, you know, with a new plan, but again.
The seller does not want to participate.
That would be an example right where you’ve identified a potential cultural risk and.
You need the seller’s participation, and they’re saying Nope, you’re not going to get it.
Right. Well, you know that that could be an example where you say look without the participation without the buy in, without the openness to understanding, you know that potential risk and and how do we collectively mitigate it.
Well, you know that that should, you know, that should potentially raise some alarm bells, you know, similarly. So in that scenario that we talked about previously that.
You know, there could be some concentration, but the sellers like look not my problem anymore. Well, you know again you may not get a deal done.
And you may have a buyer who’s who’s not going to be interested because you are not participating, you know appropriately. So I think that oftentimes what we see is, is just again this sort of hardened mindset at times from sellers that that drives buyers Drives buyers away, so you know, regardless of whether or not you’re selling in or selling out. You know, having that open collaboration and and continuing to put yourself in the in the shoes of the buyer and helping them to, you know, best understand.
Um, that the work that needs to be done post transaction is is doable is reasonable and and you’re participating in you know helping them plan for it.

Ryan Barnett   22:11
Mike you know you’ve often said the acquiring of businesses, oftentimes the most unnatural act in business. And when you think about this, I’ve got to come back to this reward question. You know, we talked a lot about risk here. Can you just one more time go through? You know why should this be done?
Well, you know why is M&A so powerful for IT services firms to help just balance out some of that risk.

Mike Harvath   22:43
Well, one main one main reason is that you know the cost to acquire new clients is expensive. I think most firms underestimate the time and expense needed to acquire new customers it takes, it’s a journey, right?
You have to do a lot right to attract new clients and sign them up.
And you know, that’s evidenced in the world of IT consulting with the plethora of firms that are put a relatively small. All under $1,000,000. There’s there’s literally 10s of thousands of firms.
You know, some would argue as many as hundreds of thousands of firms under $1,000,000 that work in our space that struggle with scale and and that’s because the approach of having excellence and cost and time and skill that aligns to a marketing and sales.
Specific mandate that you know sort of, you know fits. The market need and market fit is tough and it takes time. So when you think of the time savings alone. And the return rates associated with acquiring a firm Certainly it’s much, much faster and sometimes much more cost effective to acquire that book of business, to acquire those customers.
In that book, to further again your journey to your goal, if your goal is to build you know, let’s pick a number $50 million firm Or could be any size 5,000,050 million, 500 million, it doesn’t matter. That goal really, if you look at best in class companies that you’re going to model.
They’re going to involve both an organic and inorganic strategy, one that they’re just acquiring new customers through normal operating, operating the business as well as through acquisition.
And that’s happening because they can get there faster with a higher return rate by adding and sprinkling in acquisition than not it. It’s just a given.
And so I think, you know, having if the goal is to be excellent amongst your peers and your goal is to grow to a certain size as a milestone, maybe it’s just a purely that a milestone on your way to a bigger journey.
You’re very likely gonna get there much faster and effectively with a higher return by including inquisitive strategies in your overall plan.

Ryan Barnett   25:30
Thanks Mike. This has been a good topic, I think every CEO is gonna deal with it.
You know I frame it. Do you really have the stomach for M&A and M&A does come with risk?
There’s operational risk like retaining customers or integrating teams. There’s financial risk whether you’re you’re funding a deal through cash, data or equity, you’ve got to you’ve got to look at that funding mechanisms and how it’s going to pay off. And there’s strategic risk Just trust. Assume that the the move that you’re going to do in an M and A is going to line up, or you’re trying to go.
But if you have a really nice clear vision, M and A could be a huge tactic for to get to that next level. But to get there you have to have real growth mindset. So really thinking I know the risks I know the rewards and I believe the reward is worth it.
Is is something powerful and just keeping that growth mindset is is big. Matt, Mike, any closing thoughts here or Matt? I’ll pass it over to you for any closing thoughts.

Matt Lockhart   26:34
Yeah. I mean, I think that and we’ve talked, we talked about this on a regular basis. Ryan, is is find your team.
You know again.
As we talked about, the leading firms have an ongoing acquisitive strategy and.
That means that they’ve got a good team that they’re working with to assess opportunities to assess the risk, et cetera, et cetera. That team is is should be both your internal team members.
But then also your external team members, your peer group members and a really good advisor who you know is doing this each and every day and is, you know, helping you to surface what are potential risks versus the potential upside opportunity.
And also helping guide to, you know, bring the parties together to again work together to create that plan moving forward so You know, if you’re not thinking about acquisitions and you want to be in that top quartile within your peers, maybe you should and and start to assemble your team accordingly.

Ryan Barnett   27:59
Yeah. Any other closing thoughts, Mike?

Mike Harvath   28:03
Just that, you know, I think that the M&A journey is one that not everyone is suited to take, and I think it’s important to really look in the mirror and and say is this. Is this a a journey that I would like to undertake to further fortify my strategy? I think that if your goals are such that it is, then.
And you know echo Matt’s comments About kind of how to proceed, I think if it’s not, that’s OK, right? Because it’s it may not based on your size, it may not based on your mindset, it may not based on what you’re trying to build, frankly And I think you know that’s that’s also an OK strategy.
I think if you’re a seller I often say, and maybe that’s the same advice for buyers, right?
You know you walk them Want to walk them all? The shoes of the of the other person.
Right on the other side of the table, you need to understand. Seek to understand.
Their position on risk or questions about your business or you know, help find a win win position. I think you know no deals get done that aren’t win win in my opinion. I I think there’s too many advisors around you and accounting and legal and M&A. Advisors too, on either side of the transaction that are going to, you know, help you avoid a Win a win, lose deal. Regardless of whether you’re a buyer or a seller So you know, if you do take on this journey, you know, do lean on your advisors, do get a competent advisors on your team. And and I’d say if the decision is made that it’s something that’s complimentary to your overall strategy, whether you’re a buyer or seller then. I’d say go for it, because the future is bright.

Matt Lockhart   30:08
And with that, Mike.

Mike Harvath   30:11
It’s time to tie a ribbon on it for this week. Shoot the Moon podcast.
I encourage you to tune in next time when we’ll unpack further ideas and concepts around M &A and growth strategy and the IT services world.
With that, make it a great week. Thanks a lot for tuning in.