There are three types of buyers in the IT M&A market. You should know the differences.

There are three types of buyers in the IT M&A market. You should know the differences.

The market for M&A activity in the IT services industry is hot and heavy to say the least due to, 1) the low cost of capital, 2) the amount of funding flowing into the market, 3) the imperative for growth, and 4,) the overall consolidation of the industry. Because of the large number of IT services executives looking to sell their business it may be worthwhile to identify the types of buyers in the market, and their motivations. It’s been our experience that there are three basic types of buyers; Financial, Strategic, and Financial buyers disguised as Strategic. It’s important for sellers to know the difference as the acquired company will be managed differently depending on the type of buyer.

Financial buyers can take the form of PE firms, Venture Funds, or Family Office companies. These companies generally look to buy a unique platform and build on it. Their time horizon is short-term, about five years though this may extend out to seven or eight years depending on the market appetite for M&A. Upon acquisition there is often no defined exit as the buyers are willing to wait for the right opportunity, which is often a strategic buyer. The purchase price is likely to be two to three points lower on an EBIDTA multiple vs. a strategic buyer’s valuation.

Strategic buyers are looking to make an acquisition to significantly grow the business. It’s likely to be an IT services firm buying another IT services company, a one times one equals three type of acquisition. In this case the acquisition is of the buy and hold variety with the acquirer looking to the long-term, with no specific exit strategy. The purchase price in this scenario is likely to be market price, which today is in the 7-9 times trailing 12-month EBIDTA range.

Financially disguised Strategic buyers buy all kinds of companies and mash them up. The objective is to grow for mass, and sell pretty much to anybody with a short-term horizon. The financial maneuvers associated with this type of acquisition often shackle sellers to an illiquid stock until the final mashed up company is sold. How this works is the first company to be brought into this mash up wins in terms of being the host company, operating under its name, and for which the owners get full purchase price in terms of valuation, and some preference on the portion that remains as stock. Subsequent acquisitions are tucked in under the first, and the acquired owners of these firms generally receive one-half of the equity upfront with the remainder in stock upon the sale of the hosted company. The original buyer will use the retained equity of the second, third, fourth company to be folded in to fund these acquisitions. The EBIDTA valuations range widely on these types of deals, but in general they fall somewhere between a financial buyer and a strategic buyer valuations. In short, the early-in companies can win big, while the later-in companies can expect lower returns on equity.

If you are looking to sell your IT services firm be cognizant of who is buying, why, and what this means for you. If there is any doubt in your mind we are always available to help you sort through the M&A minefield.