Thinking about selling your GovTech business in an M&A deal? The first step is to calculate your “freedom point”: the moment at which the net proceeds from selling your company (i.e., profit minus taxes and expenses) are enough for you to live comfortably and pursue your other goals and ambitions.
Our previous article in this series discussed how to calculate your freedom point and how to know when it’s time to sell your company. In this article, we’ll wrap up by going over your various diversification and exit options, as well as special considerations for GovTech firm owners during M&A transactions.
Diversification and Exit Options for GovTech Firm Owners
Once you’ve reached your freedom point, there’s no good financial reason to keep running your business. You might enjoy other aspects, of course, such as the intellectual challenges or the social connections — but continuing to hold this position is an unnecessary financial risk. If the company were to falter and dip below this point, you could jeopardize all your hard work.
The good news is that if you want to diversify your portfolio but not necessarily retire, there are several options available:
- Sell a minority stake: In a minority recapitalization, you sell fewer than half of your shares. Often sold to a financial investor such as a private equity group, a minority recapitalization allows you to diversify your net worth while continuing to control your business.
- Sell a majority stake: In a majority recapitalization, you sell more than half of your shares to an investor who will most likely ask you to continue to run your business for many years to come. You get to diversify your wealth, keep some equity in your business for when the investor sells, and continue to run your company.
- Earn out: When you sell your company, you’ll likely have to agree to a transition period of sorts. One of the most popular is called an “earn-out,” where you agree to continue to run your company as a division of your acquirer’s business for some time. This may be as little as a year or as long as seven, but the average is three years. If you can see yourself wanting to step down in the next three to five years, an earn-out may be worth considering.
Of course, you also have the option of divesting yourself entirely if you want to make a clean break — it’s all about making the choice that’s best for you and your business.
Special Concerns for GovTech M&A
GovTech firm owners have their own special considerations when it comes to selling your company. In this section, we’ll discuss a few things you need to take into account when forming an exit strategy as a GovTech business.
1. Consider set-aside contracts.
The previous article in this series discussed getting a business valuation as part of your freedom point calculation. For GovTech firms, business valuations need to include the impact of so-called “set-aside contracts.” These are U.S. government contracts that are set aside for certain types of companies, such as small businesses or businesses owned by women or combat-disabled veterans.
Gaining access to these set-aside contracts can be highly rewarding for GovTech firms. If your company is acquired, however, it may no longer be eligible for such contracts, reducing its business valuation. Conversely, the ability to retain eligibility could be a valuable asset and a bargaining chip during the negotiation process. We suggest speaking with a skilled business valuation advisor with experience working with GovTech firms.
2. Find the right target.
You can maximize the amount for which you sell your GovTech business simply by targeting the right potential buyers. Here are some questions to consider:
- What level of government agency do you work with — federal, state, county, city, etc.? Where are these agencies located geographically? How large are these agencies, and how many citizens do these agencies serve?
- What kind of products and services do you offer, and which departments do you work with — e.g. IT, finance, human resources, executive, etc.?
Answering these questions will give you a better idea of which companies you should target for a possible acquisition. For example, look for buyers for whom you can help fill an underserved niche or expand into a new market.
3. Determine the right timing.
Timing is everything when selling your business. In particular, external factors can have a major impact on your business valuation, which in turn affects your ability to reach your freedom point and your decision to sell.
Before selling your company, you should carefully consider both the state of M&A in general and for the GovTech industry. This is especially important now, as the COVID-19 pandemic has taught us that a thriving business one day can struggle for life the next.
The good news is that GovTech M&A — and M&A activity as a whole — has been red-hot as businesses recover from the pandemic’s economic downturn. In April 2021, for example, digital government service provider NIC was acquired by Tyler Technologies for $2.3 billion — the largest M&A deal in GovTech history.
Thinking about selling your own GovTech firm, and looking for strategic guidance? We can help. Get in touch with our team of experts today for a chat about your business needs and objectives. You can also explore this topic in more detail by checking out our white paper, “Selling Your GovTech Firm in the Post-Pandemic Economy.”