In the wake of the economic disruption induced by the COVID-19 pandemic, the GovTech sector has seen a flurry of activity among major players. April of this year, for example, saw the conclusion of Tyler Technologies’ $2.3 billion acquisition of NIC — the largest GovTech M&A deal ever inked.
Valuations reached all-time highs immediately before the pandemic, allowing owners and shareholders to obtain the same amount of capital while giving up less equity in the business. In 2020, however, many companies saw their valuations decline due to factors such as decreased revenue or greater amounts of debt. Now, given the ongoing rebound of the U.S. economy as a whole, many GovTech business owners are wondering: How can I leverage this opportunity to create liquidity — whether that’s selling the company or “taking chips off the table” by recapitalizing?
Although business valuations appear to be on an upward trend following the lows of 2020, the future is uncertain. This is especially true given that the U.S. Federal Reserve has moved up its timeline for raising interest rates to as early as 2023 — which could slow economic expansion and increase the cost of capital.
In other words, GovTech businesses should be seriously thinking about how to create liquidity at a time of maximum valuation and minimum dilution. Below, we’ll explore how companies in the GovTech space can start thinking about valuation, growth, and monetization for their business.
How Can GovTech Businesses Create Liquidity?
GovTech companies have multiple options for creating liquidity in their business. The possibilities include:
- A minority equity recapitalization (i.e., selling a minority share of the business to a third party)
- A majority equity recapitalization (i.e., selling a majority share of the business)
- A sale of the entire business (e.g., if recapitalizing will cause equity dilution)
No matter which of these options you choose or consider, getting a government technology firm valuation is always the first step. Business valuations help you understand how much your company is likely to be worth and the economic drivers that add to its value. The possible value drivers for a company include technological assets, a rich array of products and services, strong financial performance, good branding, and a talented workforce.
Once you know your valuation and value drivers, you can develop a solid acquisition strategy for your business, including how to market yourself and which firms would be a good match. McKinsey & Company has outlined six types of M&A deals that tend to be the most successful:
- Improving the target company’s performance
- Accelerating market access for one of the company’s products
- Removing excess capacity from an industry or sector
- Acquiring new skills or technologies
- Exploiting economies of scale
- Developing the potential of early-stage startups
Metrics for GovTech Business Valuations
So you’re interested in selling your GovTech business, or at least getting a valuation — but what kind of information do third parties want to know about you? In this section, we’ll go over two of the metrics that are especially relevant for GovTech companies.
This metric indicates the distribution of customers in terms of how much revenue they generate for your company. For example, if your top five clients are responsible for 30 percent of your annual revenue, then we would say that your top-five customer concentration is 30 percent.
Having a high customer concentration is a risk factor for potential buyers — it indicates that losing your most important customers could dramatically impact your company (e.g., when a government agency declines to renew its federal contracts for small business). In general, GovTech businesses should aim for a top-10 customer concentration below 20 percent.
Net Revenue Retention (NRR)
This metric measures the percentage of your annual revenue that is obtained from existing (retained) customers, rather than acquiring new customers. For example, if your revenue remains the same over two years but you lose all your customers and acquire new ones, your net revenue retention will be 0 percent.
NRR is an important metric for a federal contracting company because it is a good proxy for how well the company can maintain its contracts. GovTech companies should aim for an NRR rate of higher than 100 percent (due to existing customers purchasing new products and services).
Developing an Exit Strategy
Only you can say what the right exit strategy is for your GovTech business. However, answering the questions below will help get you on the right track:
- How can I maximize business value?
- What are my acquisition strategy and value proposition?
- What will my next steps be after the exit?
- Will the “walk-away number” be large enough to maintain the same income or lifestyle (especially after taxes)?
- How can I reduce the tax impact when selling the business or creating liquidity?
- Do I need professional help with formulating a business exit strategy?
Questions of valuation, growth, and monetization are crucial for GovTech owners looking to create liquidity in their business. Do you need strategic guidance for your own GovTech business? We can help. Get in touch with our team of experts today for a chat about your unique situation.