Preparation key for PE

FPE Capital Managing Partner David Barbour gets down to the specifics of how resellers should go about attracting the private equity backing that could take their business to the next level.

The phrase ‘then and now’ does little to justify the extent of the transformation in how ICT reseller businesses are viewed by private equity houses today. There was a time when resellers went largely unnoticed, now they represent significant opportunities for investors, but only if certain pre-investment conditions are comprehensively addressed.

For many years the word reseller was a badge of second class citizenship, signifying an intermediary taking a margin but dependent on third parties and never in charge of its own destiny. Private equity tended to see resellers as low value organisations with little upside on exit. That’s emphatically no longer the case. The elevating status of resellers mirrors the rise of software and the cloud. It reflects the growing reliance of large software players on indirect channel partners and a recognition that resellers can offer a proxy on the high growth of SME and mid-size corporate adoption of these cloud and software solutions. There are some less glamorous reasons for resellers becoming attractive, such as the more reasonable entry multiples when put up against the eye watering prices being paid for software product businesses, and the general pressure on private equity firms to deploy capital.

Leadership has also improved. There was a time when resellers were seen as lifestyle businesses with a regional or local ceiling on their size. Now, private equity is working to create larger businesses of scale and the product partners are favouring these bigger partners with better supply terms and more attention. Our own firm has recently invested in a telco with a significant portion of fibre and voice resale revenues, a Microsoft ERP software reseller and most recently into a cyber software reseller. Each of these businesses came with a strong track record of growth and blue chip customer bases.

Top of any private equity checklist right now is the issue of what proportion of a company’s revenue are recurring or repeating

The key points of concern and interest that private equity brings to investing in this area are the proportion of recurring or repeating revenue in a business; the competitive strength of partners (vendors) whose products are being resold, and the reseller’s depth of relationship with those partners; the capacity to show future growth via either exposure to and expertise in high growth products, or to underlying sectors where clients are in growth; and the ability to demonstrate a quantified future proofed product and technical strategy for dealing with the strong move to the cloud.

Top of any private equity checklist right now is the issue of what proportion of a company’s revenue are recurring or repeating. These two words have become touchstones for valuation, and also for absolute investability or otherwise. And for smaller, more vulnerable businesses they are most critical. Recurring revenues are those revenues provided on an ongoing basis to the same customer under a multi-year (or auto renewing) contract. These are the most valuable and investors will want to see a multi-year analysis (probably at least three years) of the revenue per each large customer. Good examples are multi-year connectivity or managed service contracts, software licence fees and support/maintenance of a fixed amount/percentage.

Repeating revenues are those that are supplied on an ongoing basis but are not quantified at the beginning of the year, such as usage-based, maintain and support charges or variable call revenues.

The proactive actions a business can take will depend on their runway to a transaction. If there is a long (12-18 month) runway then contract terms and sales incentives for new clients can be amended to turn one-off revenue (for example, connection charges) into recurring monthly revenue and existing clients can be migrated into multi-year deals or auto-renewing contracts. But even if the time scales are short some of this can be done, and at an absolute minimum your business must understand exactly what the recurring and repeating percentages are and have the management information well presented and understood before a process is launched.  

Our experience has been that investee companies are usually ill-prepared and have not reviewed their T&Cs for auto renewal, or are often operating under unsigned contracts and are too scared to approach these customers to get a signature. It’s much better to clean these things up without the pressure of a live transaction going on.

The second key area is the competitive strength of the partners whose products are being resold (against competing solutions) and the reseller’s depth of relationship with those partners. The investor will want a direct, private reference call with these partners to ensure that the relationship is in good fettle and well prepared for what you are going to do. If you sell only one vendor’s products, be ready to defend that single relationship risk, or to have a convincing strategy for broadening into other vendors.

Be ready with market positioning for your vendor’s products and display a strong understanding of the competitive set. Try to ensure you have the best vendor ranking possible and be ready to explain how much of your sales pipeline comes from vendor referrals. If that vendor sells direct alongside resellers be prepared to talk that through in detail. Investors prefer a situation with clear boundaries to one with potential for misalignment and channel conflict.  

The third area to think about is the reseller’s ability to demonstrate future growth through either exposure to and expertise in high growth products (cyber, for example), or to underlying sectors where clients are in growth (a client base of multi-national B2B business services is much preferred to a base of UK high street retailers). Always have market information available on the growth of those underlying sectors and be ready to relate that back to your own new business wins. Private equity wants, ideally, to see a wave of demand coming towards the business. If there are volatile sectors in your customer base (retail, oil and gas, maybe even governmental) think hard about how you will negate the perception that these areas are dangerous – or it will harm your valuation.

Private equity firms have a great window on market trends through our own portfolios and through the large number of business plans we see each year. They know that cloud adoption is a strong and growing trend and they want to ride that wave. But while SaaS models (or at least software ‘rental’ versus traditional perpetual licence sales) offer the prospect of much higher recurring trail licence fees for resellers, they come with a short-term hit to revenues as perpetual licence fees were higher in year one, and they often come with a lower ongoing maintenance-support spend as software standardises around a common implementation for all clients. If this change in business model of your partner is likely to happen or has already started, you will need to have the future financial impact modelled out for this, at least at a high level.

Be ready too for questions about quickening your pace of growth through well (lower) priced bolt-on acquisitions in the same or adjacent products. Private equity sees this as a real route to value in many of these situations, and will in general react well to even some preliminary thinking about this.

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