Tech M&A went through a lull before it picked up again last year. Now, it's stronger again — but the transactions and factors have changed.
For potential acquisition targets, it’s important to understand what today’s buyers want — and it starts with a focus on costs. “For a couple years, technology firms have been shifting away from ‘growth at all costs,’ to showing profitable growth,” said Grant Thornton Transaction Advisory Principal Bryan Walker. This has pervasive effects. “Every sell-side quantitative valuation I see includes proforma adjustments to show the full-year impact of recent cost-cutting or cost-optimization measures over the last year, running right up to the fourth quarter last year. Companies have optimized their cost structures and are trying to show how that feeds into the forecast the bankers are building.”
Even early-stage companies can face scrutiny about their costs, so get ready. “It's very important to see, understand and depict the path to profitability on sell-side transactions,” said Grant Thornton Transaction Advisory Principal Bill Pollatos. That path can include growth in sales volume and price increases, but costs still need to be rationalized.
“It includes understanding and optimizing R&D spend,” Pollatos said. “On almost every transaction I see, companies are right-sizing their R&D group, optimizing add-on acquisitions or even swapping out functional groups or different job categories within those functional groups.”
Workforces are a strategic cost for tech companies, and many companies are adjusting that strategy. “Companies swap out developers who are specialized in one area for different specializations — they’re constantly making sure they have the right people in the right activities, driving the company forward to achieve growth,” Pollatos said. “The ability to pull those levers and make changes as needed is extremely important. I think the companies that have the appropriate leverage are balancing development between contractors and employee developers.” Walker agreed, “Your strategic direction has to be your core — have the strategic view and the leadership, but not necessarily hundreds of full-time employees dedicated to projects you know are going to cycle off.”
“Revenue per head is getting a lot of optics,” noted Grant Thornton Technology Industry National Leader Andrea Schulz. “Another KPI that’s building in the marketplace is the rule of 40, basically stating that a SaaS company's revenue growth rate and profit margin should be roughly 40%.” Walker agreed, “Our private equity investors are all chasing rule-of-40 companies.”
Potential acquisition targets should show a path to profitable growth, with metrics that today’s buyers are watching. Pollatos reflected, “In all of my transactions, we’re documenting that path to profitability — what it looks like, how you get there, what the future looks like from pricing perspective, and the cost structure that's needed to achieve that profitability.”
It’s even better if you can show how you’re already walking that path.
“It is about demonstrating consistency in executing against the forecast that you have,” Schulz said. “That level of predictability — especially when you're thinking SaaS — is highly desirable. Show that you're running efficiently and that you can hit your forecast. That's important.”
As buyers and sellers consider valuations, one X factor might be AI.
What about AI?
“The impact of artificial intelligence (AI) on traditional software is something that a lot of people are still trying to get their arms around,” Walker said. Still, buyers understand that they should be shopping. “There are a lot of people looking at AI companies because there’s an opportunity potential that’s significant,” Pollatos noted. “We’re seeing AI companies hit the market sooner than we would another established software company.”
“That is important to know,” he added, “because it’s attractive to get in sooner on those AI companies, even when there isn't a full path to profitability yet.” Schulz agreed, “You see it in funding. You see it in M&A activity. AI is definitely the exception to the rule right now. They’re still ‘growth at all costs’ at this point — it’s the arms race.”
Recent federal actions could reinforce the value of domestic AI ventures. “The recent orders are trying to create a moat around the U.S. development of AI and make sure that we’re protected here from that perspective,” Schulz said.
Another international issue is the semiconductor supply chain. While valuations could rise for U.S. semiconductor companies, there’s a limit to what they can produce. “It’s all anchored to the geopolitical issues because you have limited chip manufacturers providing most of the materials to everyone in the business,” Schulz said. “Even the smaller producers in the United States are still getting their supplies from jurisdictions that are likely to attract tariffs.”
Concerns about semiconductors could make tech companies look at stability up and down their verticals. When they do, though, they could find an even bigger concern.
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Power up the vertical
Technology runs on data. Data runs on energy. “In tech, you're absolutely seeing big tech companies buying and investing in nuclear companies,” Schulz said. “They're trying to head off the energy question at this point.” Grant Thornton Transaction Advisory Managing Director Tim Douek said, “It is interesting to see the tie-ups between large data centers that are scouting out locations with a secure energy supply.”
“We're starting to see a lot more linkage between new energy technologies — which sound like old energy technologies, but they're truly new — like small modular reactors on the nuclear front,” Douek said. “For those very energy-intensive technology applications, and data centers are a perfect example, there's much more awareness about a reliable, reasonably priced energy supply.” That’s why energy should enter into the value equation, and why larger tech companies are creating their own supply.
“They’re trying to own the whole ecosystem,” Schulz said. “Tech giants are vertically integrating — from energy sourcing to data centers and chip development — by acquiring companies across the supply chain. This end-to-end control could drive acquisitions.”
Companies can demonstrate their value when they show differentiating value in that ecosystem — for buyers in tech and other industries.
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“Everything in and around data, data centers, and manufacturing to meet the need for the computing power of AI is going to be significant,” Pollatos said. He cited several transactions with significant growth and growing backlogs within the datacenter ecosystem. “There is a run to be ready for what you see is coming, from the AI perspective and the data perspective.”
For buyers, Schulz said the message is clear. “Specifically for the mid-market, look at your supply chain in terms of M&A — look at how you need to reinforce and protect yourself.”
Contacts:
Bryan Walker
Principal, Transaction Advisory Services
Grant Thornton Advisor LLC
Bryan is an advisory managing director based in San Francisco, specializing in transaction services. He has more than 20 years of experience providing financial due diligence to private equity and corporate clients.
San Francisco, California
Industries
- Healthcare
- Manufacturing, Transportation & Distribution
- Technology, media & telecommunications
- Retail & consumer brands
- Private equity
Service Experience
- Advisory
- Transaction advisory
Bill Pollatos
Principal, Transaction Advisory Services
Grant Thornton Advisors LLC
Bill is a Principal in our Transaction Services practice with over 16 years of experience. He has specialized industry expertise in the technology sector and is a leader of the firm’s M&A technology team as well the firm’s most significant technology transactions.
Orange County, California
Industries
- Healthcare
- Manufacturing, Transportation & Distribution
- Technology, media & telecommunications
- Transportation & distribution
- Hospitality & Restaurants
Tim Douek
Managing Director, Transaction Advisory Services
Grant Thornton Advisors LLC
Timothy Douek is a Managing Director within Grant Thornton’s Transaction Advisory practice. He provides a range of transaction diligence services with a specific focus on the design and deployment of profitable, sustainable strategies for organizations looking to optimize their operating models through organic and inorganic growth.
Philadelphia, Pennsylvania
Industries
- Banking
- Energy
- Life sciences
- Media & entertainment
- Transportation & distribution
- Manufacturing, Transportation & Distribution
- Healthcare
Service Experience
- Advisory
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