With software multiples remaining stuck around record highs [in '22 and '23], many technology investors are pushing increasing dollars into the tech advisor and technology implementation/support partner market (often marketed as "Digital Transformation service providers"). These businesses are subject to similar market growth rates (minimum >10% p.a., many >20% p.a.), but relative to the underlying software businesses they benefit from lower entry multiples despite having greater technology diversification. Additionally, many of these businesses are now generating material recurring revenue (managed services, product/IP), thus improving the quality of their revenue – and can represent attractive platforms for both consolidation and add-on strategies.

But nothing is easy – in the past four years, we’ve seen a rapid increase in the level of competition for these assets, and a widening mix of quality in underlying businesses. Thorough Commercial Diligence is essential.

These businesses operate in a range of underlying industries, from function-focussed software (e.g., Cyber, Contact Centre/CX, MarTech) to industry-focussed software (e.g., Retail tech, FS tech). But across all these complexities and nuances, there are a number of themes that are consistent, and below we outline a few of the key factors we look for to parse bad/good/great. (Note: while these focus on the implementation and support partner business model, many also apply to the wider advisor model.)

1. The size of the truly serviceable market – and for the serviceable market, what that implies the businesses’ share can be. Four core factors exist that should all be used to define real/serviceable:
   1. Geography (both international and local) – differentiate sweet spot vs anecdotal/single examples
   2. Customer size (often # employees)
   3. Customer industry vertical - Public Sector is very different to Private (need, procurement approach); within private there is a clear trend to vertical-specialisation
   4. Technologies – which underlying software vendors they support (and don’t), and any technologies within those vendors where they don’t have expertise

2. The impact of the market transitioning to Cloud – to what extent have customers gone to cloud architectures to date? and to what type of cloud solutions: private cloud vs. public; and single- vs. multi-tenant? Does the target have the right partners and solutions that fit to each architecture(s)? If not, this has important ramifications to both in defining the served market (of the TAM) and, in many cases, can offer attractive value-gen levers.

3. Target’s software vendor focus vs. breadth in vendor coverage - there is no one right answer here:
   1. For a single-vendor partner – An assessment of that vendor’s overall growth/outlook is, of course, critical – but also: how broad is that vendor’s offering (that we serve) – does some diversification exist? How dependent is the target on the vendor for leads (typically critical), how strong is that relationship and what opportunity for growth exists (e.g., more vendor sales/account execs to map)? How could you grow beyond this base – what is the list of logical complementary vendors with whom you could build a partnership that won’t harm your existing core vendor relationship?
   2. For a multi-vendor partner – How well covered are the leading vendors (defined in terms of both % installed based and % new installs, which are often very different)? How strong are our consulting/advisory capabilities to take customers on an end-to-end journey from needs assessment through vendor selection, implementation, and support?

4. Source of new customer leads – two approaches exist:
   1. Proprietary/in-house funnel building – generally favoured by investors: great for proprietary opportunity flow and being in control of own destiny, however scalability can be challenged and expensive, and scale may be limited if buyers default straight to engaging with tech. vendor first.
   2. Leads generated by underlying technology partner – very scalable and low(er) cost, however “live and die” by your reputation with the tech. vendor’s sales teams, and often more competitive tendering dynamics. While this is less favoured by investors, driving the organisation to develop proprietary opportunity flow can be a great growth opportunity post-acquisition.

5. Quality of revenues – for one-off/re-occurring professional services work, what is a typical customer lifecycle? Take a 5+ year view, and map out the top five customers in each of those past five years – what have they done before/after that peak year? What qualitative insights do individual customer interviews provide – how embedded and sticky are we? For IP/Product – only focus on client-facing applications (heavily discount any value from internal tooling) – how critical were they to the sale, and how well utilised are they (and are there any commercially available alternatives that are threatening its utility/attractiveness)?

6. Nature of customer feedback – three key things we watch out for are:
   1. It’s essential to hear positive feedback on technical capabilities. In our experience, this is one of those “too hard to fix” areas; technical capabilities are typically the core “asset” of the business
   2. Don’t panic if the firm is weak at “advisory” work and strategic customer management (despite technical expertise). This is, in fact, an upside – fixing this drives significant growth post-transaction, and can hint at the logic of selling to a strategic at exit
   3. Hold an open mind if you hear concerns on project overrun (time and cost). More often this is systemic to the space (you’ve never heard of a major IT overhaul run over on budget and time before?) and a relative comparison is key. Plus, if the billing model is Time & Materials, this has driven positive financial outcomes

7. The business’s people model and track record in recruitment and retention – the war for talent and wage inflation is increasingly the biggest barrier to growth; key factors we seek to assess:
   1. Recruitment – how formalised are processes? Which channels are used and how scalable are they? Based on expected revenue growth (and assuming high employee churn), how many new heads will be required in three years – is the current recruitment model scalable?
   2. Retention – what is total churn, and how much of these are regretted losses? Where do people go? How does this compare to direct peers?

Ultimately, every one of the 20+ "digital transformation" services businesses we've looked at in the last couple years has proven to be unique, and the right mix/emphasis across the above list is important and deal-specific; but through applying this standard screener as an initial filter, we find we more quickly get to the heart of the deal with less risk of error.

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