In October 2009, North East Finance backed by One NorthEast presented to the European Union with plans for a £120m fund to invest in regional businesses.
The plan was called JEREMIE and aimed to plug the funding gap created by North East businesses being ignored by private equity funds which then focused on London and the South East. Furthermore, start-ups and tech businesses would not get bank support and this worsened the funding gap in this sector.
More than ten years on, and with the original plan followed by a second tranche of funding, JEREMIE 2, it’s fair to say that the original plan has worked, and the North East is now seen as a hotbed for tech businesses.
Last year saw US private equity backed business MRI acquire Newcastle based Orchard Information Systems and the investment by Livingbridge in Visualsoft in Stockton.
Including the Orchard transaction, we have advised on one technology deal per month for the last 18 months and this rate shows no sign of slowing – partly because Software as a Service business models are proving resilient during the Covid 19 pandemic.
How have valuations been impacted by the pandemic?
In general, across the whole of the UK M&A average valuation multiples have been broadly static in the last four years. Median enterprise valuations when compared to earnings before interest tax depreciation and amortisation have fluctuated between 7.5 and 8 times since 2017.
For the UK technology sector, the median valuation multiples are higher and increased from 10.4 times to 11.4 times in 2020 – which is evidence of the attractiveness of tech businesses.
But as with all statistics the average can shed light on some trends but does not explain all circumstances. We have seen tech deals successfully valued at over 20 times multiple and other tech deals fall over at valuations of 12 times.
Why is there such a wide difference and what are the critical success factors in getting deals away in the tech sector?
In simple terms, the tech sector is unlike many other sectors and has its own key valuation metrics, including:
- Cost of acquiring customers
- Lifetime value of customers
- Churn rate, or rate of loss of annual customers
- Average transaction value
- Average revenue per customer
- Viral rate, representing the rate of growth in customer numbers (and broadly equivalent to the dreaded R rate that is used to assess the virality of the pandemic)
Furthermore, risks such as the level of technical debt, which represents the future amount of programming that is required to deliver the project or planned software upgrades, need to be assessed and evaluated and will impact valuation.
Overall, the biggest critical success factor is the credibility of the forecasts.
These forecasts must be very detailed and robust – they should be evidenced by recent performances and existing data, supported by management’s planned changes be able to withstand the scrutiny of private equity due diligence.
At MHA Tait Walker we have invested heavily in data analytics and financial due diligence which means that we review many deals on behalf of private equity firms, comparing the key metrics to their benchmarks and to the averages seen in other similar tech start-ups and deals. This knowledge also allows us to advise management teams to develop the right strategies that would support forecasts attractive to investors.
Currently, there seems no slow down in the tech sector. Regional and national private equity firms, US private equity buyers and family offices are all keen to look at North East businesses. In theory, some investors may eventually start to look away from the sector to rebalance their portfolios and to seek better value elsewhere but there is no sign of this yet.
We have all come a long way since 2009!