3 keys to ensuring a smarter M&A strategy

Merger and acquisition activity in the government contracting space is expected to continue to pick up in 2017, as buyers increasingly look to acquisitions to fuel growth amid tighter market conditions and federal budget uncertainties.

Unlike a decade ago, when the focus was on bigger deals, today the emphasis is on taking a strategic approach and leveraging M&A to hyper-focus and differentiate with a significant amount of deal making taking place at the small and mid-sized level.

I joined a panel of industry experts at an event hosted by the law firm Pillsbury Winthrop Shaw Pittman, the accounting firm RSM and Capital One Bank last quarter to discuss how the acquisition landscape is evolving, and what contractors need to do to ensure successful M&A execution.

In our discussion, three keys emerged that all government contractors should be mindful of when considering an acquisition

Define why you are making the acquisition

Acquisition strategy in the GovCon space today is not a standard roll-up approach as we have seen on the commercial side and in GovCon in the past.

Instead, the emphasis is on being strategic and leveraging acquisitions as a way to break through the many barriers to entry within the industry. These barriers include acquiring new clients, building a specialized employee base, inheriting a strong track record of performance, or expanding a portfolio of services.

Buyers must be candid and realistic with themselves about the opportunities they have and the hurdles holding them back, and whether an acquisition is the best way for them to hone their strengths and differentiate their business.

Of course, some acquisitions will continue to be about scale. And these buyers need to be just as circumspect about potential revenue synergies and whether the businesses align well enough to significantly improve their bottom line.

Work closely with financial partners

Buyers need to carefully examine the broad array of potential banking institutions to find the right financial partner for their business. It is critical for contractors to select a banking team that has strong roots in the GovCon sector and deep experience in the buyer’s particular area of expertise. The right bank can help navigate the many challenges involved in financing an M&A transaction. 

Prospective buyers also need to be transparent with their banking partner about their M&A strategy and goals. The more a financial provider understands the strategy and how it differentiates and positions the buyer, the more tailored the financing package can be to meet their unique needs.

Beyond bank financing, private equity continues to show strong interest in the GovCon sector, due to its strong valuations and overall stability.

While private equity infusions offer welcome financial flexibility, they aren’t for every contractor. Buyers have to be ready and willing to take on a long-time partner, and will need to consult with investors before taking certain actions – an uncomfortable position for more entrepreneurial business owners.

For contractors that are not in a financial position to pursue acquisitions in the immediate future, the best course of action is to focus on what they do well and sharpen their competitive strengths.

Driving organic growth and strengthening the balance sheet positions a company to attract M&A financing in the future, should it be needed.

Weigh integration risks carefully – and have a back-up plan ready

Every acquisition comes with challenges, but those in GovCon carry unique and complex risks. Cultural fit should be near the top of the list in GovCon transaction considerations. Too many companies focus on operational and financial integration and overlook the importance of having their new employees buy in to their new organization and understand the M&A rationale and strategy.

Also, our entire panel agreed that acquiring small businesses that capitalize on set-aside programs is an especially challenging move, requiring a well thought-out M&A design for those willing to take the risk.

Even with a clearly defined acquisition plan, these deals usually involve great complexity. Buyers need to understand upfront if and how they can transition the set-aside work. This requires deep understanding of the particular contracts and people involved. The risk involved needs to be reflected in the pricing of the deal, and buyers should be wary of counting on the revenue converting.

Buyers that hope an acquisition will give them entry into the commercial market are also taking on a significant challenge. As one of my fellow panelists pointed out, breaking into the commercial segment requires a massive investment, usually spending 1.5 times revenue just to penetrate the market.

GovCon companies aren’t used to, and likely won’t be able to afford, that kind of outlay. Few companies are able to make the transition successfully, and there are inherent, long-term risks with splitting your lines.

Among the risks are moving from the security of long-term government contracts to a short-term contract environment, growing a complicated, new line of business in the public eye (if you are a public company) and making yourself less attractive to future buyers or partners that don’t want to take on this complexity in their business structure.

In addition, once buyers decide upon their acquisition target and strategy, they must have a clearly defined go-forward plan, as well as a contingency plan ready in case the acquisition proves to be a bad fit.

Buyers need to work closely with their financial providers to structure deals in a way that can provide an escape hatch should they need one, or mitigate the risk of failure as much as possible.

This is a time of both challenge and opportunity for the government contracting industry, and M&A remains a critical driver of growth. If there’s an acquisition in your company’s future, strengthen and sharpen your business plan and M&A design, choose the right financial partner and weigh your risks carefully before you move forward.

The best way to make M&A work for you today is to develop a thoughtful and well-considered acquisition strategy that supports your goals and execute this strategy with focus and discipline.