Building a government contracting business is a unique challenge for the small business owner for a number of reasons, not the least of which is the fact that a small business in the federal space is in the business of selling to the largest customer in the world.
Add to that the unique compliance and certification requirements, as well as the overall culture and complexity of working for a client that maintains more than 316 departments, agencies and sub-agencies, and there’s no doubt that building a small GovCon business can be extremely demanding.
Small government contractors, however, recognize that the rewards of building their business can be great. In addition to the stability of serving a customer who can always pay the bill and working to support federal government missions that have a global impact, small government contractors can build a business that offers high value at exit, when the owners are ready to retire or at other key inflection points.
Understanding the unique steps necessary to prepare your small government contracting business for exit, however, is essential to your ultimate success. Your business is not like other businesses — its structure, operations, customer relationships, financial and valuation are all unique as a result of the specific nature of the federal marketspace. With that in mind, here are five essential steps you should take to prepare your small government contracting business for a successful sale or exit:
1. Build your exit planning team.
The first thing to understand is that planning for exit is not a solo exercise, it is a team sport. And your team needs the right players, including your personal wealth manager or financial planner; an external accounting partner with business valuation expertise; a lead attorney who knows both business law and M&A transactions; an investment banker who works with businesses of your size and those in your space; and a finance professional who can help you prepare to maximize value to exit.
Also, keep in mind that there may be a ‘value gap’ identified between the valuation of your business and the financial requirements you may have for your retirement. Recognizing this further demonstrates the strategic importance of having the right team at the table from the start.
2. Know the drivers of value.
In the federal contracting M&A space, approximately half of all transactions are for less than $25 million, which demonstrates that small government contractors represent the largest segment of transaction volume. That’s why you need to understand the drivers of value for a firm such as yours, and use them to position your business as a high-value target in a crowded M&A marketplace.
The first of these drivers is the growth of the company, typically evaluated in terms of both historical and projected growth. If both of those figures are in the double-digits, and the firm plays in growing segments of the federal market (such as DoD, intelligence/cybersecurity or other technically demanding segments), then this aspect may position well.
The second driver is risk, and for small government contractors this can become tricky. Pluses for minimizing risk include a contract base that is predominately full and open competition (F&O), long-term contracts or task orders, higher margins and little to no set-aside business. Since many small GovCons are fully or heavily certification-based and set-aside dependent, overcoming this hurdle may be essential for exit success.
The third driver of growth is the leverage ability of the business, as measured by the size and ability of its contract vehicles to transition; the nature of its agency customers (are they high-demand, heavily sought-after accounts?), the unique capabilities the firm offers, and its focus or depth.
3. Understand what makes a deal work.
In addition to the value drivers for the federal M&A market, small government contractors need to consider the factors that influence how and when a deal is successfully closed.
For example, is the firm focused in a growing, high-priority market with direct mission support and an attractive customer base? Is the firm’s depth in the space high-value, positioning it as a go-to contractor for key accounts, and ensuring its recognition as a leader in certain core capabilities? Is there intellectual property (IP) that can be gained such as technology, tools or proprietary processes? And does the firm maintain a clear identity in the marketplace as a high-performance firm with stellar advisory capabilities?
4. Consider factors that influence transaction timing.
In addition to making your business attractive and preparing to maximize its effective valuation for prospective buyers, you also need to recognize that in addition to getting the deal done, *when* the deal closes is also critical to all parties. Some of the factors that influence the when side of the equation include:
– The strength, depth and stability of the leadership and management team.
– The firm’s business performance, such its revenue, profitability, momentum, strength of customer relationships and its contract backlog.
– Industry and competitive trends such as the federal budget, political landscape, regulatory environment and contracting environment (in terms of factors such as bid protests).
– Shareholder or owner considerations such as the owner’s desire for liquidity (and how much liquidity, when), along with valuation requirements and personal goals/objectives.
– Conditions in the capital markets and the M&A environment, including the nature of the buyer market, range of potential suitors, level of acquisition interest in the space, and the availability of capital.
5. Know the process ahead and plan for it.
Finally, understand that M&A is a process — one that is demanding, time-consuming and emotionally taxing for all involved. The process involves four major phases.
The first phase is the preparation phase, which includes elements such as due diligence and developing the marketing strategy, target buyer list and legal/financial plan. The second phase is the marketing phase, which is where potential suitors are contacted and in addition, potential lenders are engaged to generate early feedback. The third phase is the due diligence phase, which is where company visits, management presentations, financial reviews and formulation of a draft purchase agreement are executed. And the fourth phase is the finalizing one, where negotiation results in execution of a final definitive agreement and the transaction closes.
These five steps provide a framework that can be used successfully to help you prepare your small government contracting business for a successful future exit. By building the right team, knowing the value drivers, understanding deal success and transaction timing factors, and becoming adept at the process itself, you’ll be much better prepared for a successful transition when the time arrives.