Column: GovCon Small Business M&A Update--Reasons to Remain Optimistic in Fiscal 2023

By Scott E. Semple, senior advisor, and Sharon B. Heaton, founder and CEO sbLiftOff

      For small business founders and owners thinking about growth through acquisition – or considering selling your firm – these are not good times to read the newspaper. The headlines focus on inflation, rising interest rates and economic uncertainty; NOT the time to dive into the Mergers & Acquisitions (M&A) market, right? While these headwinds are formidable, we believe deal activity and transaction values in the government contracting (GovCon) market will remain stable.

      Here are our thoughts.

      During the past few years of booming growth, commercial-sector small business valuations grew to historic highs, with only one direction to go as the economy cooled – DOWN.

      However, the GovCon market is far steadier than other sectors of the economy. In addition to the usual financial metrics, valuations for GovCon companies are more dependent on contract vehicles (such as Best in Class, Indefinite Delivery, Indefinite Quantity Contracts); sector expertise (cybersecurity or health care IT); strength of backlog; client agencies; prime vs. subcontractor status; facility clearances; and other attributes that are unique to the GovCon market.

      These GovCon “golden assets” maintain relatively steady value regardless of commercial economic data or political winds. Like death and taxes, the US Federal government contracting business is dependable and fairly predictable!

GovCon fundamentals

      To a great extent, regional, national, and even global economic challenges tend not to materially influence the fundamentals of the GovCon market: entrepreneurs will continue to create, grow, merge, and sell new entities to serve the ever-evolving needs of the federal government.

      Regardless of rising interest rates, the government will still need facilities management for military bases, replacement parts for planes and missiles and products to modernize their IT.

      In fact, current global crises in Ukraine, China and other hot spots have accelerated growth in A&D (aerospace & defense) demand for spares resupply and next-gen munitions. This has increased demand in logistics, cyber security, supply chain and other specialty services which many small firms are well qualified to support.

      For founders and owners of GovCon small businesses engaged in these and other federal markets, federal agency budgets grow at predictable levels and opportunities for buy-side and sell-side M&A go on unabated. Life in GovCon does not revolve around inflation and rising interest rates that send commercial markets haywire.

Buyers acquiring GovCon firms

      Buyers will continue to be interested in acquiring GovCon companies for multiple reasons including:

• First, small and mid-cap GovCon firms (private companies with $15 million to $150 million in revenue) are known to bring consistent returns to acquirers. Regardless of the headwinds in the economy, the opportunity to accelerate growth by acquiring smaller privately held govcon firms by investing capital and achieving operational efficiencies is a solid inorganic growth strategy. Small and mid-market govcons are known to be attractive investments, and this will keep valuations attractive.
• Second, despite rising interest rates, there is a historic amount of capital – over $1 trillion - much of which will be deployed in lower middle-market acquisitions, including in GovCon.
• A third factor making a small GovCon an attractive acquisition is the impact of category management – the federal strategic sourcing initiative to consolidate acquisition within and across agencies to achieve economic efficiencies. While the overall impact of category management has been negative for individual small businesses (resulting in a 40% decrease in the number of GovCons in the past 15 years), the total revenue volume has steadily increased. The result is multiple $2 million to $10 million per year firms are combined into fewer and larger $20 million to $50 million per year firms. With the General Services Administration and Defense Dept. leading the acceleration of category management buying policies and practices, smaller firms will increase as attractive targets for firms looking for fast growth.
• Finally, the concentration of federal contract vehicles into fewer and larger BIC (Best in Class) contracts places increased value on firms that currently possess – or can qualify for – these platforms. As first- and second-generation IDIQ vehicles including ALLIANT, OASIS, EAGLE and many others end and are slow to be replaced by new larger platforms including Polaris and Oasis Plus, the resulting ‘federal vehicle gap’ is placing enhanced focus – and value – on higher volume vehicles. The result? M&A transaction values are driven more heavily by the revenue potential of desirable federal contract vehicles. In fact, we have already seen acquisitions occurring so that the buyer is in a stronger position to bid on attractive vehicles. This trend shows signs of continuing as solicitation releases are delayed and post-award protests become the norm.

Conclusion

      So what’s the bottom line for small and mid-cap GovCon founders and owners? Stay focused on GovCon market growth and keep building business development capabilities and operating efficiencies into your firm. There is a tremendous amount of capital on the sidelines, and investors want to put it to work.

      And since the lower middle-market is known to generate value for smart investors who are patiently investing in long-term growth, we expect the M&A environment for these GovCon companies to remain stable.

For further information or assistance email Scott Semple at ssemple@sbliftoff.com or visit www.sbliftoff.com.

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Column: GovCon Small Business M&A Update--Reasons to Remain Optimistic in Fiscal 2023

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