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Commercial Diligence Tips for Tech-Enabled Service Businesses

Many recent PE deals have targeted businesses that apply technology to help customers streamline processes which have previously been manual and “paper-based.”

Examples we have looked at include HR systems, investor relations services, property management software, compliance software, safety system testing and certification and a long list of other workflow software and services.

Whether deployed through a pure SaaS model or through a combination of technology and professional services, these businesses appear to offer customers an irresistible combination of cost reduction, lower error rates, increased regulatory compliance and enhanced organisational effectiveness.

Typically an IM for one of these businesses will describe:

  • A list of satisfied current customers, with limited likelihood of switching
  • A very large addressable market
  • Prospective customers who agree that the service “appears highly attractive”

Happily, many of these businesses turn out to be great long-term successes. But an equal number struggle – often with a healthy sales pipeline but with a long sales cycle and with limited conversion.

So what separates the winners from the also-rans – and more importantly, how can we better predict success prior to acquisition? When presented with a long list of benefits, most prospective customers will find something that they like in a potential solution. But agreeing that a new solution “appears highly attractive” and actually making a purchase are very different things.

Even when a solution seems like a no-brainer, many barriers can stand in the way of adoption. For example:

  1. Inertia and the power of “sticking with what we know”
  2. Trust and familiarity with existing systems
  3. Competing priorities (i.e., more important problems to be solved)
  4. Lack of a key decision maker
  5. Budget constraints or lack of spending authority
  6. Preferences for developing in-house rather than purchasing outside systems
  7. Inability to reassign/ rationalize current workforce to capture the savings efficiency of a new system – and thus sometimes adding rather than reducing cost with a new system

In our experience, the businesses that can scale most successfully share seven key characteristics:

  1. They address a “burning platform” – i.e., they help customersaddress a time- sensitive and critical business need (which is sufficiently important to overcome inertia) – and customers already recognise this as a business imperative
  2. They target a clear customer persona – i.e., they meet the needs of a specific individual within a customer – and that individual has sufficient power and budget authority to “get things moving”
  3. Customers are technically ready i.e., adoption doesn’t rely on the customer first having adopted other systems and processes - or if it does, those systems are widely in place among prospective customers
  4. Adoption costs are low including costs of software, costs of other related software and devices and staff training
  5. The company’s internal resources are robust – i.e., it has sufficient sales, marketing, customer implementation and onboarding programs and other resources to support growth – and if not, they have a plan in place with the necessary budget to fill the key gaps
  6. Current customers are not “outliers” – i.e., current customers are truly representative of the wider market, and not unique in some key aspect
  7. If the company offers a point solution, it is not already addressed by attractive broader solutions – i.e., prospective customers are not already receiving more comprehensive offers to this and related problems simultaneously

Almost all businesses will have some risks when judged against these issues. Sometimes a target faces too many issues. Often, however, making the deal work comes down to underwriting the right segment of the market where the identified blocker(s) do not exist, and planning the capital investments and strategic prioritisation necessary to ensure that the management team can focus specifically on high-likelihood opportunities. Using the diligence period wisely can position you to be a more effective owner, and prepare you to hit the ground running from day one.

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