REFLECTING ON 2023
At the outset of 2023, I made several predictions about the volume of activity, type of transactions and valuations that would shape the market in the year ahead. As we look back on 2023, examining what predictions were right and which were considerably off the mark is a useful way to reflect on the trends that shaped gov tech in 2023.
1. 2023 will be busier than 2022, but short of 2021’s record activity (5/5): While 2023 was busier than 2022, the path to getting there ended up being different than expected. I thought we would have more, smaller deals from strategic buyers, but instead we had some mega deals (e.g., Magnet Forensics acquisition by Thoma, Civica’s acquisition by Blackstone, etc.) that ended up moving the needle on deal activity.
2. Gov tech business poised for record growth (4/5): “Record growth” was probably too strong. A softer term such as “consistent growth” or “solid growth” would have been more on point. While most gov tech operators saw 2023 growth at or slightly above 2022 levels, there was not a major inflection in growth rate. The exception was a few segments of public safety like school safety or NG911, where a combination of legislation and funding did drive record growth.
3. Private equity will be an even stronger catalyst for activity (5/5): Private equity was a strong catalyst for activity and 2023 saw a number of meaningful platform investments including BS&A (Serent), ImageTrend (WCAS), Utility (GSV and PSG), Accela (Francisco), Avenu (Arlington) and Civica (Blackstone), among many others. We also saw the “downstream” impact of private equity platform investing, with a number of tuck-ins completed by businesses such as MCCi (Century Park Capital), Schneider Geospatial (Align Capital Partners), gWorks (BV Partners) and Euna Solutions (GI Partners).
4. Valuation multiples remain stable (2/5): The right prediction would have been “valuation multiples are unpredictable.” Average valuation multiples were down slightly from 2022, but the deviation from the mean is as wide as we have ever seen. This reflects a “flight to quality,” where the “A” quality businesses are still getting 2021-style “A” valuations, while the market is more discerning for lower-quality businesses. The dispersion of multiples is greater than any market in recent years, especially relative to 2021 where everything seemed to be valued within a narrow 20 percent variance.
5. Strong activity across gov tech subsectors, but notable uptick in public safety (3/5): Undoubtedly, public safety has considerable momentum from legislation and funding mechanisms driving a modernization trend that fuels growth. While slightly more than half of the transaction volume in 2023 came from public safety deals, I thought we would have even more volume based on the number of conversations happening across the market and the financial performance of both buyers and sellers. There certainly were a number of important private-equity-driven public safety transactions (ImageTrend, Magnet Forensics, Utility, LeadsOnline/Ultra Forensics, etc.) but surprisingly little from the large publicly traded strategics.
6. Next generation of platforms gain ground on incumbents (4/5): The M&A activity of the “next generation” of platforms, almost all of whom are backed by private equity, was markedly higher versus that of the incumbents such as Tyler Technologies, CentralSquare and Motorola Solutions. By our internal math, private equity platforms “out acquired” large incumbents in a ratio of almost 5-to-1 as they used M&A to bring new products into their portfolios and expand market share at a faster rate than the incumbents, a trend that will undoubtedly accelerate in 2024.
7. Operators seeking a balance of growth and profitability (5/5): One of the most common questions we get from operators, investors and boards is, “How does the market currently think about growth vs. profitability?” While the right answer is “it depends” based on scale, end-market and efficiency of unit economics, the reality is that the lack of profitability has become more “binary” to attracting buyer interest and getting a deal done at a great valuation. While the market over-indexed valuation multiples to growth in 2021, the pendulum has swung the other way to reward a percentage of EBITDA margin versus a percentage of revenue growth today. We are not alone in that thinking and, especially at this time of year when budgets are being finalized, we are seeing companies opt for the more conservative and more profitable plans over higher growth.
A FEW PREDICTIONS FOR 2024
- Transaction volume exceeds 2022 and 2023, but still falls short of 2021: We expect a healthy year of activity, but do not anticipate the multiple blockbuster deals needed for a record year (those blockbuster deals will be many of the large private equity deals from 2021 that are now three years old and approaching the early end of the typical private equity exit timeline). It is more likely that 2025 is the next record year, although if market conditions continue to improve that activity could get pulled into the latter part of this year. Nevertheless, we expect a year that eclipses 2023.
- Private equity involved in 80 percent of transactions: One of the stats we plan to track this year is the percentage of deals that have private equity influence, either as the seller, buyer or owner of the buyer. Anecdotally, it is a very large percentage. This year, we expect 80 percent of the transaction volume will be influenced in some way by private equity. Why? There’s $1.8 trillion of dry powder that needs to be deployed (and remember, gov tech continues to be a safe haven) and gov tech portfolio companies are top candidates for exits for funds looking to return capital to their limited partners.
- More clarity and consistency around valuation: With more volume and increased stability, we expect more consistency and less dispersion around valuation multiples. We believe that best-in-class gov tech companies will continue to be valued at multiples largely consistent with the top of the market that we have seen in the last two years. Overall, we expect overall multiples to settle slightly lower than the record multiples in 2021, which still represents a premium to the historical averages before 2019.
- More mid-size deals: In 2022 and 2023, activity was largely driven by many small tuck-in deals and a handful of large, $1 billion-plus transactions. What’s been missing and what’s historically been one of the core engines of activity is the $100-$500 million enterprise value deals, the mid-market of gov tech deals. While we saw a few last year, we expect these size deals to come back meaningfully in 2024.
- A handful of themes drive activity: We expect a few themes and investment thesis to drive a disproportionate amount of activity. In public safety, those themes include technologies at the intersection of public and private safety (e.g., school safety), AI-based threat detection, further consolidation in the evidence and forensics segment and emergency management. In public administration, those themes include consolidation in community development and government payments, building out comprehensive financial suites and growth of “high velocity sales” businesses that are able to sell to profitability and reach the low end of the market.
- An uptick in cross-border deals: Gov tech (at least the purview of this column) has historically been very U.S.-centric, and it has been atypical to see a European gov tech business buying a U.S. one, or vice versa. However, the European gov tech market has started to mature as there are more scaled and interesting companies than ever before. This coincides with many U.S.-based strategic buyers looking to expand their addressable markets, with geographic expansion being a logical area. We expect more of these cross-border deals in 2024.
