Targeting Value: Bull's-Eye On Value Added Resellers

By Adam Hark, Co-Founder, Preston Todd Advisors

Value added resellers (VARs) have long been sought after as high quality distribution channels for point-of-sale (POS) manufacturers. Their high-touch interaction with end-users and expertise in end-to-end business management solutions have made them rising stars and ideal partners within the POS industry. Over the past few years, software developers and payments processing companies have also seen the light as they, too, have come to appreciate VARs’ distribution value.

With all of this attention being heaped on VARs for their perceived value to POS players, software developers, and payments processors, it’s easy to assume VARs would command relatively high valuations in the marketplace when exiting or seeking growth financing. But this hasn’t borne out. Historically, VARs have been assigned a lower multiplier than their peers in the software, payments, and often (but not always) POS sectors. Perhaps this seems counterintuitive given an industry insider’s perspective, but there is a logical explanation for why VARs haven’t been given the same respect in the marketplace as their inter-vertical peers.

The Old
When an M&A analyst seeks to understand why valuations in certain verticals aren’t comparable to valuations in other, closely related verticals (the assumption being companies in closely related verticals have either a similar product/service offering, or their product/service offering is integrated or often accompanied by their own), the first thing they look at is historical growth and growth potential. As a general rule, higher growth businesses command higher valuations. The second thing an M&A analyst will look at is margin/profitability; by way of example, businesses that produce net income at 80 percent of their top-line revenue command higher valuations than those that run at 25 percent.

As I stated, these are general rules, and in the case of VARs, neither of these business attributes have historically accounted for VARs’ lower valuations than POS, software, and payments companies. VARs’ traditionally lower valuations can be explained by another business attribute which is often overlooked or wholly ignored by many business owners: the quality of their revenue stream.

In today’s marketplace of investors and acquirers, recurring revenue is king. Unlike the standard one sale/one revenue generating event model, selling a product or service repeatedly every month (assumed periodicity) creates continuity, reliability, and predictability which together makes recurring revenue the darling of both financial and strategic buyers alike. As such, recurring revenue has been deemed a higher quality revenue stream than revenue derived from more traditional means.

Look no further than the front-lines of the investment class for validation of this: outside of pure technology plays — tech disruptors who have created a new good or service — today’s marketplace abounds with private equity groups and venture capital firms seeking to deploy capital to businesses which can provide high growth and big margins via recurring revenue. And strategic acquirers have looked to do the same.

Applying this rationale now to VARs, it makes sense these other types of businesses are getting higher valuations. Payments and software (most especially SaaS companies) are the proverbial poster children for the recurring revenue based model, and drive much of the M&A activity I’m involved with on a day-to-day basis. Even in POS, in the instance where companies have created or built something new which disrupts the marketplace, or have amassed large client bases into which a strategic acquirer can cross sell complementary goods and services, they too will likely command a higher multiplier. But VARs, with their one sale/one revenue generating event model, for equipment purchases, installations, break/fix billings, and time-and-money customer service, have been penalized on valuations because recurring revenue simply isn’t compatible with what they do — or at least not until recently.

The New
Over the past two years, many VARs have begun to undergo a phenomenal evolution in their core business model, supplementing (not substituting) their core offerings with products and services that require and properly conform to a recurring revenue model. These VARs, much to their credit, have exhibited a great deal of sophistication and have altered the way they think about their business model in two very significant ways:

1. VARs have recognized the for product and service offerings that support recurring revenue billings to enhance enterprise value; and
2. VARs have leveraged their expertise and knowledge in their traditionally strong product and service areas to better position themselves at the center of the payments, software, and POS universe — more frequently becoming the go-to consultants and solution providers to many merchants who no longer want a piecemeal, kludgy business management solution, but prefer instead a wholesale, end-to-end to run their businesses more efficiently, effectively, and provide their clients with a rich and elegant buying experience.

VARs are in the know now and cashing in on their expertise in the technologies businesses use today. They’re developing their own POS lines, using feedback from their clients on software functionality deficiencies to develop their own software solutions, effectively turning themselves into independent software vendors (“ISVs”) and transitioning from resellers of payments processing to direct sellers of the same. I’ve even seen some instances where VARs have taken a page from managed services providers to offer cloud based, data backup systems — VARs are all-in on recurring revenue!

The Takeaway
The adaptations today’s VARs are making are nothing short of remarkable. Their understanding of the changing marketplace and their ability to reinvent themselves to create long term enterprise value enhancement through supplementing traditional product and service lines with recurring value offerings has put a bullseye on their backs, and for all the right reasons. The reinvention of today’s VARs has in many ways transformed them from resellers to direct sellers, and from choice channel partners to full-on acquisition targets. Bravo to them.

Adam T. Hark is Co-Founder of Preston Todd Advisors. With over a decade of experience in payments, payments technology, and FinTech, Adam advises clients in M&A, growth strategy, exits, and business and portfolio valuations. Adam T. Hark can be reached at adam.hark@prestontoddadvisors.com or 617-340-8779.