However, the second half of last year saw signs that this run might be coming to an end — deal volumes continued to slow, front-page headlines grew increasingly negative and technology stock prices continued to decline. Despite the headlines and what we believe will be a temporary slowdown in transaction activity, we remain optimistic that momentum in the gov tech market will continue into 2023 and we will see yet another near-record year.
Much of our confidence and optimism for the year ahead stems from conversations with owners of and investors in gov tech businesses last year. While much of the tech sector started to plan for a tough road ahead by cutting growth forecasts, planning layoffs and reducing investments, the conversation in gov tech boardrooms was much the opposite. Talk of strong pipelines, record demand, ample customer budgets and accelerating growth was a constant theme in virtually every corner of the market. Motorola CEO Greg Brown put it best by saying “this is the strongest demand environment I’ve ever seen.”
Accordingly, many gov tech businesses are looking to “play offense” in 2023, investing in both organic growth and strategic acquisitions, and will inevitably need to access capital to facilitate these investments.
A natural objection to this optimism would be “that’s great that gov tech businesses are growing, but the decline in tech valuations has dragged down gov tech valuations, and there is too large a bid-ask spread to get transactions done.” To date, we have yet to see a deal that suggests the valuation environment is materially different than it was in 2021 or 2022, and the valuation multiples from recent transactions are where we would have expected them to be a year or two prior.
But make no mistake — it’s not all optimism, as there are downward pressures on valuation, most notably the availability and cost of debt financing. However, we view these downward pressures as being balanced out by strong investor and buyer demand in the market. Strategics are sitting on record amounts of cash and private equity needing to invest capital is seeking “safe havens” such as gov tech, resulting in significant interest in businesses that test the market.
Here are a few predictions and trends that will define the year ahead:
- 2023 will be busier than 2022, but short of 2021’s record activity: While we expect deal volumes to be slow in Q1, we anticipate a significant uptick in activity later in the year as markets stabilize and operators feel increasingly confident in hitting their 2023 budgets. We anticipate 2023 deal volume to be above the $7.4 billion in 2022, but below the $13.2 billion in 2021.
- Gov tech businesses poised for record growth: We anticipate that both public and private gov tech companies will see accelerating growth in 2023 amid strong demand plus ample budgets and funding dollars.
- Private equity will be an even stronger catalyst for activity: Strategic consolidation in the last two years has actually reduced the number of private equity-backed portfolio companies for the first time ever. The opportunity to create the next generation of platforms, combined with record amounts of private capital chasing defensive sectors like gov tech, create an environment where private equity will be an even more influential force in gov tech.
- Valuation multiples remain stable: We believe the push (scarcity and competition for gov tech business) and pull (choppiness in credit markets) roughly net out, resulting in valuation multiples that are consistent with prior years.
- Strong activity across gov tech subsectors, but notable uptick in public safety: While we anticipate activity happening across gov tech, we believe public safety will be the more active sector in the year ahead. More demand, more funding programs and strong company momentum are the ingredients to make that happen.
- Next generation of platforms gain ground on incumbents: The largest consolidators have become much, much larger in recent years through acquisitions. The disparity between the top end of the market (in terms of revenue scale) and the smaller end has never been so pronounced, which creates space for the next generation of platforms to grow.
- Operators seeking a balance of growth and profitability: We anticipate that the market will reward financial profiles that balance growth with profitability, in contrast to prior years where businesses were optimizing for growth. We still expect companies to invest in growth, but on the margin the market will reward a percent of profitability more than a percent of growth this year, in contrast to prior years.
More simply put, the gov tech market is set to outperform broader tech because of demand and funding dynamics, which, paired with the “safe haven” characteristics, will attract a growing number of buyers seeking out this resiliency, creating demand and competition for businesses that decide to test the market.
