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Recently, GovTech has been seeing significant interest as an investment category. The sector is broadly defined, but is mainly inclusive of technology supporting federal, state, and local governments. With this lens, total transaction volume has reached record highs despite the uncertainty around overall market conditions. 2022 saw the second highest annual transaction volume in the sector as businesses continue to become more “forward-thinking.”
Why is GovTech gaining momentum?
Focusing on the local government segment, growth has been the result of a combination of government demand and an evolving market landscape:
Government Demand
Younger leadership pushing for more transparency / efficiency
State and local government leadership continues to become younger. These leaders tend to be more tech forward and view technology as a means to deliver better transparency and efficiency.
Need for technology modernization
The shift to younger leaders also is contributing to the rapid increase in government tech modernization efforts. There is also meaningful runway for continued modernization—According to a recent EY report, ~63% of government employees surveyed believe extensive or moderate changes are needed to enhance their workplace digital tools and technologies.
Covid shift in constituent expectations
Tech modernizations are also being driven by shifting constituent expectations. Covid helped drive greater expectations around the ability to self-service and government accessibility/responsiveness. A recent GovTech.com study reflected higher constituent expectations for service reliability (66%) and real-time service updates (55%) over the next 3 years.
Labor shortages
The public sector is having a hard time attracting workers, driving them to seek tech solutions that push efficiency and critical services. According to American City and County, since February 2020, the private sector has seen a net increase in jobs filled of +900k while the public sector still faces a net loss of 650k. Since 2020, superior wage growth among private companies has contributed to these challenges (+5.5% wage growth for private sector jobs vs. +3.4% for public sector jobs).
Structural Factors
Increasing prevalence of SaaS solutions
Investors, especially financial sponsors, are focused on sectors which offer recurring revenue.
The continued demand shifts highlighted above, alongside accelerated demand due to Covid, have pushed government solutions to be consumer friendly—meaning more agile and easier to use—where SaaS solutions can be more dynamically developed and flexible.
Market Consolidation
Strategic investor consolidation efforts are creating a major delta between the large consolidators and startups. In this "competition of opportunity," everyone is racing to create what could become the next platform. This dynamic is driving higher multiples for GovTech platforms.
Implications and considerations for financial sponsors
While strategics have inherent advantages when acquiring, financial sponsors have a number of factors working in their favor. GovTech providers are seeking to fill the space between the large consolidators and startups, the macro factors support investment, and there continue to be opportunities to address market needs given the complexity of legacy stacks and manual processes.
As mentioned, there has also been a greater expectation amongst citizens for digital services as Covid created a stepwise shift in demand (as compared to a temporary shift). At the local and state level, IT spending is expected to grow at ~5% annually from 2022-2028 in an effort to modernize and prepare for the incoming wave of tech advancements and implementations.
When evaluating assets, investors should consider the following:
1. What is the driver for initial adoption? What is the impetus and ability to move municipalities to more robust solutions? What pain points are loud enough to drive switching / trading up?
- There is a natural evolution from purely manual processes to a simplistic solution, to more robust options.
2. How centralized is the decision-making process? How much ability is there to cross-sell? Is it truly a cross-sell that municipalities are seeking or a suite solution?
- What are the target’s focus geographies and how successful has it been in that area?
3. Local municipalities look to see which technology solutions surrounding communities are using and, if it is effective, it drives a higher propensity for other communities to adopt.
- This regional approach has proven to be an effective growth strategy among GovTech providers.
4. Where is the target in its cloud offering maturity and solution flexibility? How does this compare to competitors?
- Given the range of legacy solutions governments have in place, flexible / cloud solutions which can more readily integrate various solutions offer a compelling option.
- The momentum for cloud / recurring revenue is advantageous for investors.
5. Given the prevalence of inorganic growth to add capabilities, how effectively has the target integrated its acquisitions? To what extent does it facilitate a seamless experience, allowing municipalities to unlock the full value of the platform?
7. What other features could be added alongside the core functionality to meet more of the municipality’s needs?
Evaluating tech-related spaces can be challenging when the pace of advancements are accelerating. Navigating these dynamics requires a partner which has deep expertise of both the market dynamics and the specific assets—Stax evaluates ~300 assets per year, providing a unique perspective as assets return to the market at varying intervals over their investment lifecycle. Stax also harnesses this expertise to deliver actionable post-close growth strategies to accelerate value creation. To hear more about our services and expertise, visit www.stax.com or contact us here.
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