Perhaps
the most important transaction you will ever pursue is the sale of your
business. Many owners of information technology companies attempt to do
it themselves and often times these very capable business people
approach the sale of their business with less formality than in the sale
of a home. The purpose of this article is to answer the questions - Why
would I use an investment banker and what am I getting for the fees I
will pay?
More than any other type of business sale,
the intellectual property based business is the most complex and
difficult. The primary reason is that the seller is not interested in
selling their company for a financial multiple like 5 X EBITDA. They
almost always want that amount plus a premium for strategic value.
Another very important factor is that most smaller information
technology companies run their financials on a cash basis and the buyers
usually employ the accrual method. The adjustments in transaction value
that often occur during the due diligence process are often surprising
and expensive. Below are several reasons why a seller of an IT business
should seek a firm that specializes in this type of business sale.
1.
Confidentiality. If an owner tries to sell his own business, that
process alone reveals to the world that his business is for sale.
Employees, customers, suppliers, and bankers all get nervous and
competitors get predatory. The investment banker protects the identity
of the company he represents for sale with a process designed to contact
only owner approved buyers with a blind profile - a document describing
the company without revealing its identity. In order for the buyer to
gain access to any sensitive information he must sign a confidentiality
agreement. That generally eliminates the tire kickers and deters
behaviors detrimental to the seller’s business
2.
Business Continuity. Selling a business is a full time job. The business
owner is already performing multiple functions instrumental to the
success of his business. By taking on the load of selling his business,
many of those essential functions will get less attention, sometimes
causing irreparable damage to the business. The owner must maintain
focus on running his business at its full potential while it is being
sold.
3. Time to Close. Since the investment banker's
function is to sell the business, he has a much better chance of closing
a transaction faster than the owner. The faster the sale, the lower the
risk of business erosion, customer defection, employee problems and
predatory competition.
4. Large Universe of Buyers.
The investment banking firm that specializes in information technology
and software companies already has a developed list of target companies
with contact information for the individual that runs the merger and
acquisition process. They recognize that information technology
companies with the same SIC Code 5734-01 can be vastly different and
need a further categorization like document management software, SaaS
CRM Systems, or healthcare financial software.
5.
Marketing. A merger and acquisition advisor can help present the
business in its best light to maximize selling price. He understands how
to recast financials to recognize the EBITDA potential post
acquisition. He understands the key value drivers for buyers and can
position the selling company to enhance its strategic value in the eyes
of the buyer.
6. Valuation Knowledge. The value of a
business is far more difficult to ascertain than the value of a house.
Every business is unique and has hundreds of variables that effect
value. This is especially true with companies with a strong component of
intellectual property. Investment Bankers have access to business
transaction databases, but those should be used as guidelines or
reference points. The best way for a business owner to truly feel
comfortable that he got the best deal is to have several strategic
industry buyers bidding for his business. An industry database may
indicate the value of your business based on certain valuation
multiples, but the market provides the real answer.
7.
Balance of Experience. Most corporate buyers have acquired multiple
businesses while sellers usually have only one sale. In one situation we
represented a first-time seller being pursued by a buyer with 26
previous acquisitions. Buyers want the lowest price and the most
favorable terms. The inexperienced seller will be negotiating in the
dark. To every term and condition in the buyer’s favor the buyer will
respond with, “that is standard practice” or “that is the market” or
“this is how we did it in ten other deals.” Our firm has saved our
clients transaction value greater than our total fees during the due
diligence and closing adjustments process. By engaging an investment
banker that specializes in information technology companies, the seller
has an advocate with an experience base to help preserve the seller’s
transaction value and deal structure.
8. Maximize the
Value of Seller’s Outside Professionals. Experienced investment bankers
can save the seller significantly on professional hourly fees by
managing several important functions leading up to contract. His
compensation is usually comprised of a reasonable monthly fee plus a
success fee that is a percentage of the transaction value. The
M&A advisor and seller negotiate with the buyer the business
terms of the transaction (sale price, down payment, seller financing,
etc.) prior to turning the purchase agreement over to outside counsel
for legal review. In the absence of the investment banker, that
sometimes-exhaustive negotiation process would default to the outside
attorney. The economics of the deal are not your attorney's area of
expertise and could result in significant hourly fees or even a
breakdown of the transaction.
9. Maintain Buyer -
Seller Relationship. The sale of a business is an emotional process and
can become contentious. The investment banker acts as a buffer between
the buyer and seller. This not only improves the likelihood of the
transaction closing, but helps preserve a healthy buyer - seller
relationship post closing. Often buyers want sellers to have a portion
of their transaction value contingent on the successful performance of
the company post closing. Buyer and seller need to be on the same team
after closing.
Our experiences with information
technology companies that engaged our firm as a result of an unsolicited
offer from a buyer have been quite instructive. The eventual selling
price averaged over 30% higher than the first offer. In no case was the
business sold at the initial price.
The technology
focused investment banker helps reduce the risk of business erosion with
improved confidentiality while allowing the owner to focus on running
the business. The advisor- led sale helps maximize sales proceeds by
involving a large universe of qualified and targeted buyers in a
competitive bidding process. Finally, the investment banker can improve
the likelihood that the sale closes by buffering buyer - seller
negotiations and by balancing the experience scales.
Dave Kauppi is a Merger and Acquisition Advisor and Managing Director of MidMarket Capital, providing business broker and investment banking services to owners in the sale of information technology companies. To view our lists of buyers and sellers click to visit our Web Site MidMarket Capital
Thursday, January 30, 2014
Taking Your Information Technology Company to the Next Level - It Could Be Time to Sell
Thinking
of taking your information technology company to the next level with a
major capital investment or hiring additional sales resources? These are
decisions that can impact your company's future. It might be time to
consider the alternative of selling your business.
We are often approached by information technology company owners at a crossroads of taking the company to the next level. The decision in most cases is whether they should bring on the one or two hot shot sales people or channel development people necessary to bring the company sales to a level that will allow the company to reach critical mass. For a smaller company with sales below $5 million this can be a critical decision.
For frame of reference, prior to embarking on my merger and acquisition advisor career, I spent my prior 20 years in various sales capacities in primarily information technology and computer industry related companies from bag carrying salesman to district, regional, to national sales manager and finally Chief Marketing Officer. So when I look at a company, it is from the sales and marketing perspective first and foremost. I am sure that if I had a public accounting background, I would look at my clients through those lenses.
So with that backdrop, let's look at what might be a typical situation. The company is doing $3.5 million in sales, has a good group of loyal customers, produces a nice income for its owner or owners, and has a lot more potential for sales growth in the opinion of the owner. Some light bulb has been lit that suggests that they need to step this up to the next level after relying on word of mouth and the passion and energy of the owner to get to this stage.
I have either spoken with more than 30, primarily information technology based companies over the years that have faced this exact situation and can count on one hand the ones that had a successful outcome. The natural inclination is to bite the bullet and bring on that expensive resource and hope your staff can keep up with the big influx of orders. The reality is that in most cases the execution was a very expensive failure. Below are several factors that you should consider when you are at this crossroads:
1. The 80 20 rule of salesmen. You know this one. 80% of sales are produced by 20% of the salespeople. If you are only hiring one or two, the likelihood is that you will not get a top performer.
2. The founder of the company is a technology guy and has no sales background, so the odds of him making the right hiring decision are greatly diminished. He will not understand how to properly set milestones, judge progress, evaluate performance objectively, or coach the new hire.
3. To hire a good salesman that can handle a complex sale requires a base salary and a draw for at least 6 months that puts him in a better economic condition than he was in on his last job. So you are probably looking at $150,000 annual run rate for a decent candidate.
4. If you have not had a formalized sales effort before, you are probably lacking the sales infrastructure that your new hire is used to. Proper contact management systems, customer and prospect databases, developed collateral materials and sales presentations, sales cycle timeframes and critical milestones and developed competition feature benefit matrixes will need to be developed.
5. Current customers are most likely the early adapters, risk takers, pioneers, etc. and are not afraid of making the buying decision with a small more risky company. These early adaptors, however, are not viewed as good references for the more conservative majority that needs the security of a big company backing their product selection decision.
6. Your new hire is most likely someone that came from a bigger company like IBM or Oracle and may be comfortable performing in an established sales department. It is the rare salesman that can transform from that environment to a new role of developing the sales infrastructure while trying to meet a sales quota.
7. Throw on top of that the objection that he has never had to deal with before, the small company risk factor, and the odds of success diminish. When he was hired he assured you that he would bring his very productive address book and deliver all of these customers from his Blue Chip prior employer. He and you soon discover that he may not have been totally responsible for his sales success. Having IBM or Oracle on his business card may have been the predominant success factor.
8. Finally, this transformation from a core group of early adapters to now selling to the conservative majority elongates the sales cycle by 25% to as much as twice his prior experience. If you don't fire him first, he will probably quit when his draw runs out.
With all this going against the business owner, most of them go ahead and make the hire and then I hear something like this, "Yes, we brought on a sales guy two years ago who said he had all the industry contacts and in nine months after he hadn't sold a thing and cost us a lot of money, we fired him. That really hurt the company and we have just now recovered. We won't do that again."
What are the alternatives? Certainly strategic alliances, channel partnerships, value added resellers are options, but again the success rate for these arrangements are suspect without the sales background in the executive suite. A lower risk approach is to outsource your VP of Sales or Chief Marketing Officer function. There are a number of highly experienced and talented free lancers that you can hire on a consulting basis that can help you establish a sales and marketing infrastructure and guide you through the staffing process. That may be the best way to go.
An option that one of our clients chose when faced with the eight points to consider from above was to sell his company. This is a very difficult decision for an entrepreneur who by nature is very optimistic about the future and feels like he can clear any hurdle. This client had no sales background but was a very smart subject matter expert with an outstanding background as a former consultant with a Big 5 accounting firm.
He did not make the hiring mistake, but instead went the outsourcing of VP of Sales function as step 1. When their firm wanted to make the transition from the early adapters to the conservative majority, the sales cycle slowed to a crawl. Meanwhile their technology advantage was being eroded by a well funded venture backed competitor that had struck an alliance with a big vendor.
We were able to find him the right buyer. His effective sales force has been increased from one (himself) to 27 reps. His install base has been increased from 14 to 800. Every one of the buyers current customers is a candidate for this product. The small company risk has been removed going from a little known start-up with $1 million in revenues to a well known industry player, publicly traded stock with a market cap of $2.5 billion.
A portion of his transaction value was based on post acquisition sales performance, and things worked out very well.
He avoided the big cash drain that a bad sales person hiring decision would have created and he sold his company before a competitor dominated the market and made his technology irrelevant and of minimal value.
My professional contacts sometimes tease me and suggest that I think every company should be sold. That may be a slight exaggeration, but in many instances, a company sale is the best route. When a business owner is faced with that crossroads decision of bringing on a significant sales resource that will be faced with a complex sale and the executive suite does not have the sales background, a company sale may be the best outcome.
Dave Kauppi is a Merger and Acquisition Advisor and Managing Director of MidMarket Capital, providing business broker and investment banking services to owners in the sale of information technology companies. To view our lists of buyers and sellers click to visit our Web Site MidMarket Capital
We are often approached by information technology company owners at a crossroads of taking the company to the next level. The decision in most cases is whether they should bring on the one or two hot shot sales people or channel development people necessary to bring the company sales to a level that will allow the company to reach critical mass. For a smaller company with sales below $5 million this can be a critical decision.
For frame of reference, prior to embarking on my merger and acquisition advisor career, I spent my prior 20 years in various sales capacities in primarily information technology and computer industry related companies from bag carrying salesman to district, regional, to national sales manager and finally Chief Marketing Officer. So when I look at a company, it is from the sales and marketing perspective first and foremost. I am sure that if I had a public accounting background, I would look at my clients through those lenses.
So with that backdrop, let's look at what might be a typical situation. The company is doing $3.5 million in sales, has a good group of loyal customers, produces a nice income for its owner or owners, and has a lot more potential for sales growth in the opinion of the owner. Some light bulb has been lit that suggests that they need to step this up to the next level after relying on word of mouth and the passion and energy of the owner to get to this stage.
I have either spoken with more than 30, primarily information technology based companies over the years that have faced this exact situation and can count on one hand the ones that had a successful outcome. The natural inclination is to bite the bullet and bring on that expensive resource and hope your staff can keep up with the big influx of orders. The reality is that in most cases the execution was a very expensive failure. Below are several factors that you should consider when you are at this crossroads:
1. The 80 20 rule of salesmen. You know this one. 80% of sales are produced by 20% of the salespeople. If you are only hiring one or two, the likelihood is that you will not get a top performer.
2. The founder of the company is a technology guy and has no sales background, so the odds of him making the right hiring decision are greatly diminished. He will not understand how to properly set milestones, judge progress, evaluate performance objectively, or coach the new hire.
3. To hire a good salesman that can handle a complex sale requires a base salary and a draw for at least 6 months that puts him in a better economic condition than he was in on his last job. So you are probably looking at $150,000 annual run rate for a decent candidate.
4. If you have not had a formalized sales effort before, you are probably lacking the sales infrastructure that your new hire is used to. Proper contact management systems, customer and prospect databases, developed collateral materials and sales presentations, sales cycle timeframes and critical milestones and developed competition feature benefit matrixes will need to be developed.
5. Current customers are most likely the early adapters, risk takers, pioneers, etc. and are not afraid of making the buying decision with a small more risky company. These early adaptors, however, are not viewed as good references for the more conservative majority that needs the security of a big company backing their product selection decision.
6. Your new hire is most likely someone that came from a bigger company like IBM or Oracle and may be comfortable performing in an established sales department. It is the rare salesman that can transform from that environment to a new role of developing the sales infrastructure while trying to meet a sales quota.
7. Throw on top of that the objection that he has never had to deal with before, the small company risk factor, and the odds of success diminish. When he was hired he assured you that he would bring his very productive address book and deliver all of these customers from his Blue Chip prior employer. He and you soon discover that he may not have been totally responsible for his sales success. Having IBM or Oracle on his business card may have been the predominant success factor.
8. Finally, this transformation from a core group of early adapters to now selling to the conservative majority elongates the sales cycle by 25% to as much as twice his prior experience. If you don't fire him first, he will probably quit when his draw runs out.
With all this going against the business owner, most of them go ahead and make the hire and then I hear something like this, "Yes, we brought on a sales guy two years ago who said he had all the industry contacts and in nine months after he hadn't sold a thing and cost us a lot of money, we fired him. That really hurt the company and we have just now recovered. We won't do that again."
What are the alternatives? Certainly strategic alliances, channel partnerships, value added resellers are options, but again the success rate for these arrangements are suspect without the sales background in the executive suite. A lower risk approach is to outsource your VP of Sales or Chief Marketing Officer function. There are a number of highly experienced and talented free lancers that you can hire on a consulting basis that can help you establish a sales and marketing infrastructure and guide you through the staffing process. That may be the best way to go.
An option that one of our clients chose when faced with the eight points to consider from above was to sell his company. This is a very difficult decision for an entrepreneur who by nature is very optimistic about the future and feels like he can clear any hurdle. This client had no sales background but was a very smart subject matter expert with an outstanding background as a former consultant with a Big 5 accounting firm.
He did not make the hiring mistake, but instead went the outsourcing of VP of Sales function as step 1. When their firm wanted to make the transition from the early adapters to the conservative majority, the sales cycle slowed to a crawl. Meanwhile their technology advantage was being eroded by a well funded venture backed competitor that had struck an alliance with a big vendor.
We were able to find him the right buyer. His effective sales force has been increased from one (himself) to 27 reps. His install base has been increased from 14 to 800. Every one of the buyers current customers is a candidate for this product. The small company risk has been removed going from a little known start-up with $1 million in revenues to a well known industry player, publicly traded stock with a market cap of $2.5 billion.
A portion of his transaction value was based on post acquisition sales performance, and things worked out very well.
He avoided the big cash drain that a bad sales person hiring decision would have created and he sold his company before a competitor dominated the market and made his technology irrelevant and of minimal value.
My professional contacts sometimes tease me and suggest that I think every company should be sold. That may be a slight exaggeration, but in many instances, a company sale is the best route. When a business owner is faced with that crossroads decision of bringing on a significant sales resource that will be faced with a complex sale and the executive suite does not have the sales background, a company sale may be the best outcome.
Dave Kauppi is a Merger and Acquisition Advisor and Managing Director of MidMarket Capital, providing business broker and investment banking services to owners in the sale of information technology companies. To view our lists of buyers and sellers click to visit our Web Site MidMarket Capital
Software Company Valuation - Theory Versus Market Reality
Business
valuations of software companies use proven methodologies to arrive at
an indication of value. If the technology is one in demand, however, the
valuations provided by the markets can be off the charts. This article
discusses how the pros value software companies and the limitations to
their approach.
Software company owners looking to sell their companies are often inspired to start the process after reading about the latest high profile, stratospheric acquisition price paid by a large tech bell weather company. The transaction metrics, i.e. transaction value to sales or transaction value to EBIT sometimes defy all logic.
The new, would-be seller applies these metrics to his company's sales and EBIT and determines that IBM, Microsoft, Google, Oracle, Cisco, etc. should be ready to get into a bidding war over his $5 million in revenue, game changing, best in breed software company for a value of 8 X revenue.
Let's break down the methodology that professional business valuation firms use as their standard in arriving at a company's indicated value. Their approach calls for a triangulation of three valuation methodologies.
The first is a comparison to publicly traded companies in the same category. It is very interesting to look at the lists that the valuators come up with. Technically they are all software companies with SIC Code 5734-01, but they are as alike as apples, coconuts, watermelons, and blueberries. True, they are all fruit, but that is where the similarity ends.
Next, they take the valuation metrics of these publicly traded companies. The most commonly used are sales to enterprise value and EBIT to enterprise value. Next they come up with the median value (one half of the companies are above the value and one half are below). They then apply what I can best describe as an arbitrary discount factor to account for the value differential between public companies and small, closely held companies. They come up with their adjusted metrics then apply them to the target company and voila, you have one of the valuation legs completed.
The valuation analyst next applies the same approach to actual completed transactions. If the buyer was a public company then the metrics are publicly available. If the transaction is between two privately held companies, the metrics are only available on a voluntary basis. Maybe 10% of these participants release information about these transactions. These unreported deals are probably the best fit in terms of comparables.
In order to get a meaningful number of transactions, the analyst often is forced to use transactions from a 5-10 year period. Do you know how to say Tech Bubble/Tech Meltdown? Wow, this isn't sounding quite as scientific as I originally thought.
Wait, maybe we can add some needed precision with the third valuation technique, the discounted cash flow method. My Wharton Finance Professor would be so proud. First they calculate a risk adjusted discount rate. After three pages of explanation, they usually arrive at a discount rate of between 24-30%. They next project the after tax cash flow for the next five years and discount it to present value.
They then calculate the terminal value of the company (five years of year five cash flow discounted by the risk adjusted rate less the projected growth rate). They discount that number to present value and add that to the discounted cash flow to create the third leg of the valuation stool.
How many software companies are not projecting hockey stick growth during the valuation period in question? Not only are these projections very aggressive, but cash flow margins are projected to improve by a factor of three times during this same period.
Now our seller is armed and dangerous with his company's value. That becomes his minimal acceptable offer and it must all be in cash at closing. To use a Wall Street term - this company is priced for perfection. We often discover during a sell-side engagement that these projections are not just missed, but they are missed by a large margin. In spite of this, the seller's valuation expectations remain the same.
All is not lost, however. One of the unique aspects of selling a software company is that if the technology is fresh (think SaaS, Mobile Apps, Virtualization, Cloud Computing) financial multiples are often not the driving force in the buyer's valuation equation.
One thing that we have learned in the representation of software companies for sale is that the value is subject to broad interpretation by the market. We find that strategic buyers in this space are driven by such considerations as first mover advantage, time to market, development costs, customer acquisition costs, customer defections, and enhancing an existing product suite.
The better the target company addresses these issues, the greater the post acquisition value creation potential. If the right buyer is located and recognizes the seller's potential when integrated with the new owner's distribution channel and customer base, we may find an even bigger hockey stick then our very optimistic sellers. If two or three buyers recognize a similar dynamic, then the valuations can become very exciting.
Dave Kauppi is a Merger and Acquisition Advisor and Managing Director of MidMarket Capital, providing business broker and investment banking services to owners in the sale of information technology companies. To view our lists of buyers and sellers click to visit our Web Site MidMarket Capital
Software company owners looking to sell their companies are often inspired to start the process after reading about the latest high profile, stratospheric acquisition price paid by a large tech bell weather company. The transaction metrics, i.e. transaction value to sales or transaction value to EBIT sometimes defy all logic.
The new, would-be seller applies these metrics to his company's sales and EBIT and determines that IBM, Microsoft, Google, Oracle, Cisco, etc. should be ready to get into a bidding war over his $5 million in revenue, game changing, best in breed software company for a value of 8 X revenue.
Let's break down the methodology that professional business valuation firms use as their standard in arriving at a company's indicated value. Their approach calls for a triangulation of three valuation methodologies.
The first is a comparison to publicly traded companies in the same category. It is very interesting to look at the lists that the valuators come up with. Technically they are all software companies with SIC Code 5734-01, but they are as alike as apples, coconuts, watermelons, and blueberries. True, they are all fruit, but that is where the similarity ends.
Next, they take the valuation metrics of these publicly traded companies. The most commonly used are sales to enterprise value and EBIT to enterprise value. Next they come up with the median value (one half of the companies are above the value and one half are below). They then apply what I can best describe as an arbitrary discount factor to account for the value differential between public companies and small, closely held companies. They come up with their adjusted metrics then apply them to the target company and voila, you have one of the valuation legs completed.
The valuation analyst next applies the same approach to actual completed transactions. If the buyer was a public company then the metrics are publicly available. If the transaction is between two privately held companies, the metrics are only available on a voluntary basis. Maybe 10% of these participants release information about these transactions. These unreported deals are probably the best fit in terms of comparables.
In order to get a meaningful number of transactions, the analyst often is forced to use transactions from a 5-10 year period. Do you know how to say Tech Bubble/Tech Meltdown? Wow, this isn't sounding quite as scientific as I originally thought.
Wait, maybe we can add some needed precision with the third valuation technique, the discounted cash flow method. My Wharton Finance Professor would be so proud. First they calculate a risk adjusted discount rate. After three pages of explanation, they usually arrive at a discount rate of between 24-30%. They next project the after tax cash flow for the next five years and discount it to present value.
They then calculate the terminal value of the company (five years of year five cash flow discounted by the risk adjusted rate less the projected growth rate). They discount that number to present value and add that to the discounted cash flow to create the third leg of the valuation stool.
How many software companies are not projecting hockey stick growth during the valuation period in question? Not only are these projections very aggressive, but cash flow margins are projected to improve by a factor of three times during this same period.
Now our seller is armed and dangerous with his company's value. That becomes his minimal acceptable offer and it must all be in cash at closing. To use a Wall Street term - this company is priced for perfection. We often discover during a sell-side engagement that these projections are not just missed, but they are missed by a large margin. In spite of this, the seller's valuation expectations remain the same.
All is not lost, however. One of the unique aspects of selling a software company is that if the technology is fresh (think SaaS, Mobile Apps, Virtualization, Cloud Computing) financial multiples are often not the driving force in the buyer's valuation equation.
One thing that we have learned in the representation of software companies for sale is that the value is subject to broad interpretation by the market. We find that strategic buyers in this space are driven by such considerations as first mover advantage, time to market, development costs, customer acquisition costs, customer defections, and enhancing an existing product suite.
The better the target company addresses these issues, the greater the post acquisition value creation potential. If the right buyer is located and recognizes the seller's potential when integrated with the new owner's distribution channel and customer base, we may find an even bigger hockey stick then our very optimistic sellers. If two or three buyers recognize a similar dynamic, then the valuations can become very exciting.
Dave Kauppi is a Merger and Acquisition Advisor and Managing Director of MidMarket Capital, providing business broker and investment banking services to owners in the sale of information technology companies. To view our lists of buyers and sellers click to visit our Web Site MidMarket Capital
Venture Capital Versus Smart Equity for the Software Company Entrepreneur
Many
entrepreneurs seek venture capital or private equity as a way to take
their company to the next level. Consider the smart equity alternative
of having a large information technology company take an equity stake in
your company. This article discusses why that is a superior
alternative.
If you are an entrepreneur with a small information technology based company looking to take it to the next level, this article should be of particular interest to you. Your natural inclination may be to seek venture capital or private equity to fund your growth. According to Jim Casparie, founder and CEO of the Venture Alliance, the odds of getting Venture funding remain below 3%. Given those odds, the six to nine month process, the heavy, often punishing valuations, the expense of the process, this might not be the best path for you to take.
We have created a smart equity model designed to bring the appropriate capital resources to you entrepreneurs. It allows the entrepreneur to bring in smart money and to maintain control. We have taken the experiences of several technology entrepreneurs and combined that with our traditional investment banking merger and acquisition approach and crafted a model that both large industry players and the high tech business owners are embracing.
Our experiences in the technology space led us to the conclusion that new product introductions were most efficiently and cost effectively the purview of the smaller, nimble, low overhead companies and not the technology giants. Most of the recent blockbuster products have been the result of an entrepreneurial effort from an early stage company bootstrapping its growth in a very cost conscious lean environment. The big companies, with all their seeming advantages experienced a high failure rate in new product introductions and the losses resulting from attempting to internally develop the next hot technology were substantial.
Don't get us wrong. There were hundreds of failures from the start-ups as well. However, the failure for the edgy little start-up resulted in losses in the $1 - $5 million range. The same result from an industry giant was often in the $100 million to $250 million range.
For every Google, EBay, Salesforce, or Twitter there are literally hundreds of companies that either flame out or never reach a critical mass beyond a loyal early adapter market. It seems like the mentality of these smaller business owners is, using the example of the popular TV show, Deal or No Deal, to hold out for the $1 million briefcase. What about that logical contestant that objectively weighs the facts and the odds and cashes out for $280,000?
As we discussed the dynamics of this market, we were drawn to a private equity investment model commonly used by technology bell weather, Cisco Systems, that we felt could also be applied to a broad cross section of companies in the high tech niche. Cisco Systems is a serial acquirer of companies. They do a tremendous amount of R&D and organic product development. They recognize, however, that they cannot possibly capture all the new developments in this rapidly changing field through internal development alone.
Cisco seeks out investments in promising, small, technology companies and this approach has been a key element in their market dominance. They bring what we refer to as smart equity to the high tech entrepreneur. They purchase a minority stake in the early stage company with a call option on acquiring the remainder at a later date with an agreed-upon valuation multiple. This structure is a brilliantly elegant method to dramatically enhance the risk reward profile of new product introduction. Here is why:
For the Entrepreneur: (Just substitute in your technology industry giants name that is in your category for Cisco below)
1. The involvement of Cisco - resources, market presence, brand, distribution capability is a self fulfilling prophecy to your products success.
2. For the same level of dilution that an entrepreneur would get from a VC, angel investor or private equity group, the entrepreneur gets the performance leverage of "smart money." See #1.
3. The entrepreneur gets to grow his business with Cisco's support at a far more rapid pace than he could alone. He is more likely to establish the critical mass needed for market leadership within his industry's brief window of opportunity.
4. He gets an exit strategy with an established valuation metric while the buyer helps him make his exit much more lucrative.
5. As an old Wharton professor used to ask, "What would you rather have, all of a grape or part of a watermelon?" That sums it up pretty well. The involvement of Cisco gives the product a much better probability of growing significantly. The entrepreneur will own a meaningful portion of a far bigger asset.
For the Large Company Investor:
1. Create access to a large funnel of developing technology and products.
2. Creates a very nimble, market sensitive, product development or R&D arm.
3. Minor resource allocation to the autonomous operator during his "skunk works" market proving development stage.
4. Diversify their product development portfolio - because this approach provides for a relatively small investment in a greater number of opportunities fueled by the entrepreneurial spirit, they greatly improve the probability of creating a winner.
5. By investing early and getting an equity position in a small company and favorable valuation metrics on the call option, they pay a fraction of the market price to what they would have to pay if they acquired the company once the product had proven successful.
Let's use two hypothetical companies to demonstrate this model, Big Green Technologies, and Mobile CRM Systems. Big Green Technologies utilized this model successfully with their investment in Mobile CRM Systems. Big Green Technologies acquired a 25% equity stake in Mobile CRM Systems in 1999 for $4 million. While allowing this entrepreneurial firm to operate autonomously, they backed them with leverage and a modest level of capital resources. Sales exploded and Big Green Technologies exercised their call option on the remaining 75% equity in Mobile CRM Systems in 2004 for $224 million. Sales for Mobile CRM Systems were projected to hit $420 million in 2005.
Given today's valuation metrics for a company with Mobile CRM Systems growth rate and profitability, their market cap is about $1.26 Billion, or 3 times trailing 12 months revenue. Big Green Technologies invested $5 million initially, gave them access to their leverage, and exercised their call option for $224 million. Their effective acquisition price totaling $229 million represents an 82% discount to Mobile CRM Systems 2005 market cap.
Big Green Technologies is reaping additional benefits. This acquisition was the catalyst for several additional investments in the mobile computing and content end of the tech industry. These acquisitions have transformed Big Green Technologies from a low growth legacy provider into a Wall Street standout with a growing stable of high margin, high growth brands.
Big Green Technologies profits have tripled in four years and the stock price has doubled since 2000, far outpacing the tech industry average. This success has triggered the aggressive introduction of new products and new markets. Not bad for a $5 million bet on a new product in 1999. Wait, let's not forget about our entrepreneur. His total proceeds of $229 million are a fantastic 5- year result for a little company with 1999 sales of under $20 million.
MidMarket Capital Advisors has borrowed this model combining the Cisco smart equity investment experience with our investment banking experience to offer this unique Investment Banking service. MMCA can either represent the small entrepreneurial firm looking for the "smart equity" investment with the appropriate growth partner or the large industry player looking to enhance their new product strategy with this creative approach. This model has successfully served the technology industry through periods of outstanding growth and market value creation. Many of the same dynamics are present today in the information technology and software industries and these same transaction structures can be similarly employed to create value.
Dave Kauppi is a Merger and Acquisition Advisor and Managing Director of MidMarket Capital, providing business broker and investment banking services to owners in the sale of information technology companies. To view our lists of buyers and sellers click to visit our Web Site MidMarket Capital
If you are an entrepreneur with a small information technology based company looking to take it to the next level, this article should be of particular interest to you. Your natural inclination may be to seek venture capital or private equity to fund your growth. According to Jim Casparie, founder and CEO of the Venture Alliance, the odds of getting Venture funding remain below 3%. Given those odds, the six to nine month process, the heavy, often punishing valuations, the expense of the process, this might not be the best path for you to take.
We have created a smart equity model designed to bring the appropriate capital resources to you entrepreneurs. It allows the entrepreneur to bring in smart money and to maintain control. We have taken the experiences of several technology entrepreneurs and combined that with our traditional investment banking merger and acquisition approach and crafted a model that both large industry players and the high tech business owners are embracing.
Our experiences in the technology space led us to the conclusion that new product introductions were most efficiently and cost effectively the purview of the smaller, nimble, low overhead companies and not the technology giants. Most of the recent blockbuster products have been the result of an entrepreneurial effort from an early stage company bootstrapping its growth in a very cost conscious lean environment. The big companies, with all their seeming advantages experienced a high failure rate in new product introductions and the losses resulting from attempting to internally develop the next hot technology were substantial.
Don't get us wrong. There were hundreds of failures from the start-ups as well. However, the failure for the edgy little start-up resulted in losses in the $1 - $5 million range. The same result from an industry giant was often in the $100 million to $250 million range.
For every Google, EBay, Salesforce, or Twitter there are literally hundreds of companies that either flame out or never reach a critical mass beyond a loyal early adapter market. It seems like the mentality of these smaller business owners is, using the example of the popular TV show, Deal or No Deal, to hold out for the $1 million briefcase. What about that logical contestant that objectively weighs the facts and the odds and cashes out for $280,000?
As we discussed the dynamics of this market, we were drawn to a private equity investment model commonly used by technology bell weather, Cisco Systems, that we felt could also be applied to a broad cross section of companies in the high tech niche. Cisco Systems is a serial acquirer of companies. They do a tremendous amount of R&D and organic product development. They recognize, however, that they cannot possibly capture all the new developments in this rapidly changing field through internal development alone.
Cisco seeks out investments in promising, small, technology companies and this approach has been a key element in their market dominance. They bring what we refer to as smart equity to the high tech entrepreneur. They purchase a minority stake in the early stage company with a call option on acquiring the remainder at a later date with an agreed-upon valuation multiple. This structure is a brilliantly elegant method to dramatically enhance the risk reward profile of new product introduction. Here is why:
For the Entrepreneur: (Just substitute in your technology industry giants name that is in your category for Cisco below)
1. The involvement of Cisco - resources, market presence, brand, distribution capability is a self fulfilling prophecy to your products success.
2. For the same level of dilution that an entrepreneur would get from a VC, angel investor or private equity group, the entrepreneur gets the performance leverage of "smart money." See #1.
3. The entrepreneur gets to grow his business with Cisco's support at a far more rapid pace than he could alone. He is more likely to establish the critical mass needed for market leadership within his industry's brief window of opportunity.
4. He gets an exit strategy with an established valuation metric while the buyer helps him make his exit much more lucrative.
5. As an old Wharton professor used to ask, "What would you rather have, all of a grape or part of a watermelon?" That sums it up pretty well. The involvement of Cisco gives the product a much better probability of growing significantly. The entrepreneur will own a meaningful portion of a far bigger asset.
For the Large Company Investor:
1. Create access to a large funnel of developing technology and products.
2. Creates a very nimble, market sensitive, product development or R&D arm.
3. Minor resource allocation to the autonomous operator during his "skunk works" market proving development stage.
4. Diversify their product development portfolio - because this approach provides for a relatively small investment in a greater number of opportunities fueled by the entrepreneurial spirit, they greatly improve the probability of creating a winner.
5. By investing early and getting an equity position in a small company and favorable valuation metrics on the call option, they pay a fraction of the market price to what they would have to pay if they acquired the company once the product had proven successful.
Let's use two hypothetical companies to demonstrate this model, Big Green Technologies, and Mobile CRM Systems. Big Green Technologies utilized this model successfully with their investment in Mobile CRM Systems. Big Green Technologies acquired a 25% equity stake in Mobile CRM Systems in 1999 for $4 million. While allowing this entrepreneurial firm to operate autonomously, they backed them with leverage and a modest level of capital resources. Sales exploded and Big Green Technologies exercised their call option on the remaining 75% equity in Mobile CRM Systems in 2004 for $224 million. Sales for Mobile CRM Systems were projected to hit $420 million in 2005.
Given today's valuation metrics for a company with Mobile CRM Systems growth rate and profitability, their market cap is about $1.26 Billion, or 3 times trailing 12 months revenue. Big Green Technologies invested $5 million initially, gave them access to their leverage, and exercised their call option for $224 million. Their effective acquisition price totaling $229 million represents an 82% discount to Mobile CRM Systems 2005 market cap.
Big Green Technologies is reaping additional benefits. This acquisition was the catalyst for several additional investments in the mobile computing and content end of the tech industry. These acquisitions have transformed Big Green Technologies from a low growth legacy provider into a Wall Street standout with a growing stable of high margin, high growth brands.
Big Green Technologies profits have tripled in four years and the stock price has doubled since 2000, far outpacing the tech industry average. This success has triggered the aggressive introduction of new products and new markets. Not bad for a $5 million bet on a new product in 1999. Wait, let's not forget about our entrepreneur. His total proceeds of $229 million are a fantastic 5- year result for a little company with 1999 sales of under $20 million.
MidMarket Capital Advisors has borrowed this model combining the Cisco smart equity investment experience with our investment banking experience to offer this unique Investment Banking service. MMCA can either represent the small entrepreneurial firm looking for the "smart equity" investment with the appropriate growth partner or the large industry player looking to enhance their new product strategy with this creative approach. This model has successfully served the technology industry through periods of outstanding growth and market value creation. Many of the same dynamics are present today in the information technology and software industries and these same transaction structures can be similarly employed to create value.
Dave Kauppi is a Merger and Acquisition Advisor and Managing Director of MidMarket Capital, providing business broker and investment banking services to owners in the sale of information technology companies. To view our lists of buyers and sellers click to visit our Web Site MidMarket Capital
Wednesday, January 29, 2014
How to Drive Value in Your Healthcare Information Technology Company Sale
One of the most demanding aspects of selling a Healthcare Software Company is coming up with a business valuation. Sometimes the valuations provided by the marketplace defy the valuation judgment that commonly dictates a selling price for a bricks and mortar company, for example. This article covers how an investment banker can correctly position your Healthcare Information Technology Company to the right buyer in order to accomplish a attractive transaction price.
One of the most demanding factors of selling a Healthcare
Software Company is coming up with a
business valuation. Sometimes the valuations provided by the market
(translation - a concluded transaction) defy all logic. In other business
segments there are some pretty helpful rules of thumb for valuation metrics. In
one line of business it may be 1 X Revenue, in another it could be 5 X EBITDA
or cash flow.
Since it is essential to our business to aid our Healthcare
Information Technology Company clients
raise their business selling value, I have given this considerable thought. Why
are some of these Healthcare Software Company valuations so elevated?
It is because of the profitability leverage a Healthcare
Software Company can generate. A
clear-cut case in point is; what is Microsoft's incremental expense to supply
the next copy of Office Professional? It is most likely $1.20 for three CD's
and 80 cents for packaging. Let's say the license cost is $400. The gross margin
is north of 99%. That does not materialize in manufacturing or services or
retail or most other industries.
One drawback in selling a small Healthcare Information
Technology Company is that they do not
have any of the brand recognition, distribution, or standards leverage that the
big companies own. So, on their own, they cannot produce this profitability
leverage. The buying company, however, does not aim to compensate the small
seller for the post acquisition results that are directly attributable to the
buyer's market presence. This is what we refer to as the valuation gap.
What we attempt to do is to help the buyer rationalize
paying a much higher price than a pre-acquisition financial valuation of the
target company. In other words, we want to get strategic value for our seller.
Below are the factors that we use in positioning our Healthcare Information
Technology Company for maximum selling
price:
Cost for the buyer to develop the product internally - Many
years ago, Barry Boehm, in his book, Software Engineering Economics, developed
a constructive cost model for projecting the programming costs for writing
computer code. He called it the COCOMO model. It was quite comprehensive and
complex, but I have boiled it down and simplified it for our purposes. We have
the advantage of estimating the "projects" retrospectively because we
already know the number of lines of code comprising our client's products. This
information is designed to help us understand what it might cost the buyer to build
it internally so that he starts his own build versus buy analysis.
Most acquirers could write the code themselves, but we put
forward they analyze the cost of their time to market delay. Believe me, with
first mover advantage from a competitor or, worse, customer defections, there
is a very real cost of not getting your product today. We were able to convince
one buyer that they would be able to defend our seller's entire purchase price
predicated on the amount of client defections their acquisition would avert.
Another arrow in our valuation driving quiver for our
sellers is we restate historical financials using the pricing premium of the
brand name acquirer. We had one client that was a small IT company that had
developed a superior piece of software that compared favorably with a sizable,
publicly traded company's solution. Our product had the same functionality,
ease of use, and open systems platform, but there was one very significant
difference. The buyer's perception of risk was far greater with the little IT
company that could be "out of business tomorrow."
We were literally able to increase twofold the financial
performance of our client on paper and put forward a compelling line of
reasoning to the big company buyer that those results would be immediately
obtainable to him post acquisition. It certainly was not GAP Accounting, but it
was helpful as a tool to direct transaction value.
Financials are of great consequence so we have to
acknowledge this aspect of buyer valuation as well. We generally like to build
in a baseline value (before we start adding the strategic value factors) of 2 X
contractually recurring revenue during the current year. So, for example, if
the company has monthly maintenance contracts of $100,000 times 12 months =
$1.2 million X 2 = $2.4 million as a baseline company value component. Again,
this financial analysis is to establish a baseline, before we pile on the
strategic value components.
We try to assign values for miscellaneous assets that the
seller is providing to the buyer. Don't overlook the strategic value of Blue
Chip accounts. Those accounts become a platform for the buyer's complete
product suite being offered post acquisition into an "installed
account." It is a lot easier to market add-on applications and products into
an loyal account than it is to close that new account. These strategic accounts
can possess huge importance to a purchaser.
Lastly, we use a customer acquisition cost model to propel
value in the eyes of a prospective buyer. Let's say that your sales
professional at 100% of Quota earns total salary and commissions of $125,000
and sells 5 net new accounts. That would mean that your base customer
acquisition cost per account was $25,000. Add a 20% company overhead for the 85
accounts, for example, and the company value, using this calculation would be
$2,550,000.
After reading this you may be saying to yourself, come on,
this is a little far-fetched. These factors do have real value, but that value
is open to a varied interpretation by the marketplace. We are trying to assign
metrics to a very subjective set of components. The buyers are intelligent, and
practiced in the Merger and Acquisition process and quite frankly, they try to
repel these inventive approaches to driving up their economic outlay. The
greatest leverage point we have is that those buyers recognize that we are
presenting the same analysis to their competitors and they don't know which
component or components of value that we have presented will resonate with
their competition. In the final analysis, we are just trying to provide the
buyers some reasonable explanation for their board of directors to justify
paying far more than a financial multiple for our client's
Dave Kauppi is a Merger and Acquisition Advisor and Managing Director of MidMarket Capital, providing business broker and investment banking services to owners in the sale of information technology companies. To view our lists of buyers and sellers click to visit our Web Site MidMarket Capital
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