You have made the decision to sell your Social Media technology company. Maybe it was because your prospects are selecting the inferior product but superior safety of your brand name competitor. It could be that one of the industry giants recently acquired one of your small but worthy competitors and has removed the risk component of a buyer's decision. You may think that you have a limited window of opportunity for your Cloud-Based or Mobile Enabled technology solution and you should sell it while it still enjoys a competitive advantage.
These are all good reasons to set your business sale process in motion. A critical element here is time. Good technology not achieving meaningful market penetration is vulnerable to competition. Given this scenario, the more rapidly you can get your acquisition opportunity in front of the viable buyers, the better your chance for more favorable sale terms and conditions.
All systems go, right? But wait. We have a major proposal out to that international advertising agency and when we get that deal our sale price will sky rocket. So we are just going to wait for that deal to close and then put our company up for sale.
Let me give you a gem here. We will call it the Moving Sales Pipeline Theorem. It states that the sales pipeline always moves to the right. This is based on over 20 years in technology sales and sales management experience and many years of selling companies with sales pipelines. The sales either take much longer than projected or do not materialize at all.
Given this, the time critical nature of your pending emerging technology business sale, and your desire to ring the bell from your advertising agency deal, what do you do?
You engage a great M&A firm that specializes in Information Technology companies (I know of one if you are interested) to sell your business. Let them focus on selling your business and you focus on running your business and closing that big sale.
Get several buyers interested and negotiate for your best deal. There will be a lot of give and take here. At the right moment, as a counter to one of the buyer's points, you ask for a 6-month window, post acquisition to close that deal. You then ask, for example, for an earn out incentive of 50% of the contracted first year revenues of the advertising agency deal as "additional transaction value" payable 30 days after the one year purchase anniversary date.
There are lots of moving parts here so let me elaborate. The first element is you do not delay your business sale process. We already established that it was time critical. Secondly, I very carefully chose the language "additional transaction value". We want to make sure that this payment is not confused with ordinary income at double the long term capital gains tax rate. Third, you have a way better chance of closing the big advertising agency as a division of Google, SalesForce.com, or LinkedIn, for example, than as XYZ Mobile Media Software, Inc. Finally, what a great way to kick off a relationship than a big collaborative sales win that makes the buyer look really smart. Your earn out check will be the most enjoyable payment they can make.
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
Showing posts with label Cloud-Based. Show all posts
Showing posts with label Cloud-Based. Show all posts
Sunday, February 2, 2014
Looking to Sell a Software Company - Consider an Merger and Acquisition Advisor
Perhaps the most important business transaction you will ever pursue is the sale of your business. Many information technology business owners attempt to do it themselves and when asked if they got a good deal, many respond with "I think so," or "I got my asking price," or "I really don't know," or "It was a disaster." Often times these very capable business people approach the sale of their high-tech 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 M&A Advisor and what am I getting for the fees I will pay?
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 M&A Advisor 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
Business Continuity. Selling a business is a full time job. The healthcare 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.
Time to Close. Since an M&A Advisor'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.
Large Universe of Buyers. M&A Advisors subscribe to databases of the various information technology business categories that enable them to screen for buyers that are in a certain SIC Code and have revenues that would support the potential acquisition. In addition they maintain custom software company databases of the various categories refined even further like CRM, ERP, document management, mobility management, security, vertical industry, SaaS, and many more, to hone in on only the best potential buyers for your business. A good M&A Advisor also has access to private equity groups databases that outline their buying criteria.
Marketing. An M&A 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. Higher EBITDA = higher selling price. He understands the key value drivers for buyers in a particular software segment and can help the owner identify changes that translate into enhanced selling price.
Valuation Knowledge. The value of a software business is far more difficult to ascertain than the value of a house or even the value of a "bricks and mortar" type business. Every business is unique and has hundreds of variables that effect value. M&A Advisors 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 financially viable parties bidding for his business. An information technology industry transaction database may indicate the value of your business based on certain valuation multiples, but the market provides the real answer. An industry database, for example, can not put a value to a particular buyer on a key customer relationship or a proprietary technology. Most business owners that act as their own M&A Advisor get only one buyer involved – either another business that approaches him with an unsolicited offer or a referral from his banker, accountant, or outside attorney. Just look at the additional billion plus dollars of value created for MCI shareholders because of the competitive bidding between Verison and Quest Communications.
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." By engaging an M&A Advisor the seller has an advocate with a similar experience base to help preserve the seller's transaction value and structure.
Maximize the Value of Seller's Outside Professionals. An M&A Advisor 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 M&A Advisor, that sometimes-exhaustive negotiation process would default to the outside attorney. It is not his area of expertise and could result in significant hourly fees.
Maintain Buyer – Seller Relationship. The sale of a business is an emotional process and can become contentious. The M&A Advisor 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. Many times the seller will become an integral part of the management team of the buyer's company after the sale. 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.
A model that is becoming quite popular in the software industry is for the big players to identify good technologies in smaller companies and to forge partnerships or strategic alliances with them. The larger company will have the smaller company spend a great deal of their resources and attention in educating the bigger player on their product and market. The smaller partner will often work very hard to integrate their offering into the broad product set of the bigger partner. Finally, the smaller company will put all their eggs into this one basket of opportunity. After the larger company has effectively removed most of the integration risk on the smaller company's nickel, they then make an unsolicited offer to buy. The smaller company is often less profitable during this "try it before you buy it period." The bigger player then predicates their offer on the latest period financials.
A good M&A Advisor can help the smaller company navigate and recover from this situation. Our experiences with businesses that engaged our firm as a result of an unsolicited offer from a buyer have been quite instructive. The eventual selling price averaged over 20% higher than the first offer. In no case was the business sold at the initial price.
To conclude, an M&A Advisor helps reduce the risk of business erosion with improved confidentiality while allowing the owner to focus on running the business. The M&A Advisor led sale helps maximize sales proceeds by involving a large universe of buyers in a competitive bidding process. Finally, the M&A Advisor 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
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 M&A Advisor 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
Business Continuity. Selling a business is a full time job. The healthcare 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.
Time to Close. Since an M&A Advisor'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.
Large Universe of Buyers. M&A Advisors subscribe to databases of the various information technology business categories that enable them to screen for buyers that are in a certain SIC Code and have revenues that would support the potential acquisition. In addition they maintain custom software company databases of the various categories refined even further like CRM, ERP, document management, mobility management, security, vertical industry, SaaS, and many more, to hone in on only the best potential buyers for your business. A good M&A Advisor also has access to private equity groups databases that outline their buying criteria.
Marketing. An M&A 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. Higher EBITDA = higher selling price. He understands the key value drivers for buyers in a particular software segment and can help the owner identify changes that translate into enhanced selling price.
Valuation Knowledge. The value of a software business is far more difficult to ascertain than the value of a house or even the value of a "bricks and mortar" type business. Every business is unique and has hundreds of variables that effect value. M&A Advisors 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 financially viable parties bidding for his business. An information technology industry transaction database may indicate the value of your business based on certain valuation multiples, but the market provides the real answer. An industry database, for example, can not put a value to a particular buyer on a key customer relationship or a proprietary technology. Most business owners that act as their own M&A Advisor get only one buyer involved – either another business that approaches him with an unsolicited offer or a referral from his banker, accountant, or outside attorney. Just look at the additional billion plus dollars of value created for MCI shareholders because of the competitive bidding between Verison and Quest Communications.
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." By engaging an M&A Advisor the seller has an advocate with a similar experience base to help preserve the seller's transaction value and structure.
Maximize the Value of Seller's Outside Professionals. An M&A Advisor 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 M&A Advisor, that sometimes-exhaustive negotiation process would default to the outside attorney. It is not his area of expertise and could result in significant hourly fees.
Maintain Buyer – Seller Relationship. The sale of a business is an emotional process and can become contentious. The M&A Advisor 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. Many times the seller will become an integral part of the management team of the buyer's company after the sale. 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.
A model that is becoming quite popular in the software industry is for the big players to identify good technologies in smaller companies and to forge partnerships or strategic alliances with them. The larger company will have the smaller company spend a great deal of their resources and attention in educating the bigger player on their product and market. The smaller partner will often work very hard to integrate their offering into the broad product set of the bigger partner. Finally, the smaller company will put all their eggs into this one basket of opportunity. After the larger company has effectively removed most of the integration risk on the smaller company's nickel, they then make an unsolicited offer to buy. The smaller company is often less profitable during this "try it before you buy it period." The bigger player then predicates their offer on the latest period financials.
A good M&A Advisor can help the smaller company navigate and recover from this situation. Our experiences with businesses that engaged our firm as a result of an unsolicited offer from a buyer have been quite instructive. The eventual selling price averaged over 20% higher than the first offer. In no case was the business sold at the initial price.
To conclude, an M&A Advisor helps reduce the risk of business erosion with improved confidentiality while allowing the owner to focus on running the business. The M&A Advisor led sale helps maximize sales proceeds by involving a large universe of buyers in a competitive bidding process. Finally, the M&A Advisor 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
Selling a Security Software Company - Bridging the Valuation Gap between Business Seller and Business Buyer
In an earlier article we discussed a survey that we did with the Business Broker and the Merger and Acquisition profession. 68.9% of respondents felt that their top challenge was dealing with their seller client's valuation expectations. This is the number one reason that, as one national Investment Banking firm estimates only 10% of businesses that are for sale will actually close within 3 years of going to market. That is a 90% failure rate.
As we look to improve the performance of our practice, we looked for ways to judge the valuation expectations and reasonableness of our potential client. An M&A firm that fails to complete the sale of a client, even if they charged an up-front or monthly fees, suffers a financial loss along with their client. Those fees are not enough to cover the amount of work devoted to these projects. We determined that having clients with reasonable value expectations was a key success factor.
We explored a number of options including preparing a mock letter of intent to present to the client after analyzing his business. This mock LOI included not only transaction value, but also the amount of cash at closing, earn outs, seller notes and any other factors we felt would be components of a market buyer offer. If you can believe it, that mock LOI was generally not well received. For example, one client was a service business and had no recurring revenue contracts in place. In other words, their next year's revenues had to be sold and delivered next year. Their assets were their people and their people walked out the door every night.
Our mock LOI included a deal structure that proposed 70% of transaction value would be based on a percentage of the next four years of revenue performance as an earn out payment. Our client was adamant that this structure would be a non-starter. Fast forward 9 months and 30 buyers that had signed Confidentiality Agreements and reviewed the Memorandum withdrew from the buying process. It was only after that level of market feedback was he willing to consider the message of the market.
We decided to eliminate this approach because the effect was to put us sideways with our client early in the M&A process. The clients viewed our attempted dose of reality as not being on their side. No one likes to hear that you have an ugly baby. We found the reaction from our clients almost that pronounced.
We tried probing into our clients' rationale for their valuation expectations and we would hear such comments as, "This is how much we need in order to retire and maintain our lifestyle," or, "I heard that Acme Security Software sold for 1 X revenues," or, "We invested $3 million in developing this software, so we should get at least $4.5 million."
My unspoken reaction to these comments is that the market doesn't care what you need to retire. It doesn't care how much you invested in the product. The market does care about valuation multiples, but timing, company characteristics and circumstances are all unique and different. When our client brings us an example of IBM bought XYZ Enterprise Security Software Company for 2 X revenues so we should get 2X revenues. It is simply not appropriate to draw a conclusion about your value when compared to an IBM acquired company. You have revenues of $6 million and they had $300 million in revenue, were in business for 28 years, had 2,000 installed customers, were cash flowing $85 million annually and are a recognized brand name. Larger information technology companies carry a valuation premium compared to small companies.
When I say my unspoken reaction, please refer to my success with the mock LOI discussed earlier. So now we are on to Plan C in how to deal with this valuation gap between our seller clients and the buyers that we present. Plan C turned out to be a bust also. Our clients did not respond very favorable when in response to their statement of value expectations we asked, "Are you kidding me?" or "What are you smoking?"
This issue becomes even more difficult when the business is heavily based on intellectual property such as a software or information technology firm or in a hot area like Security, Mobility Management, SaaS or Cloud Services. There is much broader interpretation by the market than for more traditional bricks and mortar firms. With the asset based businesses we can present Industry Comps that provide us and our clients a range of possibilities. If a business is to sell outside of the usual parameters, there must be some compelling value creator like a coveted customer list, a new SaaS or Cloud Based offering, a new mobile application, proprietary intellectual property, unusual profitability, rapid growth, significant barriers to entry, or something that is not easily duplicated.
For an information technology, computer technology, security software or healthcare company, Comps are helpful and are appropriate for gift and estate valuations, key man insurance, and for a starting point for a company sale. However, because the market often values these kinds of companies very generously in a competitive bid process, we recommend -just that, when trying to determine value in a company sale. The value is significantly impacted by the professional M&A process. In these companies where there can be broad interpretation of its value by the market it is essential to conduct the right process to unlock all of the value.
So you might be thinking, how do we handle value expectations in these technology based company situations? Now we are on to Plan D and I must admit it is a big improvement over Plan C (are you kidding)? The good news is that Plan D has the highest success rate. The bad news is that Plan D is the most difficult. We have determined that we as M&A professionals are not the right authority on our client's value, the market is.
After years of what are some of the most emotionally charged events in a business owner's life, we have determined that we must earn our credibility to fully gain his trust. If the client feels like his broker or investment banker is just trying to get him to accept the first deal so that the representative can earn his success fee, there will be no trust and probably no deal.
If the client sees his representatives bring multiple, qualified buyers to the table, present the opportunity intelligently and strategically, fight for value creation, and provide buyer feedback, that process creates credibility and trust. The client may not be totally satisfied with the value the market is communicating, but he should be totally satisfied that we have brought him the market. If we can get to that point, the likelihood of a completed transaction increases dramatically.
The client is now faced with a very difficult decision and a test of reasonableness. Can he interpret the market feedback, balance that against the potential disappointment resulting from his preconceived value expectations and complete a transaction?
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
As we look to improve the performance of our practice, we looked for ways to judge the valuation expectations and reasonableness of our potential client. An M&A firm that fails to complete the sale of a client, even if they charged an up-front or monthly fees, suffers a financial loss along with their client. Those fees are not enough to cover the amount of work devoted to these projects. We determined that having clients with reasonable value expectations was a key success factor.
We explored a number of options including preparing a mock letter of intent to present to the client after analyzing his business. This mock LOI included not only transaction value, but also the amount of cash at closing, earn outs, seller notes and any other factors we felt would be components of a market buyer offer. If you can believe it, that mock LOI was generally not well received. For example, one client was a service business and had no recurring revenue contracts in place. In other words, their next year's revenues had to be sold and delivered next year. Their assets were their people and their people walked out the door every night.
Our mock LOI included a deal structure that proposed 70% of transaction value would be based on a percentage of the next four years of revenue performance as an earn out payment. Our client was adamant that this structure would be a non-starter. Fast forward 9 months and 30 buyers that had signed Confidentiality Agreements and reviewed the Memorandum withdrew from the buying process. It was only after that level of market feedback was he willing to consider the message of the market.
We decided to eliminate this approach because the effect was to put us sideways with our client early in the M&A process. The clients viewed our attempted dose of reality as not being on their side. No one likes to hear that you have an ugly baby. We found the reaction from our clients almost that pronounced.
We tried probing into our clients' rationale for their valuation expectations and we would hear such comments as, "This is how much we need in order to retire and maintain our lifestyle," or, "I heard that Acme Security Software sold for 1 X revenues," or, "We invested $3 million in developing this software, so we should get at least $4.5 million."
My unspoken reaction to these comments is that the market doesn't care what you need to retire. It doesn't care how much you invested in the product. The market does care about valuation multiples, but timing, company characteristics and circumstances are all unique and different. When our client brings us an example of IBM bought XYZ Enterprise Security Software Company for 2 X revenues so we should get 2X revenues. It is simply not appropriate to draw a conclusion about your value when compared to an IBM acquired company. You have revenues of $6 million and they had $300 million in revenue, were in business for 28 years, had 2,000 installed customers, were cash flowing $85 million annually and are a recognized brand name. Larger information technology companies carry a valuation premium compared to small companies.
When I say my unspoken reaction, please refer to my success with the mock LOI discussed earlier. So now we are on to Plan C in how to deal with this valuation gap between our seller clients and the buyers that we present. Plan C turned out to be a bust also. Our clients did not respond very favorable when in response to their statement of value expectations we asked, "Are you kidding me?" or "What are you smoking?"
This issue becomes even more difficult when the business is heavily based on intellectual property such as a software or information technology firm or in a hot area like Security, Mobility Management, SaaS or Cloud Services. There is much broader interpretation by the market than for more traditional bricks and mortar firms. With the asset based businesses we can present Industry Comps that provide us and our clients a range of possibilities. If a business is to sell outside of the usual parameters, there must be some compelling value creator like a coveted customer list, a new SaaS or Cloud Based offering, a new mobile application, proprietary intellectual property, unusual profitability, rapid growth, significant barriers to entry, or something that is not easily duplicated.
For an information technology, computer technology, security software or healthcare company, Comps are helpful and are appropriate for gift and estate valuations, key man insurance, and for a starting point for a company sale. However, because the market often values these kinds of companies very generously in a competitive bid process, we recommend -just that, when trying to determine value in a company sale. The value is significantly impacted by the professional M&A process. In these companies where there can be broad interpretation of its value by the market it is essential to conduct the right process to unlock all of the value.
So you might be thinking, how do we handle value expectations in these technology based company situations? Now we are on to Plan D and I must admit it is a big improvement over Plan C (are you kidding)? The good news is that Plan D has the highest success rate. The bad news is that Plan D is the most difficult. We have determined that we as M&A professionals are not the right authority on our client's value, the market is.
After years of what are some of the most emotionally charged events in a business owner's life, we have determined that we must earn our credibility to fully gain his trust. If the client feels like his broker or investment banker is just trying to get him to accept the first deal so that the representative can earn his success fee, there will be no trust and probably no deal.
If the client sees his representatives bring multiple, qualified buyers to the table, present the opportunity intelligently and strategically, fight for value creation, and provide buyer feedback, that process creates credibility and trust. The client may not be totally satisfied with the value the market is communicating, but he should be totally satisfied that we have brought him the market. If we can get to that point, the likelihood of a completed transaction increases dramatically.
The client is now faced with a very difficult decision and a test of reasonableness. Can he interpret the market feedback, balance that against the potential disappointment resulting from his preconceived value expectations and complete a transaction?
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
Sell a Cloud-Based Software Company - Ten Costly Mistakes That Reduce Your Transaction Proceeds
Selling your Cloud-Based Software Company is the most important transaction you will ever make. Mistakes in this process can greatly erode your transaction proceeds. Do not spend twenty years of your toil and skill building your business like a pro only to exit like an amateur. Below are ten common mistakes to avoid:
Selling because of an unsolicited offer to buy – One of the most common reasons owners tell us they sold their business was they got an offer from another Software as a Service (SaaS) Company, or more often these days, an overseas company looking to buy a customer base in the United States. If you previously were not considering this business sale, you probably have not taken some important personal and business steps to exit on your terms. The business may have some easily correctable issues that could detract from its value. You may not have prepared for an identity and lifestyle to replace the void caused by the separation from your company. If you are prepared, you are more likely to exit on your own terms.
Poor books and records – Business owners wear many hats. Sometimes they become so focused on the next SaaS, Cloud Based, or Mobile version release that they are lax in financial record keeping. A buyer is going to do a comprehensive look into your financial records. If they are done poorly, the buyer loses confidence in what he is buying and his perception of risk increases. If he finds some negative surprises late in the process, the purchase price adjustments can be harsh. The transaction value is often attacked well beyond the economic impact of the surprise. Get a good accountant to do your books.
Going it alone – The business owner may be the foremost expert in ERP, CRM, Security, or Mobility Management Software, but it is likely that his business sale will be a once in a lifetime occurrence. Mistakes at this juncture have a huge impact. It is especially critical to have a good M&A advisor if you are selling a Web- Based information technology company because these companies do not fit traditional company valuation metrics. If an owner does not get the right representation and have several qualified buyers that covet his technology, he possibly can leave a lot of money on the table. Selling a software company is complex. Is it a better deal to structure some of the transaction value as an earn out based on post acquisition sales performance? Do you understand the difference in after tax proceeds between an asset sale and a stock sale? Your everyday bookkeeper may not, but a tax accountant surely does. Is your business attorney familiar with business sales legal work? Would he advise you properly on Reps and Warranties that will be in the purchase agreement? Your buyer's team will have this experience. Your team should match that experience of it will cost you way more than their fees.
Skeletons in the closet - If your company has any, the due diligence process will surely reveal them. One of the key issues in software companies is the clear title to intellectual property. Are your employee agreements well written? If you hired outside programmers, was their agreement specific in ownership of their output? The concern of the buyer is that once it becomes public that the deep pockets company is owner, previous disgruntled employees or contractors may resurface looking to bring legal action. Before your firm is turned inside out and the buyer spends thousands in this process and before the other interested buyers are put on hold – reveal that problem up-front. We sold a company that had an outstanding CFO. In the first meeting with us, he told us of his company's under funded pension liability. We were able to bring the appropriate legal and actuarial resources to the table and give the buyer and his advisors plenty of notice to get their arms around the issue. If this had come up late in the process, the buyer might have blown up the deal or attacked transaction value for an amount far in excess of the potential liability.
Letting the word out - Confidentiality in the business sale process is crucial. If your larger legacy software competitors or hard-charging new competitors find out, they can cause a lot of damage to your customers and prospects. It can be a big drain on employee morale and productivity. What if your head of systems development gets skittish and entertains offers from other companies and leaves while you are selling? The buyer wants your top people and they represent a significant portion of your future transaction value. If word you are for sale gets out, your suppliers and bankers get nervous. Nothing good happens when the work gets out that your company is for sale.
Poor Contracts – Here we mean the day-to-day contracts that are in place with employees, customers, contractors, and suppliers. Do your employees have non-competes, for example? If your company has intellectual property, do you have very clear ownership rights defined in your employee and contractor agreements. If not, you could be looking at meaningful escrow holdbacks post closing. Are your customer agreements assignable without consent? If they are not, customers could cancel post transaction. Your buyer will make you pay for this one way or another. If you are tempted to sign that big deal at bargain rates to pump up your business selling price, think again. Locking in a contract at below market rates could actually cause a discount to your selling price.
Bad employee behavior – You need to make sure you have agreements in place so that employees cannot hold you hostage on a pending transaction. Key employees are key to transaction value. If you suspect there are issues, you may want to implement stay on bonuses. If you have a bad actor, firing him or her during a transaction could cause issues. You may want to be pre-emptive with your buyer and minimize any damage your employee might cause.
No understanding of your company's value – Business valuations are complex especially in a hot area like Web-Based software, Business Intelligence software, Cloud Based analytics solutions or Mobility Management. A good business broker or M & A advisor that has experience in the software industry is your best bet. Business valuation firms are great for business valuations for gift and estate tax situations, divorce, etc. They tend to be very conservative and their results could vary significantly from your results from three strategic buyers in a battle to acquire your firm. Where a services business may sell for between 75% and 100% of last years sales, for example, SaaS companies are all over the map. One of our clients had a coveted piece of software technology and was able to get 8 X last year's sales as his purchase price. We certainly could not have and would not have predicted that at the start of the engagement, but what a nice surprise. When it comes to selling your information technology company, let the competitive market provide a value.
Getting into an auction of one – This is a silly visual, but imagine a big auction hall at Sotheby's occupied by an auctioneer and one guy with an auction paddle. "Do I hear $5 million? Anybody $5.5 million?' The guy is sitting on his paddle. Pretty silly, right? And yet we hear countless stories about a competitor coming in with an unsolicited offer and after a little light negotiating the owner sells. Another common story is the owner tells his banker, lawyer, or accountant that he is considering selling. His well-meaning professional says, "I have another client that is an information technology company. I will introduce you." The next thing you know the business is sold. Believe me, these folks are buying your business at a big discount. That's not silly at all!
Giving away value in negotiations and due diligence – When selling your business, your objective is to get the best terms and conditions. I know this is a shocker, but the buyer is trying to pay as little as possible and he is trying to get contractual terms favorable to him. These goals are not compatible with yours. The buyer is going to fight hard on issues like total price, cash at close, earn outs, seller notes, reps and warranties, escrow and holdbacks, post closing adjustments, etc. If you get into a meet in the middle compromise negotiation, before you know it, your Big Mac is a Junior Cheeseburger. Due diligence has a dual purpose. The first is obviously to insure that the buyer knows exactly what he is paying for. The second is to attack transaction value with adjustments. Of course this happens after their LOI has sent the other bidders away for 30 to 60 days of exclusivity. If you don't have a good team of advisors, this can get expensive.
Not understanding post-closing adjustments in working capital. This point is especially critical for smaller software companies that are being acquired by larger public companies. Savvy buyers (most of them are because they have done multiple prior software company acquisitions) will include language in the LOI (letter of intent) that sets a net working capital level at closing. Any overage will be paid to the seller as additional transaction proceeds. Any shortage will be deducted from the purchase price. The LOI also stipulates that this calculation will be made using GAAP or generally accepted accounting principles. GAAP is an accrual based accounting system while most smaller companies operate under a cash accounting system. So for example, if you collect your annual software maintenance or license fees up-front on the anniversary date, you likely have recognized the entire amount as revenue. Under accrual accounting you actually get to recognize 1/12 of the amount each month and you have a liability of undelivered services. This can destroy the net working capital level and cause a huge net working capital adjustment at closing. We advise our clients to require very precise language in the letter of intent about the level of net working calculation and the method of calculation, including examples and formulas.
As my dad used to say, there is no replacement for experience. Another saying is that when a man with money and no experience meets a man with experience, the man with the experience walks away with the money and the man with the money walks away with some experience. Keep this in mind when contemplating the sale of your software as a service company. It will likely be your first and only experience. Avoid these mistakes and make that experience a profitable one.
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
Selling because of an unsolicited offer to buy – One of the most common reasons owners tell us they sold their business was they got an offer from another Software as a Service (SaaS) Company, or more often these days, an overseas company looking to buy a customer base in the United States. If you previously were not considering this business sale, you probably have not taken some important personal and business steps to exit on your terms. The business may have some easily correctable issues that could detract from its value. You may not have prepared for an identity and lifestyle to replace the void caused by the separation from your company. If you are prepared, you are more likely to exit on your own terms.
Poor books and records – Business owners wear many hats. Sometimes they become so focused on the next SaaS, Cloud Based, or Mobile version release that they are lax in financial record keeping. A buyer is going to do a comprehensive look into your financial records. If they are done poorly, the buyer loses confidence in what he is buying and his perception of risk increases. If he finds some negative surprises late in the process, the purchase price adjustments can be harsh. The transaction value is often attacked well beyond the economic impact of the surprise. Get a good accountant to do your books.
Going it alone – The business owner may be the foremost expert in ERP, CRM, Security, or Mobility Management Software, but it is likely that his business sale will be a once in a lifetime occurrence. Mistakes at this juncture have a huge impact. It is especially critical to have a good M&A advisor if you are selling a Web- Based information technology company because these companies do not fit traditional company valuation metrics. If an owner does not get the right representation and have several qualified buyers that covet his technology, he possibly can leave a lot of money on the table. Selling a software company is complex. Is it a better deal to structure some of the transaction value as an earn out based on post acquisition sales performance? Do you understand the difference in after tax proceeds between an asset sale and a stock sale? Your everyday bookkeeper may not, but a tax accountant surely does. Is your business attorney familiar with business sales legal work? Would he advise you properly on Reps and Warranties that will be in the purchase agreement? Your buyer's team will have this experience. Your team should match that experience of it will cost you way more than their fees.
Skeletons in the closet - If your company has any, the due diligence process will surely reveal them. One of the key issues in software companies is the clear title to intellectual property. Are your employee agreements well written? If you hired outside programmers, was their agreement specific in ownership of their output? The concern of the buyer is that once it becomes public that the deep pockets company is owner, previous disgruntled employees or contractors may resurface looking to bring legal action. Before your firm is turned inside out and the buyer spends thousands in this process and before the other interested buyers are put on hold – reveal that problem up-front. We sold a company that had an outstanding CFO. In the first meeting with us, he told us of his company's under funded pension liability. We were able to bring the appropriate legal and actuarial resources to the table and give the buyer and his advisors plenty of notice to get their arms around the issue. If this had come up late in the process, the buyer might have blown up the deal or attacked transaction value for an amount far in excess of the potential liability.
Letting the word out - Confidentiality in the business sale process is crucial. If your larger legacy software competitors or hard-charging new competitors find out, they can cause a lot of damage to your customers and prospects. It can be a big drain on employee morale and productivity. What if your head of systems development gets skittish and entertains offers from other companies and leaves while you are selling? The buyer wants your top people and they represent a significant portion of your future transaction value. If word you are for sale gets out, your suppliers and bankers get nervous. Nothing good happens when the work gets out that your company is for sale.
Poor Contracts – Here we mean the day-to-day contracts that are in place with employees, customers, contractors, and suppliers. Do your employees have non-competes, for example? If your company has intellectual property, do you have very clear ownership rights defined in your employee and contractor agreements. If not, you could be looking at meaningful escrow holdbacks post closing. Are your customer agreements assignable without consent? If they are not, customers could cancel post transaction. Your buyer will make you pay for this one way or another. If you are tempted to sign that big deal at bargain rates to pump up your business selling price, think again. Locking in a contract at below market rates could actually cause a discount to your selling price.
Bad employee behavior – You need to make sure you have agreements in place so that employees cannot hold you hostage on a pending transaction. Key employees are key to transaction value. If you suspect there are issues, you may want to implement stay on bonuses. If you have a bad actor, firing him or her during a transaction could cause issues. You may want to be pre-emptive with your buyer and minimize any damage your employee might cause.
No understanding of your company's value – Business valuations are complex especially in a hot area like Web-Based software, Business Intelligence software, Cloud Based analytics solutions or Mobility Management. A good business broker or M & A advisor that has experience in the software industry is your best bet. Business valuation firms are great for business valuations for gift and estate tax situations, divorce, etc. They tend to be very conservative and their results could vary significantly from your results from three strategic buyers in a battle to acquire your firm. Where a services business may sell for between 75% and 100% of last years sales, for example, SaaS companies are all over the map. One of our clients had a coveted piece of software technology and was able to get 8 X last year's sales as his purchase price. We certainly could not have and would not have predicted that at the start of the engagement, but what a nice surprise. When it comes to selling your information technology company, let the competitive market provide a value.
Getting into an auction of one – This is a silly visual, but imagine a big auction hall at Sotheby's occupied by an auctioneer and one guy with an auction paddle. "Do I hear $5 million? Anybody $5.5 million?' The guy is sitting on his paddle. Pretty silly, right? And yet we hear countless stories about a competitor coming in with an unsolicited offer and after a little light negotiating the owner sells. Another common story is the owner tells his banker, lawyer, or accountant that he is considering selling. His well-meaning professional says, "I have another client that is an information technology company. I will introduce you." The next thing you know the business is sold. Believe me, these folks are buying your business at a big discount. That's not silly at all!
Giving away value in negotiations and due diligence – When selling your business, your objective is to get the best terms and conditions. I know this is a shocker, but the buyer is trying to pay as little as possible and he is trying to get contractual terms favorable to him. These goals are not compatible with yours. The buyer is going to fight hard on issues like total price, cash at close, earn outs, seller notes, reps and warranties, escrow and holdbacks, post closing adjustments, etc. If you get into a meet in the middle compromise negotiation, before you know it, your Big Mac is a Junior Cheeseburger. Due diligence has a dual purpose. The first is obviously to insure that the buyer knows exactly what he is paying for. The second is to attack transaction value with adjustments. Of course this happens after their LOI has sent the other bidders away for 30 to 60 days of exclusivity. If you don't have a good team of advisors, this can get expensive.
Not understanding post-closing adjustments in working capital. This point is especially critical for smaller software companies that are being acquired by larger public companies. Savvy buyers (most of them are because they have done multiple prior software company acquisitions) will include language in the LOI (letter of intent) that sets a net working capital level at closing. Any overage will be paid to the seller as additional transaction proceeds. Any shortage will be deducted from the purchase price. The LOI also stipulates that this calculation will be made using GAAP or generally accepted accounting principles. GAAP is an accrual based accounting system while most smaller companies operate under a cash accounting system. So for example, if you collect your annual software maintenance or license fees up-front on the anniversary date, you likely have recognized the entire amount as revenue. Under accrual accounting you actually get to recognize 1/12 of the amount each month and you have a liability of undelivered services. This can destroy the net working capital level and cause a huge net working capital adjustment at closing. We advise our clients to require very precise language in the letter of intent about the level of net working calculation and the method of calculation, including examples and formulas.
As my dad used to say, there is no replacement for experience. Another saying is that when a man with money and no experience meets a man with experience, the man with the experience walks away with the money and the man with the money walks away with some experience. Keep this in mind when contemplating the sale of your software as a service company. It will likely be your first and only experience. Avoid these mistakes and make that experience a profitable one.
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
Sell Your Information Technology Company -Why Pay an Investment Banker?
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
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
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
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