Important Indicators are Up

Because I help companies define an exit strategy and grow value accordingly, I’m always seeking better sources of data that capture the current state of the investment world. Pitchbook is one source that publishes particularly useful information about fundraising, investments, and exits. A recent Pitchbook presentation suggests that we’re on the verge of significant growth in private equity investment during the next year, and that’s good news companies moving toward an exit.

One factor mentioned in the Pitchbook prez is that capital overhang is high and growing. When that happens, valuations tend to increase because so much money is looking for a place to land and produce a return.

Additionally, chart below depicts that the number of quarterly private equity exits through corporate acquisitions, initial public offerings, and secondary sales is on the upswing after reaching a low in early 2009.

Finally, one of the best analysts in the business, Richard Davis of Needham and Company, commented in his newsletter that it’s been 25 years since he’s seen so many companies in a great position for an IPO.

Taken together, all these indicators suggest that, despite the continuing malaise in the broader economy, a CEO who keeps his/her company’s partnerships, product strategy, services, and partnerships aligned with potential acquirers can expect to see greater opportunity this year and through the next.

Clarity Affects the Bottom Line

Last week I spent a morning leading a management team through a strategic positioning session to achieve more clarity about their business. The next day I read an article containing this quote by the leader of a technology incubator:

My team and I probably saw, heard or read more than 200 business pitches last year. And after about 75 percent of them, we didn’t understand the businesses. I’m convinced that this is a primary cause of entrepreneurial failure. Every entrepreneur needs to be able to clearly and succinctly communicate the essence of his or her business to an intelligent stranger.

While it’s important for startups to have an elevator pitch, it’s equally important for the management team of an existing business to share a clear vision that provides a context for making business decisions. The lack of this understanding is so common among $10-50M companies that I’ve stopped being surprised when they can’t articulate a clear positioning statement. Why do you think so many companies have trouble with something so basic and so important? I have a theory.

Recently a CEO friend in Dallas shared the “PerformanceManagement” matrix below. While the origin is unclear, it’s a useful framework for examining issues, and it offers a clue as to why so many companies lack the clarity they need to operate efficiently.

Urgent Important Matrix

For many CEOs, sustaining an up-to-date picture of the company’s value in the market is either neglected or delegated to Marketing because it lacks urgency compared to operation issues and cost management. This falls under the heading of “Poor Planning.” The CEO’s number one priority is growing shareholder value, and clear strategic thinking contributes directly by enhancing the quality of important decisions affecting future value.

If you’re a CEO, do you stay on top of your company’s value in the eyes of players that matter, especially potential acquirers? Or will you leave this non-urgent critical issue unaddressed until the day you’re shocked to read that your closest competitor was just acquired by a company with whom they’d partnered?

Restart with the End in Mind

Chances are you’ve heard Stephen Covey’s Habit #2 in his classic self-help book called Seven Habits of Highly Effective People: “Begin with the end in mind.” Or said another way by the author of the Peter Principle, “If you don’t know where you’re going, you probably will end up somewhere else.”

When a business is launched, founders typically have a clear end in mind. A successful company survives the first couple of years and finds its way to profitability or at least breaks even. Then a critical point is encountered where the CEO’s focus on “where we’re going” can devolve into a focus on “staying alive.”

An early 20/20 Outlook post tagged the resulting condition as “The CEO Dilemma.” The CEO lets the pressure to fix operational issues and manage cash flow dictate a daily routine of addressing those needs and neglecting his/her responsibility to relentlessly consider how to grow shareholder value.  Working in instead of on the business becomes a comfortable norm.

If this sounds familiar, realize that you can hit the RESET button by employing the 20/20 Outlook process. Understand how simply saying “if I build a great business, I don’t need to worry about my exit strategy” can keep you from leading the pack among acquisition candidates in your market space.

Instead “restart with the end in mind” by considering the sources that contribute to the value of your company’s product and service offerings. Drill into how relationships with potential acquirers and potential acquisitions can unlock and grow that value. And create and implement a rational plan to align your company with other organizations that can help your business reach its full potential and move into a leadership position.

I’m On a Mission!

In Bob Dylan’s song “Gotta Serve Somebody” he points out that, no matter who we are, we all have to make significant choices:

You’re gonna have to serve somebody
Well, it may be the devil or it may be the Lord
But you’re gonna have to serve somebody

The implication is clear for our spiritual life, but the broader principle applies in our work life. At the core of what drives us are competing priorities, and the one at the top will be the “decider” most of the time. What is the top driver in your work life?

What drives me personally is a passion for building effective business partnerships. Over the years, I’ve seen great ones lift companies to new levels of value and effectiveness. Much more often, I’ve seen poorly planned ones consume significant resources with little or nothing to show for the effort.

Three principles characterize the most effective partnership strategies – context, planning, and execution:

Context means understanding your own organization and its offerings in relation to the market they live in. What kind of company are we? What value do we deliver? Whom do we compete against? How are we unique? A simple positioning project can bring great clarity of thinking and purpose, yet it’s amazing how unclear the answers to these questions often are.  If you don’t understand your own company, don’t expect success in partnering with others.

Planning partnerships is imperative. Stephen Covey’s second habit “Begin with the end in mind” is based on ancient wisdom from Aristotle that’s often ignored. Once armed with a clear understanding of your market positioning, you’re ready to think about partnering and what you want to accomplish. What is your vision for growing the value of your company? If you clearly understand where you’re going, business partnerships will help you get there faster.

Execution of partnerships requires effort and resources. Why expend time and effort in creating a business relationship only to let it die from lack of care? A partnership needs focus in order to produce expected benefits. Increasing the odds of success requires architecting self-sustaining elements into the partnership from the beginning, and that can only be done successfully through clarity of purpose and a clear vision for growth.

Anonymous, my all-time favorite writer, said it best:

“Action without Vision just passes time.”

Technology M&A Is Accelerating

A few days ago, I posted links to interesting articles in an exit strategy update. Indications are that the next 12-18 months  will produce an increase in the acquisition of technology companies, so having an exit strategy in place and aligning with potential acquirers remains top of mind for CEOs. Let’s review some of the evidence.

One significant indicator is that tech companies have started using debt to raise capital. A recent WSJ article said that “the decision to take on debt breaks from tradition in tech, where companies have typically preferred to raise money by selling stock. Debt has become a more attractive fundraising option largely because interest rates are low… Turning to debt is an especially big change for software companies, which typically generate lots of cash and aren’t saddled with large one-time expenses like opening a factory.”

While the focus of the article was on the largest companies like Cisco, Microsoft, H-P, Oracle Corp., International Business Machines Corp., and Dell Inc. who raised more than $20 billion combined in 2009 selling bonds, smaller companies are following suit. Salesforce.com’s $575M debt offering and Adobe’s of $1.5B, both in January, mean that the acquisition drive is broadening.

Yesterday StreetInsider.com quoted an FBR Capital Markets report that “software vendors are flush with cash given the cashflow-rich nature of the software model and more than a handful of vendors have even recently raised additional capital.” The FBR Capital report even suggested some likely acquisitions:

So what should CEOs of smaller technology companies who want to grow shareholder value do? At a minimum, three things:

  1. Understand who your most likely acquirers are and keep the list up-to-date.
  2. Ensure that your company stays focused on activities that increase your attractiveness to those acquirers.
  3. Create partnerships with potential acquirers and other companies who make your company more compelling to those acquirers.

Whether you want to be acquired in the short term or the long term, your company’s value is in the eye of the beholder, and the most important beholders are acquirers.

Exit Strategy Update 04/22/2010

WSJ: Tech Firms Bulk Up With Debt
“The decision to take on debt breaks from tradition in tech, where companies have typically preferred to raise money by selling stock. Debt has become a more attractive fundraising option largely because interest rates are low. The shift comes as mergers and acquisitions are reshaping the industry, with a handful of tech giants that have huge cash hoards—such as Cisco Systems Inc. and Hewlett-Packard Co.—snapping up firms. Now smaller tech companies are hoping that adding debt will allow them to get in the buying game.”

Virtual Intelligence Briefing: AOL dumps $850M Bebo acquisition – Why big M&A rarely works
“Don’t pay product valuations for feature companies – It is a good strategy to acquire small companies to gain super star employees, cool new features, and access to new market segments. But, the acquiring company needs the discipline to only pay a valuation commensurate with a “feature” not a “product”. Don’t add lots of valuation for synergies that probably won’t happen, or for revenue streams that may not materialize.”

WSJ: Eating Into Apple’s Cash Pile
“With a market cap of around five times book, Apple could choose to use its stock for large-scale acquisitions. But as its market value is around $220 billion, this would need to be a very large-scale acquisition indeed. To give some perspective—and not to propose these companies as targets—U.S. software giant Oracle Corp. has a market cap of around $130 billion, while European leader SAP AG is valued around $60 billion.”

MercuryNews: Palmisano Needs ‘Bold Strokes’ to Sustain IBM Growth
“Under Palmisano, IBM has spent $25 billion buying companies. Compare that with at least $42 billion for Oracle and Hewlett-Packard’s $45 billion. IBM’s share price had risen 31 percent in the Palmisano era, versus 53 percent for Oracle and 165 percent for Hewlett-Packard.”

Optimal Board Conversations

Based on feedback from experienced CEOs, getting the optimal value from boards of directors is a common challenge. Of course, it starts with picking solid board members. As serial CEO Bill Bock said recently, “Building a strong board is every bit as important as building a strong management team.” He recommends at a minimum that you include at least one very strong financial mind and at least one “crusty operational type” on your board to provide balanced guidance to the management team. “The ideal director sees a bigger world than the CEO.”

Assuming that you already have the right people, deriving value from them is up to you, the CEO. You have to engage their best thinking while keeping in mind that they don’t manage daily operations – you do. Giving too much or too little control to the board can decrease its value.

By focusing on growing the value of the company, the 20/20 Outlook process provides a constructive framework for discussions at the appropriate level. Another serial CEO, Mike Shultz, describes 20/20 Outlook as “a methodology that is clear and focused on developing the strategies to fulfill Job One for the CEO and in the process, creates a framework for solid communications with the Board of Directors about their most important measurement of success.” Job One, of course, is increasing shareholder value.

The diagram below depicts the continuum of choices a CEO has for achieving value from his/her board of directors:

Board Balance

Two common problematic relationships with boards can develop: micromanagers and cheerleaders . A CEO may allow the board to have too much control and encourage micromanagement. Since board members often have CEO and operational experience, they can be easily tempted to fill any perceived vacuum in leadership that you display as CEO. While reviewing financial and operational performance is valuable and appropriate, constrain the resulting conversation to high level suggestions for improvement rather than drilling into the nuts and bolts of daily operations. (If a particular board member has directly applicable experience, engage that person offline and don’t occupy the entire board’s time.)

On the other hand, a CEO who over-controls the board wastes everyone’s time. Having a board full of cheerleaders that rubber-stamps decisions and flatters the CEO may feel good, but it defeats the purpose of having directors and prevents their having an impact on the value of the business.

Either extreme implies weakness. The CEO who allows the board to micromanage may lack confidence in his/her ability to lead, while the CEO who totally controls the board may incapable of handling constructive criticism. Optimally you want to engage the board in strategic conversations about increasing shareholder value.

Are you having optimal conversations with your board?


When Should You Partner?

Given that we’ve answered the “why partner” question, now let’s think about the “when to partner” question. Marketplace issues, whether threats or opportunities, commonly drive partnership decisions. For each issue, consider three factors that determine your desire and ability to grow through partnering:

  • Timing: What is the timing associated with this threat or opportunity? Is it immediate or long-term?
  • Potential Impact: What is the potential impact of some threat or opportunity that is currently presenting itself? Is it high or low?
  • Ability to Respond: What is my current ability to respond? Is it strong or weak?

As far as the Timing factor goes, if an issue, i.e. a threat or an opportunity, is not immediate, set it aside. Maybe someday you’ll find time to worry about that one!

For each immediate issue, determine whether it can have a relatively high or low impact and how strong is your ability to respond. Here’s a diagram depicting these points, followed by a brief description of each one:

Partnerships When

High threat/opportunity, strong ability to respond (“Pursue Aggressively”)
This issue is too pressing to postpone, and your company has the resources needed to address it aggressively through product enhancement and new product creation.

Low threat/opportunity, strong ability to respond (“Quick Hits”)
When you spot a weakness in a competitor’s ability to respond to such an issue, attack by leveraging your strength in this area.

Low threat/opportunity, weak ability to respond (“Prepare to Respond”)
These are usually “who cares” issues now that may grow into high impact issues later, so keep an eye on them while doing little to address them.

High threat/opportunity, high ability to respond (“Create Partnerships”)
If you can’t adequately respond to a pressing threat or opportunity, a partnership is the right answer. A partnership can be a precursor to an acquisition.

If I’m right and I’ve communicated clearly, you have a better understanding of why and when to form a business relationship. These are practical business concepts that will ensure your efforts are directed at the best opportunities to achieve the desired outcome for your business – a business that knows where it’s going!

So Why Partner at All?

Developing a partnership strategy is a critical concern for any company. Key to its formulation is an understanding of why partnerships make sense and under what circumstances they should be pursued. Understanding the context for developing a partnership strategy clarifies the decisions that need to be made.

So why partner at all?

“Whether it sells computers, clothing, or cars, your firm’s fate is increasingly linked to that of many other firms, all of which must collaborate effectively in order for each to thrive…                                          more than ever before, success depends on managing assets your company doesn’t own.”            (from The Keystone Advantage by Marco Iansiti and Roy Levien)

While this is universally true, it’s especially the case in immature and fragmented markets where no one company can possibly own all the pieces of a solution. Customers face a bewildering array of possibilities and choices. Gaining their attention and commitment is not as simple as relating your value proposition. You’re not just selling against direct competitors – you’re usually competing for a piece of a finite budget, and the customer can choose to invest in another area while declining to buy anything from you or your competitors.

By understanding the broader space in which you compete and by knowing how your company fits within that broad context, you’re more likely to successfully educate your customer and help them move to a buying decision. If you’ve analyzed the total market and have partnered and/or acquired to achieve a more complete set of offerings, you’ll be in a position to meet almost any customer’s needs.

So what are the most common reasons to partner? Here are some that come to mind, in no particular order:

  • Increase: ability to deliver, credibility, revenue, market presence
  • Leverage market clout and intellectual assets of market-leading companies
  • Become certified on a process or technology
  • License a product or technology
  • Remove a competitor
  • Negotiate strategic alliances
  • Prepare to execute acquisitions

While these are fairly specific, here’s a matrix that boils the reasons down to the most common ones:

Partnerships Why

In evaluating potential partners, determine early on which drivers are important to your company, the partner, or both. Then begin compiling a list of specific factors that may be important to the target partner. These may become critically important in later negotiations (we’ll talk about “elegant negotiables” another time).

Next we’ll address the issue of when to partner, i.e. under what circumstances does it make sense).

Acquisition Market Outlook

The timing of an exit is naturally influenced by overall activity levels in the market, and today’s market outlook for acquisitions is mixed. The pace of merger and acquisition activity has slowed down somewhat, but the picture is far from bleak. Large strategic companies continue to grow through acquisition. Private equity investors still have capital and are looking for opportunities to put it to work. Owners of private companies are looking for timely exit strategies, and prices are still strong for high-quality assets.

While there were several high-profile deals in 2008, the volume of software acquisitions M&A transactions decreased from the previous year. Fewer large-scale transactions occurred, while middle-market deals were more prevalent.

M&A Market Dynamics

Valuations were generally steady. EBITDA values in 2008 were down less than 2% year over year, and 2008’s median EBITDA multiple remained higher than 2006. Buyers still seem willing to pay solid prices for attractive acquisitions.

What are the characteristics of software industry acquisition activity thus far in 2009?

M&A Market Dynamics - First Half

Overall transaction volume dropped 10% from the same period in 2008, and aggregate transaction value dropped 27%. On the other hand, large companies like Oracle and IBM remained very active, and most people I talk to expect the acquisition market to rebound somewhat in the middle of 2010.

BerkeryNoyes provides merger and acquisition services for middle market companies. Each year they publish reports on trends in acquisitions for key industries. Most of the research for today’s post was drawn from information on their site, which is included in the 20/20 Outlook blogroll.

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