Confessions of a Corporate Dealmaker

Why They Leave

Here's a bonus track for today.

Over the last few years, and especially since I started this blog, I have talked to a number of people who used to work in corporate development.  I always ask them why they left.  I think I have finally reached a statistically-sound sample size, and can tell you that the overwhelming majority of people who leave corporate development do so because they completed no deals during their tenure with the company.  It's not that they didn't complete enough deals, it's that they couldn't complete any deals.  Further, all of these people tell me there was plenty of deal flow, and they often signed LOI's and negotiated merger docs.  It's that their company's didn't have the cajones (thank you Guy) to close the deal.

Before you sign that LOI check your potential acquirer's track record, but more important look into the management team's record.  Does the acquirer have a new CEO or CFO (or even CIO) that has never done an acquisition?  What about their board - do the new members have acquisition backgrounds?

M&A is risky.  It takes a certain kind of management team to do deals.  Don't get pregnant and left at the alter.

Due Diligence & Integration

Last week I discussed how the deal screening process works, and with this post I'll finish up this series that looks inside the new corporate development function, by providing an overview of the due diligence and integration teams and committees.  In a future series I'll write about the tactical things you can do to make your company more attractive from a screening, diligence and integration standpoint.

Due diligence hasn't changed much over the years, but two trends I see more of these days are larger, multi-disciplined teams; and the use of due diligence committees.  It used to be that an attorney, banker, accountant and a couple of people from the company would sit in a law firm's conference room and wade through boxes of documents for a few weeks.  Now, there tends to be a lot more operational people involved, and since many of the data rooms are virtual, it's much easier to directly include several ops functions.  Use of a diligence committee also seems to be gaining popularity.  This committee is made up of C-level execs and business function leaders from the due diligence team.  The committee meets regularly to review the status and findings of diligence, and to ask "hard" questions.  Often this committee has built-in stops, or pre-determined times where the members must discuss or vote on whether or not to move ahead with the transaction.

Integration hasn't changed much either, but it's planned for much sooner than in the past.  Integration used to start right after the deal was signed, as it was commonly referred to as post-merger integration or PMI.  Everyone now talks about how critical pre-merger integration planning (PMIP I suppose?) is.  Thus the integration team and committee are put into action at the same time due diligence commences.

Here's what you need to understand as an entrepreneur.  First, both teams (diligence and integration) are often staffed by the same people - that's not new, as for years diligence teams morphed into integration after the close - what's new is that they now do diligence and plan integration at the same time.  Believe me this really changes the flavor of due diligence, in addition to making it take longer.  Second, this is extra credit for the operational members of the teams.  They all have primary job responsibilities to get done as well, and they were all probably told, not asked, to be on the team.  So do yourself a favor, and treat them with the utmost respect and courtesy.  Remember their names, offer to get Starbucks not the stuff in the kitchen, walk them to the restrooms instead of providing directions, laugh at their jokes and listen attentively to the same stories they told you yesterday.  Due to the committee system, these people now have power!

Revenue to go Public

Devin in Salt Lake City asks an excellent question, "How big [I assume you mean revenue] does a company have to be to go public today?"  Well, I like numbers because they've never lied to me, so let's let the stats answer the question.  I analyzed just the 13 tech IPOs in 2005 (there were 41 total, but I'll let you do the rest Devin) and found:

• Average TTM Revenue Prior to IPO = $82.6 million
• Average Quarterly Revenue Growth (YOY) Prior to IPO = 39.3%

Here is what's interesting to me - based on my quick analysis of the current valuation multiples for the class of 2005, only 60% are trading above were they would have likely been sold.  So the question I have is why risk it?

Corporate Mating Season?

Stacey Higginbotham, in today's TechConfidential post, and this InfoWorld article (which is based on an IDC report - I don't have the link, but how's that for three degrees?) bring up some good points about IT standardization and merger integration.  Two take-aways for entrepreneurs, especially at tech companies:

1. While it is important to know what your potential acquirers' run under the hood, don't get too carried away.  They probably all develop on different platforms, and the minute you switch they probably will to.  That said, if you find everyone in your segment is standardizing, then you probably should to.
2. Here's the bigger problem (particularly for software companies) - you're too smart, and for some reason (cost, pride, competition, too much time on your hands?) you'd rather build business process applications than buy them off the shelf.  The only secret sauce at your company should be in the product(s) you sell.  I've seen home-made accounting, billing, CRM, work-flow, SFA and HR systems to only name a few.  They may work great for you, but for me they're an integration problem [read: your valuation is going down].

By the way, don't make the mistake of building the value of a non-core, home-grown application into your valuation case.   I will agree with you as to its monetary value, then announce we're doing an asset deal, carving out the IP around the app, lowing the valuation by the agreed value of the app and letting you and your VCs keep it.  I have yet to have any takers, so we've all agreed that the app is really worth nothing and the valuation goes down anyway.

It's A Long Way To The Top (If You Wanna IPO)

Traffic.com IPO stalls?  In the old days (pre-1990's) if you took a company public, and it traded up just a little on the first day, everyone said the bankers did a nice job not leaving any money on the table.  I think it was the Boston Chicken IPO in '93 that changed all of that.

I did a search on Simply Hired for "pre IPO" in company descriptions - 1,019 matches.  Two of these  are actually "Killer pre-IPO" companies, while three are only "Hot pre-IPO" companies.  Why would I work for a Hot pre-IPO company when I could work for a Killer pre-IPO company?

Deal Screen Part III

Many companies, along with their boards, have begun creating acquisition parameters or a set of boundaries for their acquisition strategy.  While I don't think understanding these parameters is as important as gaining clarity on would-be acquirers' strategies, it may impact how you position your company for a sale.  Plus, it may make you reconsider which companies are viable acquirers.

Examining a buyer's past acquisitions should give you a good idea of where they would like to play.  To give you examples of the types of limits you can run into, I've spent some time this week talking to three corporate development colleagues from the software industry.  Their companies are all public but vary in size and market segment.  Here is a sample of what they had to say about acquisition parameters:

Company #1: "We're a company that's about products not technology, so we look for acquisitions that are proven in their markets.  Most of our acquisitions have been in business for at least of seven years.  We believe that's the amount of time it takes for a product to be mature enough to live without its management team.  Size isn't an issue to us - we're not afraid to do large deals, and our smallest deal was around $25 million - I can't imagine going any smaller.  Every deal goes in front of the board no matter the size.  They may not vote on it, but they want to know what's going on.  We use both stock and cash depending upon circumstances, FAS 141/142 has made using stock a lot easier.  Valuation is our biggest issue, we will never pay a higher multiple than where we trade.  We are very patient - we walk away from about two-thirds of the deals we're interested in because of valuation.  We've never done a cross-border deal, but targets with a strong presence outside the U.S. are more appealing to us."

Company #2: "We limit our acquisition size to 10% of our market cap per deal.  Our board is pretty stringent on that.  They've shot down a couple deals that would have gone beyond.  We don't have any valuation parameters per se.  We work with the target's management team to develop of plan and base the number off that.  We can be pretty aggressive if we feel the team is energized by the plan.  Too often we see management teams completely burned out by the time they show up.  We walk from those deals - we want people who are still hungry.  We prefer to buy local [Silicon Valley].  We want everyone in the same building - that's important to us."

Company #3: "Mid-sized acquisitions ($250 - $350 million in value) are our sweet-spot - we're committed to doing one a year.  We're moving away from the small stuff.  In the past we've bought too much technology and not enough market share.  We need immediate impact, the Street wants numbers not promises.  We've never used our stock for a deal, and I don't see that changing.  Our #1 rule is that you must beat us at least once in the market place to get bought.  I spend an enormous amount of time with our sales managers finding out who customers are considering using and why.  We look at public comps for valuation, but for the most part we stick with the multiples we've paid in the past - we know they're right."

It's All About the Carrot Juice

I was fortunate to be on a trading floor ten years ago when Pixar went public.  What stands out for me about that day is carrot juice.  Steve Jobs and the rest of the Pixar management were waiting in a conference room for the first trade when he became pretty upset that there was no carrot juice.  Suddenly people were scurrying about trying to find carrot juice.  I'm thinking to myself the guy's about to become a billionaire, and he's worried about carrot juice?  Then I realized for Steve it's not about the money, it's about the details, it's about people doing their jobs and doing them right, it's about striving for perfection in every situation.

I recalled this about six months ago, as I sat in on a product development meeting.  Two things that the product manager said really took me back:

1. This release satisfies 80% of the new features and functionality that our customers want.
2. The GUI's not perfect, but we'll deal with that later in an update.

I realized that the most important thing for the product manager was hitting the release date, which is important but so are the other details.

The Deal Screen Part II

Your exit goal as a venture-back company is to be bought not sold.  Holding the top spot on several acquirers' target lists is the best way to achieve that, and it makes getting through the deal screening process much easier.  Understanding the acquisition strategies and parameters of your potential acquirers will help you to begin positioning and preparing your company to make it to the top of the list.

Gaining this intelligence is not that hard, but I find very few small companies take the time or have the discipline to do it.  Here's how it's done.

Take our merry band of managers from yesterday's post, they had no idea what eBay's acquisition strategy is, but they should have.  Take the low-hanging fruit first - enter "eBay's acquisition strategy" in Factiva or Lexis-Nexis for the last two years and you will see 62 written articles.  Now google eBay and "acquisition strategy" and you will get 26 results.  Check the earnings call transcripts, especially after a big acquisition.  Research analysts will usually ask several questions about how the acquisition fits into the strategy.  Next, find the press release about the company's Analyst Day, as it usually lists who attended from the research community.  Then call an I-banker from those firms and get each of the research reports from Analysts Day, they usually have a paragraph on acquisitions.  Also, ask the banker if he or she knows the strategy.  Often times they have met with the company and know exactly what the strategy is.  Keep digging and pretty soon, I guarantee, you will have a very clear picture of your potential acquirer's strategy, as well as, a wealth of knowledge on their operations, strengths and weaknesses.

Take that cobbled together strategy and ask yourself honestly does your company fit within it?  What changes does your company need to make to be more attractive to the acquirer?  What are they trying to accomplish with acquisitions?  Does your company solve their stated problems and help them reach their stated goals?

Cool Geek Deal

OK stop with the emails on my Google post from last week.  I wholeheartedly agree and predict that Google will make an acquisition in 2006, for $3,141,592,653.58 in consideration with an earn-out that lasts 137 months.  Nerds around the world will rejoice.

The Deal Screen

This week's focus is on the how the corporate acquisition process has changed within the last three years.  The primary changes have been brought about by the tech bust, FAS 141 & 142, SOX and some of the recent corporate scandals.

Within the corporate acquisition process, there are three main committees and teams - screening, due diligence and the integration.  I'll look at the screening committee today.

Deal screening used to be a one-person affair - usually the CEO would take a call from another CEO or intermediary (banker, board member, VC) and decide whether or not to proceed.  So your relationship, or that of your intermediary, with the CEO of a potential acquirer was extremely important.  This certainly led to conflicts of interests and some deals that should have never been done.  Today, many acquirers use a deal screening committee and formal process to adhere to their acquisition strategy and parameters.  This committee usually meets once or twice a month and consist of the C-level execs, BU heads and the corporate development team.  They look at any deals that have come in unsolicited and discuss proactive attempts to contact pre-defined targets.  No deal process can start until the committee "green-lights" it.

As an entrepreneur why does any of this matter to you?  Well, let me give you a good example.  I met with a start-up in November that had a decent product, good niche and was getting some traction in their market.  They had raised a couple of rounds of funding, had hockey-stick projections and talked about an exit within three years via sale or IPO (don't even get me started on the IPO stuff).  For better or worse, it seems that the only viable buyer would be eBay, to which I agreed.  The problem is that when I asked them to name all the companies that eBay has acquired, or the multiples paid, or the smallest deal size, or the business model of each acquisition or the structure of each deal they hadn't a clue.  But, one of their VCs knows Meg Whitman!  And LinkedIn tells me that I'm actually only three degrees separated from Kevin Bacon - big deal!  If the extent of your preparation for a sale is that your VC knows someone, you're in trouble.

So we rolled up our sleeves and did some work.  First I brought their projections down to something slightly more realistic and figured the amount of funding it would take to get there.  Then I got some data on eBay's past transactions.  Bad news - when I applied the revenue multiples from eBay's three smallest deals (in terms of revenue not consideration) to the future time when our company thought it would hit those revenues, not only didn't they beat their liquidation preference, but it meant running the company a lot longer than they had originally thought.  Reality sucks!