Preparing for the Exit – CEO’s Need to Start Early

The “when” and “how” of the exit stage of a business poses one of the biggest opportunities and challenges for a software company CEO. Unfortunately, many address the exit much too late – and often only when they get an acquisition offer that forces them into a reactive mode, wondering if the offer at hand is the best outcome for shareholders. This failure to adequately assess the time and preparation required for a successful exit can result in substantial value being left on the table or worse – an unsuccessful outcome. Yet this does not have to be the case. The outcome of an exit event can be dramatically improved by adopting some key strategies well in advance that prepare the venture to be both appropriately positioned for exit and ready to act when dictated by industry shifts and/or consolidation events.

Some of the major activities that should be handled 18-24 months in advance of an exit event or engaging an investment banker include the following:

  1. Start the Due Diligence Process – ask your counsel for the most exhaustive due diligence list they have.   Narrow it down for your company and start collecting the information well in advance.  Put all the documents into an online repository – thsi process is extremely time consuming but if you start it early you can chip away at it when you have free cycles.
  2. Develop your Pitch Deck – start assembling your PowerPoint pitch that you would make to a prospective buyer.  Break the deck into sections that correspond to your organization.  As you build the materials, you will identify gaps that you can fill in to solidify your position, promote your strengths and solidify your value.
  3. Map the Ecosystem – gather analyst reports on your market from reputable 3rd parties.  Understand the tangential solutions to your domain and create a visual diagram to represent the playing field.
  4. Score the Ecosystem – once you have identified all the players, dig deeper and look at how each of the players in the market would “fit” with your company.  We recommend scoring analysis in which you can rate each companies fit with your company based on technical, sales and financial metrics.  The laborious process now begins – start filling in the detail for each.  Be consistent in teh scoring approach and look beyond the obvious.
  5. Concentrate on Alliances – if you are not paying attention to alliance efforts with partners, you need to start.   You need to align with the top ranked partners in the ecosystem and build a relationship with them.  Enter into either a technology, marketing or sales partnership alliance.  Remember potential suitors normally buy companies that they have worked with in the past.

Ideally, you should be in the market when the sector is “hot” or a few of the top companies in the ecosystem are at the top of their game.

Many CEO’s are concentrated on the core business operations and spend too little time on these activities in advance or don’t prioritize these activities until they engage an investment banker.

Proper preparation, strategic assessment and alliance initiatives are necessary in advance and will have a material impact on valuation – so start well in advance!

March 2011 Monthly Flash Report: Software Valuations Up and Financial Performance Improving

Software Equity Group has published the March 2011 Flash Report, providing information and insight about the financial health, market performance, and acquisition activity of the Software, SaaS and Internet industries’ key players and product sectors.  Highlights from the report are included below.  You can download a complete and detailed version of the complimentary Flash Report from our website:
http://www.softwareequity.com/research_flash_reports.aspx.

Software Equity Group Index updates:

  • Over thirty companies added across Software Equity Group’s Software, SaaS and Internet indices
  • Revision of virtually all Software Equity Group’s 22 Software and 8 Internet product categories

Software Public Valuation and Financial Performance Highlights:

  • The median EV/Revenue multiple ticked up slightly to 2.7x, up from 2.6x the month prior
  • The median TTM revenue growth rate grew 37% to 13.6%, up from 9.9% the month prior
  • Despite a slight tick down in median gross margins, median EBITDA margins continue to climb, reaching 19.8%

SaaS Public Valuation and Financial Performance Highlights:

  • The median EV/Revenue multiple increased to 4.6x, up from 4.3x the month prior
  • Select companies experiencing month over month EV/Revenue multiple increases of 10% or higher include: Intralink Holdings, Live Person, NetSuite, SuccessFactors, Taleo and Vocus
  • The median TTM revenue growth, gross and EBITDA margins all ticked up from the prior month

Internet Public Valuation and Financial Performance Highligts:

  • The median EV/Revenue multiple increased to 2.6x, up from 2.3x the month prior
  • All five companies trading above 10.0x EV/Revenue multiples, as of the last trading day February 2011, are from China: Baidu (34.2x), Ctrip (11.5x), Mercadolibre (13.1x), SINA (10.5x) and Youku (70.1x)
  • Median TTM revenue growth held steady from last month but gross and EBITDA margins rose to 59.2% and 16.9% 

Download a complete and detailed version of the complimentary Flash Report from our website:
http://www.softwareequity.com/research_flash_reports.aspx.

The Buyers Speak: Software Equity Group’s 2011 M&A Survey

The following excerpt is from Software Equity Group’s 2010 Software Industry Equity Report

In early January 2011, Software Equity Group conducted its third annual Software Company Buyer Survey to provide our readers a better understanding of 2011’s software M&A ecosystem and buyer thinking. We polled 176 of the largest software companies in the world, both public and private, and received an excellent response. Collectively, the respondents to our 2011 survey spent well over $13.9 billion on software acquisitions in 2010, and their plans and playbook will heavily influence the software M&A ecosystem in the year ahead.

Unsurprisingly, 83% of our respondents bought at least one software company in 2010 and stayed close to home. Buyers remained focused on strategic transactions that leveraged and enhanced their core businesses, acquiring tuck-ins and eschewing bargain shopping and unsought opportunities. Their M&A behavior in this regard was consistent with their responses to our 2010 survey, and reflected the economic uncertainty that persisted through much of 2010.

What lies ahead? The number of software M&A transactions will almost certainly grow this year, as 93% of respondents stated they plan to acquire at least one software company in 2011 and 51% stated they plan to acquire three or more software companies in 2011. Indeed, 17% of respondents stated they plan to acquire six companies in 2011, up from only 6% in 2010.

And what’s motivating these buyers? Buyers are laser focused on improving their products and broadening their current offering. Product enhancements – to plug holes, add incremental functionality, competitively differentiate and improve the user experience – was ranked by 40% of respondents as their most important M&A objective in 2011, and by an additional 27% as their second highest priority. Broadening their current offering – adding new product categories, entering new markets and expanding territories – was named the most important M&A objective by 30% of respondents, and as their second priority by an additional 40%. Financial benefits and market share as primary motives were seen as considerably less important. By contrast, in 2010, buyers were almost equally divided amongst financial objectives, product enhancement, market expansion and market share.

Software M&A spending will likely be robust in 2011, with 54% of respondents expecting to spend at least $100 million on software acquisitions this year. Valuations should also see an uptick. 60% of respondents expect to pay at least 10% more in 2011 for a company very similar to one acquired in 2010.

While SaaS providers have been on many large software company radar screens for the past three years, it hasn’t been an M&A spending priority for most. Until now. 30% of the buyers in our 2011 survey believe that it is “very important” that a target be all or sustainably SaaS/subscription based, a remarkable increase from just 13% in the 2010 survey. In fact, only 17% felt that SaaS was “unimportant” in 2011, a stunning decline from the 47% who expressed disinterest in 2010. It’s unclear whether big software company interest in acquiring SaaS providers has suddenly peaked because of the attraction of subscription based revenue, or because of market demand. Likely, it’s some of both.

What do buyers consider most important when selecting and valuing an acquisition target today? Since most buyers in 2011 are seeking to enhance and extend their own offerings, it’s of little surprise an overwhelming 63% of 2011’s Survey respondents deem the target’s products and technology platform the most important factors in deciding whether, and for how much, to extend an offer. The target’s profitability and growth, to the dismay of many private software company founders, is relatively unimportant to the overwhelming majority of our 2011 Survey respondents.

A notably greater number of buyers this year ranked the caliber of the target’s management team and operations to be the most important factor in deciding whether, and for how much, to extend an offer. It’s almost certainly because buyers today deem continuity, orderly transition and phased management withdrawal essential to the success of the transaction post-closing.

As our founder, Ken Bender, wrote in the editorial column of our 3Q10 Quarterly Report, the buyer mindset today has changed since the Great Recession. Our 2011 survey results back him up. M&A decision making has shifted from top down to consensus according to 60% of buyers responding to our survey; 72% say they’re doing much more analysis today of the market opportunity, go forward strategy and target synergies; and 84% of respondents indicated they conduct much more pre-LOI due diligence on a target’s financials, products and operations.

Despite this unprecedented degree of due diligence by buyers, we’ve observed a higher mortality rate in the past two years of software M&A transactions under LOIs that never closed, and decided to ask why.

Our 2011 Survey makes clear the exit valuation gulf between buyers and sellers is wide, and often gets wider during due diligence. A whopping 41% of our respondents told us that unrealistic valuation expectations were the single greatest reason why a deal under LOI failed to consummate. This response should be read in conjunction with responses to another of our questions regarding those post-LOI events that most imperiled the closing of a transaction.

According to the buyers we surveyed, the closing of a deal under LOI is most imperiled by the renegotiation of the proposed purchase price due to matters uncovered or clarified during due diligence. These can cover the gamut of missed revenue or EBITDA forecasts, uncollected sales taxes, missed product release dates, open source languages embedded without appropriate license, deceased third party developers who didn’t sign work made for hire agreements, customer attrition beyond what was indicated during pre-LOI discussions… it’s a long list, and buyers today do not react kindly. Often they see the value of the company as being less than originally bid, and reduce their offer. The targets, in turn, are often outraged for being “nickel and dimed”, especially when they’re so “strategic” to the buyer. More often than not, that’s the reason behind the “unrealistic exit valuation” response given by so many of the buyers we surveyed when asked, “What’s the most common reason an acquisition fails to consummate once you enter due diligence?”

It’s clear from the results of our 2011 Survey that buyers in 2011 will be more acquisitive; will pay modestly more; will be product and technology focused; will be process and consensus driven; and will closely scrutinize the target prior to closing to reduce risk and enhance the likelihood of realizing the expected return. Thus far, as we go to press, that certainly appears to be the case. We’ll detail that more in our 1Q11 Quarterly Report.

Software M&A Deal Volume and Spending

The following excerpt is from Software Equity Group’s 2010 Software Industry Equity Report.

Software M&A transactions accounted for 11.7% of all U.S. M&A activity in 2010, down from 13.3% in 2009. There were 1,586 mergers and acquisitions worth $51.9 billion in the U.S. Software sector in 2010, compared to 1,329 transactions aggregating $27.4 billion in 2009 (Figures 37 and 38).

1Q10 began on a positive note with 431 transactions, the fourth consecutive quarter of increased software M&A deal volume. Unfortunately, that level of activity was not reached again in 2010, as software M&A deal volume declined 12% to 385 transactions in the second quarter, rebounded a bit in Q3, then fell off again in the final quarter (Figure 39). Year-over-year, each quarter in 2010 posted an increase over 2009, assuming 4Q10’s 368 software transactions (vs. 372 in 4Q09) will increase by 10-15 deals in our final tally.

Overall, 2010’s software deal total was healthy in comparison to transaction volumes over the past decade. Note to our readers: The deal and dollar volumes in Figures 37 and 38 have been updated from our previously published quarterly reports due to transactions newly reported or deleted (i.e., scrapped deals) after our publication dates.

Based upon our 2011 buyer survey results and our conversations with a broad array of public software company corporate development heads and private equity firm managing directors, we anticipate a modest increase in software M&A transaction volume in 2011. Asked how many software companies they anticipate acquiring in 2011, 20% said six or more; 31% said three to five, and 41% stated they plan to buy one to two this year (please see Survey results). Overall, responses to our 2011 Survey indicate software M&A deal volume will rise approximately 12% to 1,775 this year, driven primarily by buyers seeking product enhancements, extensions and competitive differentiation. =

2010’s total software M&A spend was 90% greater than 2009’s, although deal volume increased only 16%. It would be erroneous to conclude, however, that the average deal size increased dramatically in 2010 because valuations were markedly higher or many larger companies were acquired. Major fluctuations in software M&A spending each quarter are typically the consequence of a relatively small number of software industry mega-deals (transactions with enterprise values greater than $500 million). Of 2010’s $51.9 billion total software M&A outlay, $26.3 billion was spent on 17 mega-deals. By comparison, 2009’s $27.4 billion total software M&A outlay included $9.6 billion spent on seven mega-deals, while 2008’s $56.2 billion total price tag included $32.6 billion on 21 mega-deals.