building a software company with the end in mind business in the 21st century is different ... ($3t...

Building a Software Company with the End in Mind

Ivan Ruzic, Ph.D., Vice President

ISV Insights, Philadelphia, October 2017

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What we’ll discuss Conventions – companies, value & valuations

Why business in the 21st Century is different

Why understanding M&A is critical to success as an entrepreneur / state of M&A today

Starting with the end in mind means building around an Exit Plan

Why managing the Exit Plan is really important

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Two types of Information Technology companies

All companies can be classified into two types: “Lifestyle” companies - designed to maximize cashflow “Growth” companies - designed to build value and exit

This presentation focuses on the second group – how to build value and secure a good exit

But these lessons also apply to the first group as well - eventually everyone wants to monetize the value they’ve built!

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What does it mean to “Build Value?” 1. Value is “relative” and determined by the buyer

2. Value to a buyer depends on its strategic imperatives at the time of purchase

3. So value depends on the seller’s unique mix of attributes and how they match the buyers “white space”

4. Value is driven by supply & demand and fluctuates by market sector

5. Value depends on product and market lifecycles

6. Value also depends on financial market cycles

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Methods for estimating “Value” Industry conventions: Sales multiple – Public peer group Earnings multiple – Public peer group Comparable M&A transaction analysis Discounted cash flow (DCF) Replacement cost analysis

For simplicity we will only use one here – EV/Sales (Enterprise Value-to-Sales)

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Business in the 21st Century is inherently different

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Business is different in the 21st Century Information Technology/Connectivity is/will

remain pervasive and central to success

Technological change is driving ever faster / shorter business cycles

Large companies cannot innovate fast enough

But, large companies are very good at scaling businesses - that’s how they became big!

Have to buy to survive and thrive – many spend more on M&A than R&D

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Business is different in the 21st Century Entrepreneurial activity will remain the innovation

engine for these organizations

Innovation will continue to drive future job creation

The Innovation pump is being primed mainly by research institutions, friends, family and angel investors

Innovate – grow - sell – scale – repeat : virtuous cycle

Being in an entrepreneurial company is THE place to be!

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Understanding M&A is critical to success as an ISV

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Representative Corum M&A Transactions

Unique viewpoint: Sold more IT-related companies than anyone in the world

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Corum Index

Market Transactions

2016 2015

4307 3948

Mega Deals 59 76

Largest Deal $63B $39B

Pipeline 2015 2016

Private Equity Platform Deals 232 323

VC Backed Exits 658 648

Attributes

2016 2015

34% Cross Border Transactions 35%

Start-Up Acquisitions 12% 13%

15 yrs 14 yrs Average Life of Target

39%

29%

8%

38%

2%

12%

2%

8%

17%

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Complementary products/services/ distribution

Similar businesses – different geography

Part of your “food chain”

New advanced technology

Competitors (approach with caution)

Strategic Buyers ($1T cash)

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Financial Buyers ($3T cash)

Financial engineers (“smart money”) Some high-volume, tech-savvy firms Others lower volume and/or less tech-

savvy Usually cash – be careful of complex

structures Primarily concerned with ROI Usually plan to hold and sell again Due Diligence is tougher (NO leverage) Platforms, bolt-ons, roll-ups

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Private Equity Portfolio Companies Financial buyers behaving like strategics

Deploying cash through portfolio companies

Doing deals for strategic reasons (technology, footprint, channels, etc.)

Often with strategic prices

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21 20

15 14 13 12 12 11 11 10 10 10 10

Top Strategic Acquirers – 2016

Source: Corum Research

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39

21 21 19 19

16 16 15 14 13 13 12 11 11 11

Top Private Equity Acquirers – 2016


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It’s Not Just About Technology User Base – NT

has acquired

Agent Network

has acquired

New Market Opportunity

has acquired

Market Solution

has acquired

ISC LP

https://www.daceasy.com/daceasy/default.asp

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Other Compelling Reasons

Content Purchase

has acquired

Market Beachhead

has acquired

Domain Expertise

has acquired

Management Team

has acquired

http://www.streamserve.com/%20/default.aspx?id=3

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Acquisitions in the last 24 Months

60% 12%

21%

7%

Strategic Buyers

0-50

50-100

100-500

500+

24%

19%

35%

22%

Financial Buyers

0-50

50-100

100-500

500+

• 72% of exits < $100M EV

• 60% of exits < $50M EV

• 89% of all acquisition were by Strategics

• 57% of exits > $100M EV

• 22% of exits > $500M EV

• 11% of all acquisitions were by Financial Buyers

Source: 451 Research & Corum Research

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Median Valuation at Exit < $50M EV $50-$100M EV $100-$500M EV > $500M EV

Strategic Buyers Financial Buyers


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Strategic Buyers

$10.0M $70.0M $200.0M $900.0M

Financial Buyers

$24.7M $67.0M $220.6M $1,125.0M

Implied Median Revenue at Exit < $50M EV $50-$100M EV $100-$500M EV > $500M EV

Strategic Buyers Financial Buyers


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Strategic Buyers

$10.0M $70.0M $200.0M $900.0M

Financial Buyers

$24.7M $67.0M $220.6M $1,125.0M

Implied Median Revenue at Exit < $50M EV $50-$100M EV $100-$500M EV > $500M EV

Strategic Buyers

$2.5M $17.5M $50.0M $225.0M

Financial Buyers

$6.2M $16.8M $55.1M $281.3M


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Implied Years to Exit – Strategic Buyers Growth Rate < $50M EV $50-$100M EV $100-$500M EV > $500M EV

10% YOY

25% YOY

50% YOY

75% YOY

100% YOY

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10% YOY 15 ? ? ?

25% YOY 8-9 15 ? ?

50% YOY 5 9-10 12-13 15

75% YOY 4 7-8 9-10 11-12

100% YOY 3-4 6-7 7-8 9-10

Implied Years to Exit – Financial Buyers Growth Rate < $50M EV $50-$100M EV $100-$500M EV > $500M EV

10% YOY

25% YOY

50% YOY

75% YOY

100% YOY


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10% YOY 15 ? ? ?

25% YOY 8-9 15 ? ?

50% YOY 5 9-10 12-13 15

75% YOY 4 7-8 9-10 11-12

100% YOY 3-4 6-7 7-8 9-10

Implied Years to Exit – Financial Buyers Growth Rate < $50M EV $50-$100M EV $100-$500M EV > $500M EV

10% YOY ? ? ? ?

25% YOY 12-13 15 ? ?

50% YOY 7-8 9-10 12-13 15

75% YOY 5-6 7-8 9-10 11-12

100% YOY 4-5 6-7 7-8 9-10


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What it means to start with the end in mind ?

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Building a Business with the End in Mind For a growth company, the single most

important plan is the Exit Plan

Do this FIRST - start with the goal (the end)

Will drive the entire business plan

Will drive the entire financing plan

Will drive exit timing

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How do we do this? Determine the market / problem to be solved

Type of business / how you’re going to solve the problem

Develop the exit plan - make sure all founders are aligned

Develop the financing plan - only then, contact potential investors

Remember - different investors are compatible with different exit strategies

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Some Optimal Exit Strategy considerations Market you’re in

Type of company you have built

State of economy and financial markets

State of the M&A market

How quickly these elements change

Shareholder / stakeholder alignment

Uncertainty and rapid change favors shorter exit cycles

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Trends matter in defining your markets

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Technology Trends Matter

1. Trends create change

2. Change drives strategic imperative

3. Strategic imperative drives acquisitions

4. Well-positioned companies get sold

So … Trend alignment is important!

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Corum Top Ten Technology Trends 2017

AI Enablement IoT Software

Visual Intelligence

Systems

Digital Currency Flow

Data Science Monetization

Online Exchanges

Omni-channel Sales

Connected Health

Focused IT Services

Data Security

CO

RE

CO

NTO

UR


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Corum Top Ten Technology Trends 2017

AI Enablement IoT Software

Visual Intelligence

Systems

Digital Currency Flow

Data Science Monetization

Online Exchanges

Omni-channel Sales

Connected Health

Focused IT Services

Data Security

CO

RE

CO

NTO

UR


If you are not aligned with these trends you will be swamped by them

If you are not aligned with these trends you may not get buyer attention

If you are not aligned with these trends you may not secure an optimal exit

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Software-Related Valuations

Vertical

Horizontal

Consumer

Internet

Infrastructure

IT Services

1

2

3

4

5

6

7

8EV

/S

EV/SALES (2017)


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Twelve Month Change in Valuations


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Things to remember As you develop the Business Plan

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1

Value Is Driven By A Range Of Dynamics

FINANCIAL

Revenue

Earnings

Growth Rate

Cash Flow

Balance Sheet

Leadership

Talent/Skills

Product/Technology

Sales Channels

Customer Base

ORGANIZATIONAL

Market Growth

Market Position

Level of Competition

Barriers to Entry/Exit

Threat of Substitution

MARKET

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Top 10 Intangible Assets that Add Value

Alliances Staff Technology Processes Web-SEO

Intellectual property User base Channels Leads Domain Expertise

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The Financial Plan should mirror the Exit Plan

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Three things to consider

How starting a company has changed How buyers preferences have changed How sources of funding have changed

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How starting a company has changed Universities now teach entrepreneurship

Comparatively costs little to build a company Cheap hardware / Cloud Open Source Instant global access Virtual companies New business models

Entrepreneurs can often build saleable companies for $100,000’s not millions

Marginalizes some of value provided by VCs

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Big Company buying has changed Internal processes at large companies mean

that $20-$30M M&A investments are easy - $100M investments are much harder

Large company Corporate Development and M&A don’t see VCs as adding much value and prefer to acquire before VCs invest They know VCs have to hold on for huge exits

This may have a BIG impact on your preferred source of funding!

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Many sources of financing today Incubators

Friends / Family

kickstarter and other crowdsourcing

Angels, super-angels and angel groups

Family offices

VCs & Growth Equity

Strategic investors

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In Praise of Angel Investors Angels invest their own money - don’t earn fees –

contribute expertise - only make money when the value of their portfolio companies increase

Small Investments ($5-25K) can make sense as returns > 300% over a few years are attractive

Can easily reinvest their gains

Exit objectives much more aligned with entrepreneurs and 21st century timelines

Angel syndication has become common: $1-$5 million investment is now common - enough $$ for many companies today

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Crowd Sourcing

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What about VCs? Angels Venture Capital

Capital Investment < $5 million > $5 million Years to Exit 2-5 years 9-13 years Required Exit range < $50 million > $100 million Required Return 3-7 X 10-30 X

• VC funds have become larger – most need to write a check for $5+ million

• VC fund returns come from < 20% of deals • Limited partners expect an IRR of 20%+ (I know – I

am one) • Success rate & IRR hurdle rate dictates that VC’s

winners must produce 10-30x return • => 60%+ of likely M&A Exits don’t work for VCs!

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Optimal Exit Plan for the 21st Century

Target exit of under $30 million in 4-5 years

Looks like it just might be …

Innovate - Grow – Sell – Scale – Repeat !

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Managing the Exit Is really important

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Exit percentage of saleable IT companies

50%

25%

25%

Failed to Exit Good Exit Sub-Optimal Exit

Missed the timing window

Consolidation / market shift

Negative momentum

Over-investment

Only one buyer

Contact at the wrong level/person

Misalignment of stakeholders

Improper buyer research

Misunderstanding buyer process /models

Improper due diligence preparation

Poor buyer qualification

Poor buyer orchestration

Deal fatigue

Probability of 75% that if a company succeeds, and becomes valuable, will still fail to secure an optimal exit

Source: Corum data and “Early Exits,” B. Peters, 2009

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1

Corum’s Stages for an Optimal Outcome

Integration Closing Due Diligence Negotiation Discovery Contact Research Preparation

Managing an Exit is a multi-step process

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When Should I Sell?

Company A - ERP 2016 2017 Change Revenue EV/Sales Nominal Valuation


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When Should I Sell?

Company A - ERP 2016 2017 Change Revenue $5.0M $6.5M +30% EV/Sales 2.6 5.3 +104% Nominal Valuation $13.0M $34.5M +165%

Company B – SCM 2016 2017 Change Revenue EV/Sales Nominal Valuation


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When Should I Sell?

Company A - ERP 2016 2017 Change Revenue $5.0M $6.5M +30% EV/Sales 2.6 5.3 +104% Nominal Valuation $13.0M $34.5M +165%

Company B – SCM 2016 2017 Change Revenue $5.0M $6.5M +30% EV/Sales 7.2 4.7 -35% Nominal Valuation $36.0M $30.6M -15%


No magic formulae – keep close tabs on the M&A market

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M&A Follows Financial Cycles

No magic formulae – keep close tabs on the economy and financial markets

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Advantages of using a good Intermediary

Increases chance of getting a deal done

Increases the likelihood of a higher valuation

Expected Outcome =

Probability(expected valuation) x

Probability (exiting)

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Example M&A Advisor Value Add

Enterprise Value

Revenue



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Example M&A Advisor Value Add

Enterprise Value

Revenue



The value-add of a good advisor

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Form of Payment Amount Cash $14,000,000 Note $2,000,000 Annual Employment Compensation $100,000 Common Stock 200,000 Shares Stock Options 20,000 Shares

Form of Payment Amount Cash $17,000,000

Note $2,000,000

Annual Employment Compensation $120,000

Common Stock 225,000 Shares

Form of Payment Amount Cash $22,000,000

Annual Employment Compensation $175,000

Common Stock 260,000 Shares

Example LOI Evolution

Initial LOI

Second LOI

Third LOI

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Some closing thoughts

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1. Disruptive trends – Strategic imperative to buy

2. Cash – Strategic & financial buyers

3. Low cost debt for leveraged buyouts

4. Many new buyers (IPOs, non-tech)

5. Strong financial markets

Five Reasons Tech M&A Will Remain Strong

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Tech M&A Guideline Percentages

Buyer solicitations that result in transaction

Average improvement from first offer with an auction process

How often another firm is willing to pay more than the initial bidder

Deals involving only one bidder that are suboptimal

Failure rate in “self-managed” tech M&A

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Finally …. A company is worth what a knowledgeable buyer is willing to

pay for it Formal valuations don’t capture the strategic value to a given

buyer If selling, be sure you fully understand your unique value

enhancers relevant to buyer interests You will never secure an optimal outcome unless you align with

the trends driving the industry You will never secure an optimal outcome without negotiating

with multiple buyers You will never secure an optimal outcome without a well

executed Exit Plan

So … start by building value with the end in mind!

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Contact Information

[email protected]

Visit our website at: www.corumgroup.com

Corum Group Ltd. 19805 North Creek Parkway Suite 300 Bothell, WA 98011 USA +1 425-455-8281

Corum Group International S.à.r.l. Buechenstr. 9 8185 Winkel Switzerland +41 43 888 7590

Questions ?

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Corum Valuation Lifecycle

Stages of Growth

PIONEER BUILDING ESTABLISHED

Valu

atio

n Pr

emiu

m

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Common Misconceptions “Good companies are bought and not sold”

“We can’t sell, we’re not profitable”

“We have conflict to resolve first”

“I’ll launch my next version, then sell”

“We’ll get locked into a bad deal”

“We’ve lost key people, can’t sell now”

“We’re going to work it out with our inbound buyer”

“We’ll raise another round then sell”

“Preparation starts when you decide to sell”

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Common Misconceptions “We have too much debt to sell”

“Buyers don’t want an exclusive intermediary”

“We’re not SaaS so buyers won’t bite”

“I need and audit before selling”

“I already know my buyer”

We want to buy first, then sell”

“Buyers won’t want our legacy tech”

“I don’t want to go to market too early”

building a software company with the end in mind business in the 21st century is different ... ($3t...

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