Buying Your Way to Growth

How mergers and acquisitions can put your company on the fast track.

Solutions Consulting Group (SCG) Inc. wanted to expand into a new
geographic area in hopes of becoming more of a regional solution provider. Intervoice Inc., already a big player in the market for voice self-service
solutions, was looking to gain additional critical mass and new product technology that would give it a solid hold on the No. 1 market position. And Astea International Inc. wanted to add an elite customer base and some leading-edge technology to its field service management business.

Although their specific goals were somewhat different, all three Microsoft Gold Certified Partners were focused on the same idea: growing their businesses. And all came to the same conclusion about how to reach that goal: by merger or acquisition.

In choosing the merger/acquisition route, each of these companies eschewed the chief alternative: organic growth. You can certainly expand into a new geographic area by adding personnel and sales people to drum up business, but the effort will take time and money, and the losses you suffer before you begin to break even in the new area will be a drag on overall company performance, says Eric Gebaide, managing director for Innovation Advisors, a New York City-based boutique investment bank that focuses on M&A activity for midmarket technology firms, many of which are in the IT services and software industry.

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The same goes for developing a new product line. "It may be that you have customers who need it right now, and you can service it now and make money on servicing it. If you wait to build it, it may take you two years and the market may have moved on," Gebaide says. "Purchasing a company is going to add speed and/or expertise."

Of course, the end result isn't always rosy. "Mergers and acquisitions fail more times than they succeed," warns Howard Diamond, who knows something about the topic. He became CEO of his current firm, ePartners Inc., a Seattle-based Gold Certified Partner, roughly 14 months after it merged with his previous company, EYT. Prior to that, he was CEO of CorpSoft Inc., which he doubled in size in six years -- to $1.2 billion in annual revenue -- largely through a series of acquisitions. He ultimately sold that company to Level 3 Communications Inc. "The ones that succeed succeed because you really have your act together," he says.

Assessing the Option
Gebaide cites three reasons to do an acquisition: to increase customers and revenue to critical mass, expand to a new geographic region or add to your product mix.

SCG was squarely in the geography camp when it acquired a Microsoft Dynamics practice from LightEdge Solutions Inc., a Gold Certified Partner, says Bill Edmett, Jr., a partner in practice management for San Diego-based SCG. LightEdge is a managed service and application provider based in Des Moines that years ago acquired a Microsoft Business Solutions practice in Phoenix (the Microsoft Dynamics product line was previously known as Microsoft Business Solutions). "It never really was part of their core business," Edmett says. "The only value it added was giving LightEdge a chance to provide hosting services for that product line."

For SCG, however, the practice offered a foothold in a new metropolitan area, one with significant activity in one of SCG's main focus areas: construction. And while the LightEdge practice focused solely on Dynamics products, SCG can now pitch those same customers on a bevy of additional products and services, including custom application development, business intelligence and integration services. It also has a deal with LightEdge to provide application hosting services for any company that wants it.

M&A advisor Eric Gebaide offers three reasons to do an acquisition:

1. Increase customers and revenues

2. Expand to a new geographic region

3. Add to your product mix

Dallas-based Intervoice got both critical mass and new product capabilities when it acquired Edify Inc., in a $33.5 million deal that closed on Jan. 4, says Kristen Axline, Intervoice's director of alliances and marketing. Axline came from the Edify team, where she held the same title. Edify had been acquired earlier by S1 Corp. of Atlanta, which makes software used in the banking industry. S1 never really succeeded in consolidating Edify's voice-enabled and Web-banking applications under the S1 brand, Axline says; indeed, Edify continued to operate as a subsidiary, under its own brand. Eventually, S1 decided to sell off Edify.

Enter Intervoice, which was in a neck-and-neck battle for the leadership position in the market for voice-enabled, self-service software. "By acquiring Edify, Intervoice got speech talent and expertise that they needed to nurture their bedrock business," Axline says, noting that Edify saw itself as a "premium" player in the market, largely on the strength of its natural speech technology. Acquiring No. 4 player Edify "put Intervoice squarely in the No. 1 leadership position," she says.

Astea's acquisition of FieldCentrix Inc., which made solutions for mobile field-service organizations, was aimed at both gaining critical mass and adding product capabilities, says John Tobin, president of Astea, based in Horsham, Pa. "We wanted to be best of breed, the standing survivor for field service, and service lifecycle management," he says. That requires having superior expertise; adding FieldCentrix' 10 years of experience to its 26 years was compelling. So was the company's customer base: "It has some giant customers, including Ingersoll Rand, Honeywell and Praxair," Tobin notes.

Making the Connection
Potential merger and acquisition partners can find each other in numerous ways. Astea wasn't exactly looking for an acquisition when the FieldCentrix deal arose, but "we do try to be opportunistic," Tobin says. "You find a lot of companies in our space that are venture-backed and the venture investors don't want to put any more money up. So they start shopping the company."

That was the position in which FieldCentrix found itself in the spring of 2005, when its chairman approached Astea about a deal. Tobin liked the company's product, which was focused entirely on mobility, whereas Astea's was more of a field-service application that had mobility functions tacked on. "Ours was probably more complicated than it had to be," he says. After further due diligence, Tobin found that the two companies' product roadmaps meshed perfectly, adding that the middleware FieldCentrix had developed was top notch, a viable product in its own right.

SCG learned about the LightEdge practice when it was looking to expand its Dynamics business and wound up recruiting one of the Phoenix employees. "Employees start getting discontented when what they're doing isn't part of the core business," Edmett says. "People were looking." Rather than fight to keep its employees, LightEdge approached SCG to see whether the San Diego company would be interested in buying the entire practice.

In the case of Intervoice, the companies were well aware of each other from being players in the same market. Indeed, company salespeople are often a source for finding potential partners, given that they frequently run into the competition. Leads can also come from bankers, attorneys and accountants, Gebaide says, as well as from trade publications and industry organizations.

Doing the Deal
No matter how you find your chosen partner, communication is the key to getting the deal done. "The most common thing that can go wrong is a lack of frankness," Gebaide says. "It's not untypical that, taking the same exact data, if you say it in the first meeting, it's a non-event; if you say it in the fifth meeting, the deal craters." By the same token, don't try to be so polite that you fail to ask what's on your mind. Nor should you overdo the sales pitch.

Financing is another issue, especially when both companies are privately held. While many buyers like to finance deals by issuing stock, most sellers don't want to give up control of one company for stock in another privately held firm; instead, they want cash. There are exceptions to the rule, however, such as when the acquiring company is significantly larger and well-established, or if there's a pre-existing relationship between the firms. "For most entrepreneurs, going out and buying another company is risky, hard and should probably be limited to smaller companies that'll let you use your [stock]," Gebaide says.

Another option is an earn-out strategy, where the amount paid depends on the revenue the acquired company brings in after the deal is complete. Such a provision is what made SCG's acquisition of the LightEdge unit a low-risk endeavor, Edmett says.

Financing a deal with cash means raising money by either selling equity in your company, such as to a venture capital (VC) firm, or by borrowing money from a bank or another source. If you choose the equity route, you need to be confident that the return on the acquisition will more than cover the return that the VC expects. You can't simply sell $2 million worth of equity, then pay $2 million for another firm and call it even. Unless the acquired firm delivers enough revenue to enable you to cover all the guarantees you've made to the VC, you'll lose out on the deal, Gebaide warns.

Getting Set to Sell

Selling your company can also be a growth strategy of sorts. Whether the next step in your firm's evolution is to expand geographically or to create a bigger sales and marketing force, you have to determine whether you can afford to invest the resources it'll take to get there, says John Tobin, president of Astea International in Horsham, Pa. Sometimes, getting acquired by a larger firm will be the road to success. Or, perhaps you've simply put in your time and want to cash out.

In either case, Eric Gebaide, managing director of Innovation Advisors, has three rules to follow in the run-up to a sale:

1. Make business performance your top priority. "Focus on profitability, invest in your business and focus on revenue growth, in that order," he says. It's a mistake to try to dress up your company for a sale. "Buyers are going to see through window dressing pretty readily. What they're trying to acquire is solid management, solid financial performance and solid customer relationships."

2. Get an advisor. While admittedly a self-serving rule, given that his company is in the business of acting as advisors, Gebaide claims the deals his firm is involved in deliver a yield that's nearly 60 percent more than other comparable deals. "Business people know how to run their businesses, but they don't know how to sell their companies," he says. Public companies, he notes, are supposed to get a fairness assessment before selling. Private companies would be wise to do the same. While he wouldn't say what you can expect to pay for such services, industry averages generally range from 5 percent to 7 percent of the deal value for deals of less than $10 million down to about 2 percent for deals of $20 million or more.

3. Think post-sale. Consider what the two companies will look like once the deal is done. The transaction is not an end event; the repercussions will resonate for a couple of years. What will happen to your people? Your lifestyle? What will the new firm expect of you? Consider such intangibles that are involved in the sale of a company. -- P.D.

Borrowing money carries similar risk. "Then I'm faced with a guaranteed payment that I have to make, and I'd better be darn sure the risk I'm taking on is worth the reward," he says.

All of which means determining the value of the acquired company is crucial, which returns to the frank discussions among executives from both sides. "Try to assess opportunities from both of your client bases, plus research and development and service staff," Gebaide says. "It's not a simple thing; it's not science by any means."

Astea's Tobin likes to see "some substance behind the numbers," such as recurring revenue streams from services or maintenance contracts with specific customers. When the acquisition is in the same market space, he says, product roadmaps should mesh well.

But the most important thing Astea did in terms of due diligence for its FieldCentrix acquisition was to "make sure the customer base was real," Tobin says. Primarily, that involved talking to key customers to make sure they were happy.

Getting the Value
The customer outreach effort didn't stop once the Astea-FieldCentrix deal was signed, either. Just as the customer base was key to deciding whether the acquisition was a good investment, it was crucial to getting the value out of that investment. Toward that end, Tobin says Astea conducted customer focus groups and visited most customers in person within two months after the acquisition closed in late September.

The strategy is paying off, as all 30-odd FieldCentrix customers have stuck around, and some of the largest are upgrading to the latest software release. "That means they're going to stick with us," Tobin says.

Keeping employees on board is likewise important to maximizing an acquisition's value. (See related article on employee retention, "Never Let Them Go.") FieldCentrix had been through a number of layoffs prior to its acquisition, leaving a core group of employees who were "crucial to keep," Tobin says. "We let them know the acquisition is strategic for us; we're not going to come in and slash and burn. We want to build it back up."

SCG made a similar effort. It brought the six employees it acquired (plus a sub-contractor) to its headquarters to spend time with their new colleagues and explain how the Dynamics business was strategic to the company. Additionally, SCG explained how the employees would be exposed to new areas and be able to offer customers additional products and services. Since the acquisition, which closed in September, an SCG partner has been spending two or three days per week with the new group in Phoenix.

Convincing employees from the merged company that their participation is valued is crucial to the process, ePartners' Diamond says. One way to do it is to give executives a chance to compete for jobs in the combined company. Look at every overlapping position and get input from a broad group to pick the best person for the job -- and make it clear to everyone what the process is, he says.

Even better, acquire a company where there aren't many overlapping positions, as was the case with Intervoice's acquisition of Edify, according to Axline. "I've never seen a company accomplish a merger with this little impact on staff," she says. "It helps that Edify was so much smaller -- we were about one-fifth the size of Intervoice."

According to Gebaide, the most important thing you can do to ensure you get value after the sale is to put in the work prior to the sale. Put a communications plan in place that includes details on who will work where, how the companies will work together, a product and service roadmap and a client benefits roadmap. Spending time on such a plan prior to the transaction reduces the number of surprises afterwards, he says.

"The worst transactions are when people just hope it's all going to work out," Gebaide says. "They're always disappointed, because it never does."