Cashing-in on Your Company (Part 1 of 5)
8/8/08 at 1:25 PM by David Cook “One Buyer is No Buyer.” It’s a tried and true saying in the M&A community. It’s also a cautionary tale: the sweetheart deal outlined in the term sheet when the “dating” began erodes, bearing little resemblance to the deal left standing at the end of due diligence. Unilateral negotiations favor buyers because they control the timetable, the terms, and the checkbook. On the other hand, an orchestrated multi-party process flips the leverage 180° and allows owners to gauge success by learning how the “market” – and not just one party – values their companies. Process is the operative word here. A transaction should receive the same planning and execution resources (if not more) as the development of a major software release. Yet transaction planning is more often reactionary – an unsolicited offer or personal crisis – rather than a pro-active exercise in execution. So how’s your strategic/succession plan looking? The intent of this blog series is to help put you on the road to preparedness for future capital transactions. First, let’s set the table with an overview of market conditions…
Today’s Marketplace. Much has been made about tight credit markets slamming the brakes on “Bulge Bracket” M&A activity (billion dollar mergers and LBOs). The “lower middle market” (sub $100 million deals), however, remains robust and is supported by very strong supply and demand fundamentals:
Supply drivers:
- The leading edge of Boomer businesses is hitting the market. A significant succession gap now exists with 45 million Gen X’ers replacing 78 million Boomers. The Fed Reserve estimates that ~500,000 of these will change hands in 2008, and by 2009 ~750,000 business owners will be seeking a sale.
- Capital Gains tax – the rush is on to sell now. It’s no secret that the next administration will usher in a new capital gains tax rate. Additionally, individual tax rates may be increased, making the sale of C-corporations on an asset basis particularly onerous.
Demand drivers
- Record private equity inflows. 2007 was a record year for private equity raised to invest in private business; total funds under management now exceed $1 trillion. Private equity is increasingly viewed favorably against other asset classes (e.g. real estate and public equities).
- Foreign capital: the Dollar sale. The decline of the dollar has contributed to a significant increase in cross-border transactions. Of the $1.5 trillion of U.S. M&A transactions in 2007, $444 billion (29.1%) involved foreign acquirers, up from $229 billion (17.3%) in 2005.
All of this has translated to a strong local M&A market place (see graph below).
Industry Overview. As we zoom in on the market for VARs, ISVs and IT Service Providers we find lots of holes in the market data but a clear growth trend and many new entrants. Some of the data problems are a result of blurring business definitions. Many companies are a mixture of VAR, ISV and IT Service Providers. The key takeaway is that these industry verticals are highly fragmented and ripe for consolidation. However, there is a certain scale that target firms need to reach in order to justify the expense and execution risk of most buyers/investors. Typically, annual revenues of $10 million and/or EBITDA of $1 million will generate an effective “market” for a transaction. Even so, there are many transactions occurring at much smaller levels which ultimately lead to companies that generate $10 million-plus in annual revenues.
VARs [1]
- 21,500 firms
- $115 billion in annual sales
- Less than 20 firms with 1,000 employees
- These “Tier 1″ firms comprise only 18.5% market share [2]
ISVs [3]
- 18,500 firms
- $205 billion in annual sales
- Less than 25 firms with 1,000 employees
- These Tier 1s comprise 35% market share
IT Service Companies [4]
- No reliable market size data
What’s Ahead? Future blog posts in this series will cover topics including Common Mistakes Sellers Make, Tips for Selecting Professional Advisors, Preparing for Due Diligence, and Understanding the Private Equity Recapitalization.
[1] U.S. establishments primarily involved in developing or modifying computer software and bundling with purchased hardware to create application-specific integrated systems.
[2] Contrast with Server & Storage Hardware, where the Top 2 have 58% share, and the Top 5 has 86%.
[3] U.S. establishments primarily involved in design and production of computer software as well as installation, user documentation and training.
[4] U.S. establishments primarily involved in supporting and managing computer infrastructure such as networks, servers, desk-top computers and mobile devices as an outsourced service provider.
