|Home - Software M&A Review - Apr 09 Issue
What Do You Do Now?
By Ken Bender, Managing Director, Software Equity Group, L.L.C.
Mention at a cocktail party that you own and run a software company and
people are still impressed – at least in places outside Silicon Valley. Software
is clean, high-tech, sexy – and filled with storybook millionaires. To an
outsider, you’re in the same business as Oracle, Microsoft, Google and Facebook.
There’s no plant and machinery to maintain, no inventory to manage, no
distribution facilities to oversee – and unlimited upside.
However it may appear to outsiders, software is a tough business. Most software
entrepreneurs are bootstrapped, with little or no outside capital. There’s
fierce competition and cost-conscious customers that place real pressure on
prices and margins. There are underachieving sales reps and long sales cycles.
There’s ever changing technology and a host of new modules to develop. There may
not be plant and equipment, but fully 70 cents of every dollar you make goes to
salaries, payroll taxes and benefits. There are disparate personalities to
manage and personality conflicts to mediate and customers who require a good
deal of attention.
Well no one ever promised you a rose garden. You’ve made some pretty good money,
created jobs, nurtured careers and built products that actually solve problems
and make people more productive. In the good times, when customers are spending,
and sales are easier, you might even say it’s fun. But in the downtimes, when
sales are slow, and cash flow declines markedly, it seems, once again, to be a
really tough business.
Many software entrepreneurs, who were contemplating exit in the near future, now
believe they’ve missed the boat. Some have. But for others, ironically, the
prospects of sale at an attractive valuation are as good or better today than a
year ago. Buyers, according to our survey, remain actively acquisitive. Most,
according to the data in this report, have healthy balance sheets and lots of
cash. If they deem you strategic, your chances of a successful exit are still
For other software company owners, however, the prospects for a successful exit
at an attractive valuation are dimmer than a year ago, and will remain so for a
time. No one knows how long. Certainly not the economists, analysts or pundits,
and certainly not us. It will just have to play out.
If you’re a software entrepreneur, or an investor in a private software company
that is unlikely to be seen as strategic in the current market, what do you do
now? The prevailing wisdom, and the instinctive reaction of most software
entrepreneurs, is to do nothing different. In times of fear, doubt and
uncertainty, make no substantive changes other than those that become absolutely
necessary, hunker down, and hope for the best.
Indeed, for many of the 200 software companies we met with, screened and
mentored in 2008 – from a dozen countries spanning virtually every software
category – there’s really no reason to alter course. Sales may have been pushed
out and revenue growth may have fallen off some, but no need to panic. No need,
really, to do anything different.
We respectfully disagree.
As we’ve often demonstrated, tech sector downturns typically lag economic
downturns (and upturns) by a year, and we’ve now been officially in a recession
for more than twelve months. Microsoft, our industry’s largest and richest
company, just reported an 11% drop in second quarter profits and announced it
will cut 5,000 jobs over the next 18 months. It’s the latest harbinger of things
to come. We believe the decline in software spending will be substantially
greater than current surveys indicate, further layoffs among most of the
Software 100 are likely, an the economic downturn will take a toll on private
What can a software entrepreneur do? Plenty. First, scrutinize your P&L as
though your short-term health and your longer-term exit valuation and retirement
depend on it, because they do. Ask your CFO, Controller or bookkeeper to prepare
an especially detailed profit and loss statement that breaks down revenue,
expenses and margins for each product and each service you provide. Then, slice
it by each market and submarket you serve, and by size and type of customer. On
the expense side, focus especially on labor, which typically accounts for 70% of
a private software company’s expenses. Two organizations deserve special
scrutiny: Sales and Product Development.
For the vast majority of private software companies, sales are their Achilles
heel. Most were founded by entrepreneurial software developers who, of
necessity, learned how to sell, but were never especially adept at doing so.
More important, many of these programmer-entrepreneurs knew nothing about how to
build and run a highly proficient sales organization, develop and refine
effective sales strategies, and properly onboard, train, goal, incent and manage
sales managers and representatives. Years later, their companies have grown and
achieved a measure of success, but their sales organizations remain inefficient
and underperforming. Some CEO’s are in denial about it; many others acknowledge
the fact but are loathe to do anything about it because prior efforts proved to
be expensive disappointments. Maybe so. But improving sales process and
performance are vital and achievable goals, and now, during the lull, is the
best time to consciously address them.
Many software entrepreneurs, mindful of their developer roots, regard their
development organizations as sacrosanct. It’s a bit of a paradox, because a good
number of these same CEO’s lament delayed product launches and budget overruns.
The skill sets and mind sets of some long-term programmers no longer match the
requirements of the job, but the programmers are nonetheless retained. New
development and product lifecycle management tools are eschewed as too costly or
disruptive. The net result of such benign neglect? Unnecessary labor costs that
have a direct and dramatic impact on EBITDA, and lost or delayed revenues. Now
is the time to align your product strategy and your development team, ensuring
you have just what you need – and only what you need to satisfy current
obligations and to cost-efficiently bring new products to market.
Finally, turn your attention to revenue and profits. What’s dragging you down?
Are there orphan or old legacy products? Can they be cut, or at least
deemphasized? Though it seems counter-intuitive in a tough economy, can products
or services priced too low be increased in 2009, at least to the point of
reasonable profitability? Is your annual maintenance and support (M&S)
under-priced (e.g., 15% – 17%, rather than the industry norm of 20%)? Have you
resisted imposing annual price increases for M&S because of concern customers
might leave, even though you have retention rates of 95% or more? When was the
last time you actually audited concurrent user licenses, desktop licenses and
server licenses, transaction fees, etc.? Are there specific products that your
sales and marketing organization can tout as genuine cost savers and
productivity enhancers, with a demonstrable ROI that would make move them higher
up the IT priority list of your customers? If you sell indirect, is it time to
clean the channel, eliminating underperformers that require resources and
support but deliver little in return?
The current economic crisis is unprecedented and it may last for some time. Make
the hard choices to ensure your survival. But also, prepare now for better
times. Do what’s necessary today so that tomorrow, when the economy recovers and
happy times are here again, you’re fully poised and positioned for accelerated
growth and increased profitability.
Software Equity Group is an investment bank and M&A advisory
serving the software and technology sectors. Founded in 1992, the firm has
represented and guided private companies throughout the United States and
Canada, as well as Europe, Asia Pacific, Africa and Israel. They have advised
public companies listed on the NASDAQ, NYSE, American, Toronto, London and
Euronext exchanges. Software Equity Group also represents several of the world's
leading private equity firms. They were recently ranked among the top ten
investment banks worldwide for application software mergers and acquisitions.
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