Introduction
Timothy Goddard
Welcome to tech M&A monthly, I’m Timothy Goddard, VP of marketing here at Corum Group. We have a great event for you here today, so let’s just jump in and get to our agenda.
We’re going to start off with a report from a CEO breakfast that we held just yesterday in the emerging tech hub of Berlin. Then we’re going to talk about some lessons learned on patents and M&A from a conference we co-sponsored last month. Then we have a number of other events we’ll be participating in from the coming months that we hope you can join us at. Then we’ll go into our research report, looking at the deals, the trends and valuations from the last month. Then we’ll get to the heart of our agenda, which is deal structures today, looking at stock options, earnout, and many of the other issues you’ll need to be cognizant of as you look ahead to your exit. Then our president Nat Burgess will close us out with some final thoughts.
Let’s begin with Jon Scott, senior VP of Corum Group, based in Amsterdam.
Berlin CEO Breakfast
Jon Scott
Berlin is turning into one of the leading entrepreneurial tech hubs in Europe, Tim, and this his has all come about in the last few years. I’m in Berlin frequently and impressed with the depth and breadth of the software talent there. Corum and our partner, law firm Olswang, who has a significant presence in Berlin, hosted an invitation-only breakfast for tech CEOs this week on Tuesday morning. This was a fast-paced look at current M&A and had a very interactive discussion on “closing the deal” led by my colleague Mark Johnson out of our Stockholm office. Mark presented a case study on the negotiation, offer and counter offers leading to the conclusion of a very successful recent transaction of a Corum client. The CEOs provided their input to the negotiation and then got to see the actual issues and positions of the seller and buyer, and how the final agreement was reached. We hope to hold more of these invitation-only CEO briefings in other European cities in the coming months. Back to you.
Timothy Goddard
Thanks, Jon.
Patents and M&A Conference Report
Now we’ll return to headquarters where Rob Schram, senior VP recently hosted a webcast on M&A and patents. Rob, tell us a little bit about what we learned during that event.
Rob Schram
Thanks, Tim. In late August – and for the 2nd month running - Corum was pleased to sponsor the World Financial Symposium Spotlight webcast entitled “Patents, Technology and M&A.” The session included a wealth of material from 2 key presenters: Corum’s own Elon Gasper, VP and Director of Research, with deep patent and other IP experience and 11 patents to his name; and top patent attorney, former chair of the Intellectual Property Section of the State Bar of California, Dave LaRiviere.
The session explored the multi-faceted value of Intellectual Property and related technology patents including the increasing value of software patents today and IP as cornerstones of business architecture. All are highly relevant to strategic decision making, a company’s growth and exit strategies, and every phase of the M&A process. Although filings are increasing, most software firms still haven’t been getting patents, with the possible exception of recent venture-backed startups.
Studies peg the average value of an individual patent during an M&A transaction to be about a quarter-million dollars. There are many other valuation aspects to consider related to secured IP, but deal structure is critically important, and the presence—or lack of—a strong patent or patent portfolio can affect the acquisition terms, indemnifications, escrow hold-backs, etc.
The session also explored ways for small companies to leverage their potentially infringed patents with the big companies and also covered the three conditions encompassing a patent process, that is, owning a patentable technology, owning a patent application in process, and owning an issued patent. We also covered what to do at each stage.
Given the large number of attendees, cogent questions, and positive follow-on response, the high relevance of this session was, well, patently obvious. If you happened to miss the event, you can find a full recording of the webcast at WFS.com.
Timothy Goddard
Thank you, Rob.
Research Report
Now let’s go to Elon Gasper, VP and director of research and senior analyst Amber Stoner for a look at the last month in tech M&A.
Elon Gasper
Thanks, Tim. We begin with the public markets, where all three indices we track rose again last month, lifted by profits and European Central Bank plans to escalate cheap money policies with its own QE program. The tech M&A market took its cue from this as the story remains low rates and bulging corporate coffers, though Mid-East and Ukrainian battlegrounds are continuing concerns.
Our Corum Index printed with a rising number of total and cross-border transactions, in particular megadeals which doubled last August, the biggest being the $3.5B acquisition of Comdata from Ceridian by FleetCor, which took advantage of the loose credit environment to finance the deal primarily with new debt. The Atlanta-area buyer thus enters the business of virtual bank-card payments as part of the ongoing digital currency flow trend, one of the top 10 presented here by Corum in March. This week’s announcement of the Apple Pay system confirms the importance of this trend, underscoring again the value of companies applying creative solutions within this huge and now even faster-growing ecosystem.
Returning to our Index megadeals, the Siemens Health Services purchase by Cerner for a $1.3B, by far its largest acquisition ever, should significantly expand its European base, top line and overseas profits, and shows the window is still open for consolidation in this space, especially since their CFO indicated the future could hold some more small, strategic acquisitions, too.
Finally, the purchase of video game streaming platform Twitch by Amazon holds implications for software execs to be examined in next month’s webinar by Alina Soltys, as well as in her presentation at GamesBeat next week
.
Turning now to the six markets Corum covers, we’ve news and analysis for 3 today, starting with Horizontal Applications. Amber?
Amber Stoner
SaaS companies, in addition to keeping Horizontal valuation multiples at the top of our six sectors, are also supporting the sector’s global acquisition volume since Q2.
Intuit continued its acquisition spree, six deals so far this year, picking up UK-based payroll SaaS provider PaySuite, expanding Intuit’s reach in the UK market.
And Swiss HR services company Adecco grabbed US-based workforce management SaaS provider OnForce which will merge with Adecco’s other American subsidiary, Beeline, to deliver a multichannel talent management solution.
The highly competitive ad market has also pushed ad tech firms into expanding their capabilities quickly, leading to artificial intelligence advertising solutions company RocketFuel’s acquisition of ad tech firm [x+1] for $230M, a 2.6x multiple. [x+1] delivers a marketing and data management platform to Rocket Fuel’s existing AI and Big Data driven optimization technology.
In addition, WPP subsidiary Millward Brown bought media analytics solutions company InsightExpress continuing WPP’s current strategy of investing in data and digital and supplying Millward Brown with cross-platform advertising measurement capabilities across digital, mobile and TV.
What’s going on in the Vertical sector?
Elon Gasper
While multiples in the Vertical market experienced a slight dip since Q2, activity in its healthcare subsector remained steady.
The healthcare IT vertical saw some interesting transaction sets beyond the Cerner megadeal, with medical analytics proving it still commands value around the world. For instance, Nirvaco, a Norwegian medical coding and analytics company, was bought by Finnish healthcare SaaS provider Datawell; while it looks like medical SCM and analytics public company Premier may break a billion revenue by means of its continued M&A-powered growth, with an August roll up of two more companies: TheraDoc, a clinical infection surveillance and analytics sub of Hospira, for $117M, at an impressive double-digit sales multiple; plus another healthcare SCM/ERP player, Aperek; both based in North Carolina.
In another roll-up Accruent, an Austin facilities management solutions company, entered the healthcare vertical by acquiring two providers of medical facilities management software, Texas-based SiteFM and Pittsburgh’s Four Rivers Software.
Over on the buy side, PE firm Riverside Company had an active August, including two deals for Verticals, venturing into the government sector with its buyout of Lexipol, a public safety risk management SaaS provider; and the financial sector with its purchase of DMA, with its marketing analytics SaaS for banks and credit unions.
What’s the news from the Infrastructure market, Amber?
Amber Stoner
With Infrastructure valuation multiples trending up, identity and access-related technology acquisitions set sail over the last month, finding safe harbor with both PE and strategic buyers.
Thoma Bravo became the majority shareholder of Austin-based identity management provider Sailpoint with an estimated $300M investment, solidifying Sailpoint’s position in the enterprise security space and bolstering its acquisition ability going forward.
IBM bought cloud-based identity and access management solutions provider Lighthouse Security Group, the subsidiary of its long-term partner Lighthouse Computer Services. Coupled with the acquisition of CrossIdeas, another provider of user access technology, the deal reflects IBM’s steady move into the hot identity access management market.
And VMware shored up its end-user portfolio with two acquisitions in August. CloudVolumes, a virtual desktop application service provider, builds on the existing VMware Horizon to offer a real-time application delivery system, while Singapore-based Virtual System Solutions buoys VMware’s cloud migration capabilities.
Elon Gasper
And that’s our report on a hot August market; for next month’s quarterly report we’ll fan out to cover our full 6 markets and 26 sector survey of activity and valuations on October 9th. Back to you, Tim.
Timothy Goddard
Thank you, Elon, great stuff.
Deal Structure
Now, one of the things these rising valuations are creating is a need for buyers to get more creative when it comes to deal structures. That also means more complexity, so now we’re going to talk about deal structures. We’ll start things off with Corum CEO Bruce Milne to introduce the topic.
Bruce Milne
With today's record deals, global buyers using a range of structure options to handle higher valuations, related risks. Structure depends on many variables: balance sheets, ownership, debt, forecasts, litigation, patents. Improperly structured, you can lose you much of the value to taxes.
Results of due diligence will affect employment agreements, escrows, hold backs, liabilities. In our online sellers video one client stated "I thought the negotiations would all about price, but they were all about liabilities" so, be prepared for heavy due diligence if you want an optimum structure.
The Private Equity firms use cheap financing to leverage up. Strategic buyers have a number of ways to compensate you: cash, notes, stock , options, employment agreements, earn outs, etc.
Today’s experts will share their experiences on how to use structure to increase value, plus, how to handle problems like Active vs. Passive shareholders.
I'll be back with you shortly with on how you can structure the transaction to retain employees to ensure a successful merger.
Timothy Goddard
Thanks, Bruce. We’ll start with Jim Perkins out of Phoenix. Jim will look at cash, but not at the easy, simple cash deals, but the more complex varieties, addressing minority and installment sales. Jim?
Jim Perkins
Let’s talk about minority investment first. There are times when an initial minority investment makes sense as a step to eventual purchase. Such offers are common among Asian buyers.
To be successful, that initial investment must to be tied to a clear plan of who’s running the company how the buyer will purchase the rest of the firm and when.
Here are other considerations:
1. What is the upside for the seller by taking an initial minority investment?
2. Are there clear seller bonuses for outstanding performance?
3. And how is that performance measured? Who has control of that performance?
4. What accelerators are tied to the buyer purchasing the rest of the company.
An Installment Sale may have considerable upside as well if there are clear payment values and agreed upon timing.
As a seller, research the quality of the buyer.
1. What should the premium be to the seller to consider an Installment Sale?
2. What happens if the buyer defaults on the any of the installments?
3. What happens if the buyer gets bought? Does that trigger the acceleration of the complete acquisition of the seller?
These are valuable points to consider in an Installment Sale
Timothy Goddard
Thanks, Jim. Now let’s talk about the other primary form of compensation, and that’s stock, and with that we’ll go back to Jon Scott.
Jon Scott
With respect to this, should you accept stock as part of deal consideration? I get asked that by CEOs quite frequently.
Sometimes it makes sense. If the buyer is already public it is easy to look at their financial and market position. You will be most concerned about whether you will be restricted from selling your stock for some period and what might happen to its value over that time. If the stock offered is private, that’s another story. There are different regulations with respect to tax implications depending on your tax jurisdiction. Here in Europe I know it’s different than in the States, and then in the States it can be different even at the individual state level. One big red flag people don’t always think about is that you may have tax due on the paper gain when receiving the stock, even if you don’t sell any or it is illiquid. So really get great advice before you agree to accept any stock component.
Back to you, Tim.
Timothy Goddard
Thank you, Jon. Now let’s dive a little deeper into this question of stock and turn to Ward Carter, chairman of Corum Group, who’s with us at headquarters, to look specifically at pre-IPO stock.
Ward Carter
Yes, Tim, with a flood of tech IPOs coming to market, we’re seeing more pre-IPO stock offered as part of deal consideration. You’ll need to understand the market risks and brace yourself in the event the IPO does not occur. That said, we’ve had some great outcomes such as last year when a Corum client accepted pre-IPO stock in Textura, a SaaS construction management vendor, Their equity value more than doubled when the stock was priced at 15 dollars for the IPO and ran up to nearly 48 dollars before settling back in the high 20s. Wed had plenty of opportunities for our clients to cash out at a nice profit. So, don’t ignore the potential value of pre-IPO stock as a way to capture additional value as well as getting the deal done.
Timothy Goddard
Great, thanks, Ward. Now let’s look at exploring stock options in particular with Corum VP Jeff Brown.
Jeff Brown
After we’ve negotiated the buyer to his limit on cash valuation, buyers and sellers may still differ. So we need to bridge the gap. That’s when stock options can be helpful. Options rewards performance inducing sellers to stay on board and aligned after the deal.
For buyers, options are cheaper than cash. This is especially true for high growth buyers keen to preserve cash. The value of options can be tough to know in advance. So don’t let too much of the deal get tied to them and make sure you can meet those targets. Rely on simple, clean metrics like gross revenue instead of profit for vesting triggers. For options to be valuable, you need a way to be liquid, so be sure your buyer has a plan to sell, IPO or buy them back at a later time.
Here are two deal examples from my portfolio.
For the first example, in addition to cash, the founders received options at a low strike price that vested each year over the next 4 years as performance bonuses, adding another 15% to the deal value.
In the second, the buyer, a $1B company with IPO aspirations held the seller’s company as a wholly owned subsidiary carving out 20% of the equity for the two seller with options for another 5% if first year performance targets were reached.
Timothy Goddard
Thank you, Jeff. We’ve alluded to it, but now let’s dig deeper into the question of earnouts with Rob Schram again.
Rob Schram
Earnouts help buyers and sellers “bridge the gap,” tying upside to specified goals like product releases, new customers, revenue, or profitability, either over years or at one time. This is especially applicable when the seller projects aggressive financials for improved valuation, but can also serve as a “sweetener” to help keep key people in the company post-closing.
I recently concluded a sell-side engagement that added a valuable new dimension to the buyer’s offering, but included an absolute requirement that the founder stay on to head up the new division. The earnout package, paid out over multiple years, included cash, restricted stock and incentive bonuses. As with this case, it’s always important to contractually secure the authority and resources to meet the earnout criteria; and for this reason, profitability isn’t a recommended benchmark.
If the base price falls within an acceptable range, earnout can be “frosting on the cake” - especially if there is good opportunity for future growth and accelerators for performance over target. Properly executed, sellers can earn significantly more from a sale including earnout—but given the risks, we generally recommend that earnout not exceed 25% of the consideration.
Timothy Goddard
Thanks, Rob. That leads us very nicely into another way of looking at what comes after the sale, which is employment agreements and non-competes with Ed Ossie.
Ed Ossie
Well, no buyer is going to pay millions and have you compete, and most want you around for a transition period. This gets us into the personal part of structure: employment/consulting agreements and non-competes which are usually the last thing negotiated.
As a former buyer I wanted to know that our interests were aligned and we were on the same page for the future. We tried to capture that in an employment agreement that set forth some pretty basic guiding principles and protected both parties.
Sometimes due to age, interest level or health a multi-year employment agreement isn’t desirable to either party but a 6, 12 or 18 month consulting agreement makes more sense.
You know your business, customers and technology better than any due diligence process will illuminate, so buyers may want access to your expertise for a defined period of time.
On non competes, you’ll want to pay particular attention to the buyer’s definition of a competitor in the proposed agreement. You might inadvertently agree to a broad segment
like SaaS software for vertical markets, when you assumed it was just Healthcare.
Employment Agreements are personal and your behavior in negotiations sends signals to the new boss.
Timothy Goddard
Thank you, Ed. Now, back across the pond, we’ll hear from Mark Johnson on a particularly tricky aspect of what Ed just referred to, and that is the question of active versus passive sellers. Mark?
Mark Johnson
One of the biggest structure problems we see as M&A professionals involve two issues between active vs. passive owners.
First, we often see that offers by buyers are made to keep ACTIVE management owners, giving them more in the form of earn-out, options, profit sharing, etc. These aren't offered to outside PASSIVE investors not working in the company; who may cry foul because the buyer often try's to cast these extras as part of the purchase price.
Second, these outside investors: angels, VCs, Private Equity etc. often do not want any part of ongoing shareholder liability. The outside passive investors, pushing for more at closing, while eliminating risk afterwards can turn the buyer off, too often killing the deal after you've worked so hard to make it happen.
It’s essential to be prepared for this eventuality. Sometimes this means separate deals to different sellers; crafting a total exit to passive owners and a partial exit with an attractive upside to the active owners.
"Managing your outside investors for a successful merger" will be the topic of an upcoming webcast. I'll go into more detail then.
Timothy Goddard
Thank you, Mark. Finally, we’ll go back to Bruce who will discuss the question of employees and close us out with some final thoughts on the topic.
Bruce Milne
An Ernst and Young study claims that 53% of mergers fail. Biggest problem? Keeping employees.
With a little advanced planning, there is so much you can do.
Here are three examples of successful retention programs Corum negotiated on behalf of sellers:
The first is a cutting edge company where a new technology HAD to be completed. To do that, we implemented a retention bonus, a completion bonus, PLUS profit-sharing, which generated over $7M in extra deal value.
The second firm involved 25 employees who received a two-stage cash welcome bonus, new four year stock options, and a severance of a year’s salary if they were terminated within the first two years.
The third example involved 60 employees in a sale to a European buyer - they got earnout and a lump sum cash settlement if they stayed 2 years.
In closing, remember, the buyers are buying the future. What you can produce together that will go to their bottom line affecting their stock price?
The more you are willing to share in those future earnings, and related risk, the more the buyer can pay you.
While cash is still the dominant structure, most of you will have some of these elements in the structure of your final sale.
Timothy Goddard
Thanks, Bruce.
Closing Thoughts
Now, to close out our conference, let’s go to Nat Burgess, president of the Corum Group, for some final thoughts.
Nat Burgess
Thanks, Tim. This has really been a tremendous session. I think any one of these topics could be expanded to a full hour, and there was lots of great advice for anyone considering making deals. I have just a couple of closing thoughts.
The first is on patents, so I encourage you to tune into Elon’s awesome patent segment, it’s available online, and if you’re looking into current trends and constraints and opportunities, you should check that out.
Tactically, when you’re in a deal, if you have patents and you bring them up in the negotiations, the deal could end right there. I’m thinking about two specific scenarios. One is, if you’re Microsoft, for example, and you bring up patents with the M&A team, just policy says time to involve the lawyers, and that can freeze things for years. It’s also a huge mistake to bring any kind of threat over infringement. If you show up to the party and say, “hey, you should really buy us and oh, by the way you’re infringing on our patents,” the response is going to be, “do us a favor and sue us so we can spend the next ten years figuring out what those patents are actually worth.” I’ve had that conversation. It does happen. So, patents, more than just protecting your IP, there is a tactical aspect that is critical to consider.
The second point here is that we’re looking at data that is hugely encouraging in valuation and M&A trends. Valuations are going up, buyers have new capital, we have new buyers going public, raising money. Rocketfuel’s $2M acquisition is incredible, because having that kind of war chest, given their short operating history and background, that is exemplary and it could not have happened two or three years ago.
But here’s the thing, this is the double-edged sword. If you’re a relatively small emerging company trying to get acquired by the big guys, it may seem like a good thing, capital is cheap, acquisitions are happening daily, and there is a lot of momentum in the market, but guess what? All those buyers have raised the bar. They’re going after bigger deals, more competitive deals, and you may be under the radar, so it becomes even more important to be crisp, prepared, going in at the right level, and being professional. It doesn’t make life easier. You ultimately have the opportunity for a higher value deal with a better buyer, but you have to get your act together and really do it right.
The last thing I wanted to say here is that we’ve talked a lot about deal structure. We’ve talked about earnouts, we’ve talked about options. Jeff mentioned bridging valuation gaps and then Bruce brought up something at the end, and that’s using structure to take care of employees. We have a lot of plans where either the business is owned entirely by the founder, or completely controlled by outside investors, and so the employees frankly aren’t going to see a big payday at closing. But there is a desire on the part of the owners to make sure that they are rewarded for their efforts and a desire on the part of the buyer to make sure that they are motivated to stick around and make sure things happen.
So, when we talk about deal structure, we’re not just talking about money going into shareholder pockets, we’re talking about creating a collaborative synergistic deal where everyone is working together to make sure that everyone achieves the goals that they set out to achieve when they close the deal.
Great content again, thanks to everyone who contributed, and back to you, Tim.
Timothy Goddard
Thanks, Nat.
Q&A
We just had a question come in on that topic. “How do you target purchase by allocation in case it is tied to a fraction of employees staying?” Do you have perspective on that.
Nat Burgess
I do. I’ve done this with Google, Microsoft, Yahoo, and others. The first question is who owns the business? If, in fact, the employees who are being targeted own a part of the business, then frankly that allocation is going to be a hold back. Rather than getting all their money at closing for the equity they own, they’re only going to get a piece of it, and then a piece of it later. If it’s a scenario where those key employees don’t have a significant shareholding, then you’re going to be looking at additional payments to them, and that will be outside of the purchase price. So those are the first two distinctions. Is it a pull back of an equity payback to an employee? Or is it an additional bonus that is paid on top of the transactional consideration.
Rule of thumb for early stage deals with a really strong team. If you’re talking about a scenario with one of those big players like Microsoft and Google, they’re going to want to hold back between 25-40% of purchase price for retention and frankly the practice has gotten a lot stricter. You’re not going to have a lot of flexibility as an employee in having some protections in there. For example, if you’re terminated without cause, making sure you’re going to get paid anyway. I’m happy to go into this offline, but as a seller, there are some things you really need to pay attention in order to protect your interest.
Timothy Goddard
There were some other questions, but we’re right up against our half-hour mark. We’ll reach out to folks who didn’t get their questions asked as we go to our close. Thank you.