It’s not quite as simple as saying “you get what you pay for” – but it’s close. Establishing the brand of your law firm is hard – and it is every bit as hard for the software developers who want your business. The boxes all look the same, the people all have the right patter, there are horror stories and reference sites in equal measure. In UK legal practice, case and matter management software development there is a full range: some suppliers cater for early adopters, some avoid the bleeding edge, some integrate, some claim integration, some stay with best of breed. Some do hardware, some do clouds, some do document management; for some, document management is collaborative versioning across borders and jurisdictions, for others it is the size of your shredder. Some cover firms of all sizes, some only big firms, some only small and some only in-house teams. There is a bewildering choice of suppliers and competencies in legal software development – and these days that is actually a very “good thing”.
Ponder for a moment the alternative – a take it or leave it, one-size fits all, low service world? Yes it would be cheaper, but would it put your firm where you need to be when faced with top 100 US law firm competition, more GC fixed price packages, or Co-op Legal Services?
Comparisons with Accountancy Software:
Parallels are often drawn with the neighbouring profession of accountancy. They wear similar suits, send their kids to the same schools, and allegedly take to computerisation quicker and easier than lawyers. Maybe; but the shape of the accountancy professions’ software support market is radically different. The theory goes that if you can serve one profession well you know how to do others too. So what shape is the accountancy profession software support sector and why?
It is a bit of a caricature, but large accountancy firms basically have two choices: do it yourself or go see CCH; the mid-market firms largely have to either take it or leave it from IRIS’ old Transaction Technology platform, while smaller firms are at the mercy of assorted spreadsheet jockeys – always ingenious, but sometimes fragile.
The accountancy software market has played hard ball with suppliers for decades – it has been very prepared to run its own software development teams and squeeze price and external development investment accordingly. It has also had the luxury that many of its core processes are eminently automatable. The balance of power between buyers and suppliers is heavily weighted towards the buyers – so much so that the size of this market is around a third of the comparable legal one.
IRIS’ market leadership in mid-market accountancy solutions is well known and while the product has its detractors, it does what it says on the tin. They are good at what they do, and they know how to hold and defend a market leadership position.
There are a number of good entrepreneurial teams mounting rival challenges. To Thomson Reuter’s credit, they have both Digita and Abacus in harness now to build a credible alternative – arguably the Waitrose to IRIS’ Tesco style ubiquity. Smaller firms like Practice Engine, TCSL, APS and innovators like Liquid Accounts will change things in time and typically offer solutions and service that IRIS cannot match. This is a tricky market, however. Sage, for example, built a whole division here over a decade ago, and was unable to achieve many synergies given their brand. Lexis has given the accountancy and tax sector a wide birth, which is odd, considering that the Butterworth’s brand is as strong if not stronger than the CCH brand in tax.
The reasons for the apparent lack of choice in the tax and accountancy software sector are cultural as much as anything. Just as the accountancy professional information market is less than a quarter of the size of the legal one, their attitude towards software is fundamentally different. Having some experience of looking under the bonnet in enterprise systems used by their clients, accountants know that it is rarely rocket science, but they also assume the five most dangerous words in strategy: “how hard can it be?” It is a defining characteristic of the tax and accountancy software market that the larger firms have repeatedly developed solutions themselves, sold them and started them up again in a long term strategic display of major buyer power. Both of the major corporation tax specialists in the market, TSCL and Abacus started life inside KPMG and Andersen respectively. Thomson Reuters recently acquired the Abacus branded solutions from Deloitte and the cycle will no doubt go full circle again in due course.
What the accountancy market loses, precisely because of the power of its buyers, is a strong enough gene pool among independent software development firms willing to commit to excellent long term solutions. The end result is that only a few stalwarts are willing to play, and who can blame them? You can spend decades building intricate solutions for large firms with complex integration protocols and global competence only for the client to offer your core developers twice the salary and better kit to jump ship. You can get as cost effective as possible only for the client to move supplier after a long standing relationship or take the business inside capriciously, purely “because it is time”. Ironically the “we need to avoid complacency” or “we can’t afford to rely on one supplier” arguments end up delivering precisely that.
Economics in the UK Legal Software Market
So the theory goes that the legal software market will go the same way – it’s just a matter of time. It has even had some big players trying to force the pace in recent years such as multi-billion pound VCs who see the consolidation of the UK Legal IT market as a no brainer. In the noughties an impressive lady by the name of Vin Murriah did a sterling job rounding up MSS Alphalaw, AIM/Teamflow, Laserform, Opsis, Meridian Law, Mountain Group and Videss for CS Group. After the £500m take over by Hellman & Friedman, IRIS carried on picking up smaller targets in barrister’s chambers and other niches; so if that agglomeration be for you – who can be against you?
Well, Thomson Reuters – a £30bn global conglomerate – with their Elite brand for one. Lexis, a paltry £10bn global conglomerate by comparison brings VisualFiles and Axxia to the party. The home grown smaller listed team of Tikit are well known and while IT managed services is their core, the old TfB/Avenue brand came out of the recession quite well. Wolters Kluwer UK sold their legal operations to Thomson some years ago and have stayed out so far while a US VC-backed Aderant is largely doing what they would have done. Wilmington have been pre-occupied with core issues in CLT and training through the recession, while Bloomberg are looking hard for ways into the UK legal scene. EMAP and Euromoney remain more focused on the know-who than the know-how markets in legal services for now, while neighbours such as Civica (3i backed since 2008), Achilles (backed by Hg, IRIS’ former backers) and Landmark (Daily Mail General Trust backed – a £2bn group) are taking targets of opportunity in niche legal services areas already. In short, at a headline level there are 3-4 other major and global groups active, at least 3-4 others are prowling, and 3-4 other major players nibbling actively. The same cannot be said of the tax and accountancy market.
So is this a good thing? Well what the above picture doesn’t tell you is the strength of entrepreneurial and innovative talent elsewhere in the market. IRIS, Lexis and Tikit did not buy everyone and many of the remaining independents are actively showing up their big group rivals. A raft of exciting and innovative firms are offering genuine alternatives to the “big blues”. Eclipse, Flosuite, IKEN, Practicce, Pilgrim, Linetime, FWBS and Quill to name but a few are doing some really quite exciting things, as are Bar Squared for the chambers market.
The Recession’s Impact
The CS Group (as was) merged with IRIS in mid-2007, and a little matter of the legal profession heading into a recession first instead of last interfered with their plans somewhat. In economics terms the recession for Legal IT was bigger than in ’02; different in both size and shape. A £12m reverse in 2001-2 equates to a £20m one in 2008-10, a sharper and more condensed hit than the last recession.
So where was the list of casualties from the smaller developers? Thankfully it is missing. There were no comparable casualties in accountancy either, but that’s what you expect from a consolidated market run by “big boys” – the point is, the diverse market in legal IT fared just as well if not better, consolidated or not.
Bear in mind also that pre-07 many of the development teams had already invested significantly in repositioning their platforms, in some cases rewriting whole swathes of core code from scratch on new platforms aiming to launch in 2009-10. All were stretched; many were caught by the double whammy of recession and investment cash flow exodus simultaneously. That they emerged in rude health is a very heartening sign, not just for them, but for the profession.
Consolidation versus Choice
Managing partners and their CIO’s can expect this range of choice to continue. For the very largest global players, there remains Elite, Aderant, FWBS, Flosuite, Norwel, internal teams and a few more attempts to squeeze SAP or Oracle into the box. For the public sector, GCs and in-house teams players like Eclipse, Flosuite, and IKEN offer good alternatives to established services from Civica (as well as reliable top firm pitches too). Private practice has a strong choice from Pilgrim, FWBS, Norwel, Linetime and SOS in addition to the usual suspects from Lexis, IRIS and Tikit. Smaller practices have some great solution from experienced teams like Pracctice, Peapod, DPS and Meridian Legal and even LPO options, from firms like Quill/Pinpoint. Niche specialists such as ICSA Software, Business Integrity, Class Legal and Bar Squared offer variety as well as depth.
81 brands have become 64 firms over the past decade - to see the market map in full go to http://bit.ly/hgXokh for RBP's pictorial version. The respective sizes of the boxes are good approximations of the turnover of each firm. All of these firms pictured have achieved critical mass and survived a tough recession so there will remain a healthy scramble to find the elusive nirvana of matter management and practice efficiency. Yes, the profession is paying more for its software pro rata than the accountants are, but it has a healthier talent pool to call on and more choice and creativity at all levels. The suppliers survived the hardest test of 07-09 well and there are even new entrants emerging such as Peppermint – well worth a look.
Good Enough versus Critical
If anything the economic lesson from the market data is to certainly ignore any nonsense about lawyers tailgating accountants. More importantly it is probably also to stop comparing “one stop” and “best of breed”. In a sense everyone wants best of breed – it’s just that for some (usually smaller firms) the best of breed is a time and fees based single box. The real vibrancy in the market seems to come from in-house counsel needing industrial strength matter management, whereas for them time and fees needs to be very project specific rather than department generic. For private practice, time and fees remains essential, whereas case management does not need industrial strength, but bespoke tailoring. The neighbouring market of CRM systems probably still suffers too much from GIGO – garbage in, garbage out – but at least for lawyers there are more and better brains tackling the issue than in other markets.
Monday, 28 March 2011
Wednesday, 2 March 2011
Metastorm and IRIS management - pebbles with big ripples
$182m sounds like a lot. So does £112m. But compared to $3billion, let alone £30billion or £55bn - it's a small drop in a modestly sized pond. A bit like changing the business card to say "non-" in front of "Executive" - a small but significant change with ripples spreading.
The recent deal in which Opentext bought Metastorm only really makes sense if you see it alongside a range of deals such as the Complinet deal from Thomson Reuters recently. In both cases, the price paid was breathtaking. Neither is really big enough to affect the share price of the acquirors on their own unless market traders see them as symptomatic of something else - good or bad. But they are just the latest in a round of strategic bouts, which have kept the M&A headlines ticking along in a market which should by rights have been acquisitively dormant, and certainly not pushing deal benchmarks higher.
From a UK perspective, the small pebble is Metastorm's UK size. The big brand in the UK boils down to a business with less than £10m overall sales, most of which are overseas, and still less relating to purely legal clienteles. We typically do not map firms with less than £1-2m sales, and frankly Metastorm are borderline in this category in UK legal IT - although we have now relented and are including their profile in our market research profiles for Legal Technology.
The test seems to be - are you "legal" or are lawyers just a niche to you: "where do you live?" One of the strategic themes we keep banging on about is: "if we're an option to you, you're not a priority for me". For Complinet, in-house compliance teams were what they did; period. For Metastorm, legal was one of a range of industries they serve well, but they are a niched BPM specialist. Strategically if lawyers went south, they could migrate to bankers, pharmaceuticals, or a range of others - a "good thing"; but also a bad thing if you want true legal specialists. It is comparatively easy to see this degree of specialism in tax and accounting software - harder with legal practices, and harder still with GCs and in-company teams. But this is where the "strategic" premiums are being paid. Thomson Reuters (30bn) want SAP (51bn) and EMC (56bn) to see the lines in the sand, and others like Wolters Kluwer (5bn) are helping to draw the lines more clearly with players like Automony (4bn) and Opentext (3bn).
The other issue is VCs versus global trade. Cash is not something VCs get dewy eyed about - it is a commodity to them, so the main punch in M&A terms of Thomson, Reed, WK etc is neutralised. A surprising number of big IT names, ie Northgate and Ceridian for example are not only not listed, but VC held, as is Aderant. IRIS has been in VC territory for most of a decade. It must be immensely frustrtating for trade players not to be able to play with leaders and get the synergies proven, but that's life. Enough Big VC's, not least Hellman & Friedman, Hg Capital or Vista Equity Partners, are still convinced that this global spat has mileage to run and that they can see a way of keeping the exit multiples as high as possible. A range of smaller VCs in the UK are consistently snapping up smaller tech assets and perhaps it is only when one of these VCs hits a significant capital loss that this run will stall - but who's going to be the one to call it?
Meantime - can Lexis dna, Thomson Elite, or CCH/Sol6 shut down the operational freedom of IRIS, Aderant, etc? Will Tikit or Elite keep SAP/TCS at bay or Flosuite or FWBS hamper Metastorm?
We'll tell you when the score changes - the recent changes at the top of IRIS are symptomatic. IRIS legal's 2010 results are in their profile on the RBP site now. Merging the legal division with the enteprise one suggests they see two exits - a tax one, probably to one of the publishers, alongside an enterprise one to a global BPM/ECM player. A buyer for the whole is increasingly unlikely, and patience with on-sell breakups is not high or a favoured ploy by these big groups. For what it's worth, we think their assumption that legal technology is just another BPM niche is wrong - and yes, I'll shoot the next guy who explains to me that Sharepoint is really the messiah, not just a naughty boy.
So a c£2-3m firm acquired well up the tree by another US major group, has ripples far beyond its horizon. No doubt there will be some shadenfreude over changes at IRIS, but if they can still get a screaming exit multiple(s) - it's premature. It's a complex market with big stakes, and a lot of group think and gossip going around. RBP have just published their guide to M&A in this sector - reviewing the facts: see http://bit.ly/i66a9q
The recent deal in which Opentext bought Metastorm only really makes sense if you see it alongside a range of deals such as the Complinet deal from Thomson Reuters recently. In both cases, the price paid was breathtaking. Neither is really big enough to affect the share price of the acquirors on their own unless market traders see them as symptomatic of something else - good or bad. But they are just the latest in a round of strategic bouts, which have kept the M&A headlines ticking along in a market which should by rights have been acquisitively dormant, and certainly not pushing deal benchmarks higher.
From a UK perspective, the small pebble is Metastorm's UK size. The big brand in the UK boils down to a business with less than £10m overall sales, most of which are overseas, and still less relating to purely legal clienteles. We typically do not map firms with less than £1-2m sales, and frankly Metastorm are borderline in this category in UK legal IT - although we have now relented and are including their profile in our market research profiles for Legal Technology.
The test seems to be - are you "legal" or are lawyers just a niche to you: "where do you live?" One of the strategic themes we keep banging on about is: "if we're an option to you, you're not a priority for me". For Complinet, in-house compliance teams were what they did; period. For Metastorm, legal was one of a range of industries they serve well, but they are a niched BPM specialist. Strategically if lawyers went south, they could migrate to bankers, pharmaceuticals, or a range of others - a "good thing"; but also a bad thing if you want true legal specialists. It is comparatively easy to see this degree of specialism in tax and accounting software - harder with legal practices, and harder still with GCs and in-company teams. But this is where the "strategic" premiums are being paid. Thomson Reuters (30bn) want SAP (51bn) and EMC (56bn) to see the lines in the sand, and others like Wolters Kluwer (5bn) are helping to draw the lines more clearly with players like Automony (4bn) and Opentext (3bn).
The other issue is VCs versus global trade. Cash is not something VCs get dewy eyed about - it is a commodity to them, so the main punch in M&A terms of Thomson, Reed, WK etc is neutralised. A surprising number of big IT names, ie Northgate and Ceridian for example are not only not listed, but VC held, as is Aderant. IRIS has been in VC territory for most of a decade. It must be immensely frustrtating for trade players not to be able to play with leaders and get the synergies proven, but that's life. Enough Big VC's, not least Hellman & Friedman, Hg Capital or Vista Equity Partners, are still convinced that this global spat has mileage to run and that they can see a way of keeping the exit multiples as high as possible. A range of smaller VCs in the UK are consistently snapping up smaller tech assets and perhaps it is only when one of these VCs hits a significant capital loss that this run will stall - but who's going to be the one to call it?
Meantime - can Lexis dna, Thomson Elite, or CCH/Sol6 shut down the operational freedom of IRIS, Aderant, etc? Will Tikit or Elite keep SAP/TCS at bay or Flosuite or FWBS hamper Metastorm?
We'll tell you when the score changes - the recent changes at the top of IRIS are symptomatic. IRIS legal's 2010 results are in their profile on the RBP site now. Merging the legal division with the enteprise one suggests they see two exits - a tax one, probably to one of the publishers, alongside an enterprise one to a global BPM/ECM player. A buyer for the whole is increasingly unlikely, and patience with on-sell breakups is not high or a favoured ploy by these big groups. For what it's worth, we think their assumption that legal technology is just another BPM niche is wrong - and yes, I'll shoot the next guy who explains to me that Sharepoint is really the messiah, not just a naughty boy.
So a c£2-3m firm acquired well up the tree by another US major group, has ripples far beyond its horizon. No doubt there will be some shadenfreude over changes at IRIS, but if they can still get a screaming exit multiple(s) - it's premature. It's a complex market with big stakes, and a lot of group think and gossip going around. RBP have just published their guide to M&A in this sector - reviewing the facts: see http://bit.ly/i66a9q
Wednesday, 18 March 2009
Keeping IRIS' eye on the ball
The IRIS Group accounts for 2008 have created some noise among web commentators recently. Were IRIS a listed company burdened with full listing disclosures and the repository of funds from major pension funds - those with no locus standi would at least be entitled to target fair game. As a private company, however, CEO Mr Leuw has been provoked into explaining what looks like a significant loss of £28m. Even by our reckoning it’s now a business of £113m sales and 46% underlying profitability and he must feel like a goalie hit by a coin thrown from his own terraces. We hold no brief for IRIS or any one else for that matter - but we like to see the facts as straight as they can be.
Times have certainly changed since the mid-year 2007 deal headlined at £500m. The ins and outs of the Hellman and Friedman funding package are no doubt intriguing to investors in their funds, but the core underlying position of the operating companies remains robust. Net operating cash has risen from £21m to £38m in the period – up by over 74% - and even allowing for the elision of CS Group and IRIS figures, these commercial fundamentals are solid – whatever the state of the financing wrangles.
Hands up who wouldn’t love to be in the position of dealing with leverage issues without having to renegotiate covenants with some teenager handcuffed to a spreadsheet model. Any hands not up yet? And who else would rather deal with investors who’ve actually made the money they are lending you and understand market vagaries better than many of the banks (who until recently were hanging on their coat tails)? God forbid - should IRIS financial activities unravel - the likelihood of their core assets and brands not being viable and indeed vibrant even so is extremely remote.
IRIS, in common with other recession resistant businesses, is also maintaining their acquisition activity – and so they should. It is time to not get distracted. Fundamentally we remain far from convinced, however, that IRIS’ legal teams inherited from the CS Group are either (a) the market leaders they claim, or (b) in any way enhanced by being in the same stable as the accountancy services. By the time the acquirer of these teams was sent on her way, no significant integration had been tackled. Forced integrations in professional services – and especially for those smaller regional professional firms – can be painful; ask Sage. At a time when High Street legal firms are having a rough time and the might of Lexis Nexis Butterworths/VisualFiles/Axxia is ploughing into legal software how IRIS manage their third division is pivotal. IRIS have added Alphalaw to the group last December showing a continuing appetite for consolidation of the market. Good on them, another £3m in sales is unlikely to hurt; but the point remains - can a core team in professional services best at grafting telesales operations onto owner developer specialists rise to the diverse challenges of the portfolio development?
Will the Mountain/Meridian/Laserform/MSS/Alphalaw/Aim Professional/Teamflow/Videss conglomerations be able to merge effectively – or indeed should they? IRIS is now a group of three main divisions, of which only £26m or so by 2008 numbers (including Alphalaw) relates directly to legal services. Whether they can maintain focus is the issue.
The US VC parents are grown ups and should deal with investing horizons a lot quicker and with less trouble in relative terms than the moribund UK retail banks. The hard yards remain to be covered in seeing whether IRIS take up the torch lit by CS Group. A legal software consolidator was always coming – it still remains to be seen whether IRIS, Lexis or Tikit make a better fist of it in a legal services market which has only just experienced leading the nation into a rcession instead of following it.
Times have certainly changed since the mid-year 2007 deal headlined at £500m. The ins and outs of the Hellman and Friedman funding package are no doubt intriguing to investors in their funds, but the core underlying position of the operating companies remains robust. Net operating cash has risen from £21m to £38m in the period – up by over 74% - and even allowing for the elision of CS Group and IRIS figures, these commercial fundamentals are solid – whatever the state of the financing wrangles.
Hands up who wouldn’t love to be in the position of dealing with leverage issues without having to renegotiate covenants with some teenager handcuffed to a spreadsheet model. Any hands not up yet? And who else would rather deal with investors who’ve actually made the money they are lending you and understand market vagaries better than many of the banks (who until recently were hanging on their coat tails)? God forbid - should IRIS financial activities unravel - the likelihood of their core assets and brands not being viable and indeed vibrant even so is extremely remote.
IRIS, in common with other recession resistant businesses, is also maintaining their acquisition activity – and so they should. It is time to not get distracted. Fundamentally we remain far from convinced, however, that IRIS’ legal teams inherited from the CS Group are either (a) the market leaders they claim, or (b) in any way enhanced by being in the same stable as the accountancy services. By the time the acquirer of these teams was sent on her way, no significant integration had been tackled. Forced integrations in professional services – and especially for those smaller regional professional firms – can be painful; ask Sage. At a time when High Street legal firms are having a rough time and the might of Lexis Nexis Butterworths/VisualFiles/Axxia is ploughing into legal software how IRIS manage their third division is pivotal. IRIS have added Alphalaw to the group last December showing a continuing appetite for consolidation of the market. Good on them, another £3m in sales is unlikely to hurt; but the point remains - can a core team in professional services best at grafting telesales operations onto owner developer specialists rise to the diverse challenges of the portfolio development?
Will the Mountain/Meridian/Laserform/MSS/Alphalaw/Aim Professional/Teamflow/Videss conglomerations be able to merge effectively – or indeed should they? IRIS is now a group of three main divisions, of which only £26m or so by 2008 numbers (including Alphalaw) relates directly to legal services. Whether they can maintain focus is the issue.
The US VC parents are grown ups and should deal with investing horizons a lot quicker and with less trouble in relative terms than the moribund UK retail banks. The hard yards remain to be covered in seeing whether IRIS take up the torch lit by CS Group. A legal software consolidator was always coming – it still remains to be seen whether IRIS, Lexis or Tikit make a better fist of it in a legal services market which has only just experienced leading the nation into a rcession instead of following it.
Wednesday, 9 April 2008
What Buyer's Want to Know
M&A prospecters are as active now as ever in compliance and professional services markets. If you don’t ask yourself these questions, a buyer will:
1.1 Can you list your sales and operating profit for 3-5 years back, current year to budget, and at least 1 year ahead of the current budget? Can you cross check sales by service line back and forwards? Do you know the relative profitability of each major service type?
1.2 Can you state your overall profit at gross profit, operating profit, normalised operating profit (ie adjusted for owner benefits, R&D etc), profit before interest tax depreciation and amortisation (ebitda), and post tax profit? For each of the above 5-7 years?
1.3 Can you explain in the accounts any years where sales didn’t grow or even dropped? Can you restate previous years on a comparable basis if business lines have been discontinued? Some 20:20 hindsight is allowable and best done by you – if you launched a service/product that you later pulled and it hurt the numbers - show both as it was and as it could have been.
1.4 Can you state your revenue recognition policy clearly, as well as quantify its impact on the relationship between profits and cash? In any business with long term client contracts (1year +) anything other than deferring client revenue evenly over the period of the contract is only going to cause problems.
1.5 Are you happy that your finance staff are qualified enough, supported by auditors and working on software which is up to the job? Discipline is key. Management accounting should be on rails with monthly headlines for all senior management and quarterly reviews of major issues. It’s finance’ job to provide cross checks and balances – list where they have to, and why.
1.6 Have you got your operational benchmarks at your fingertips? Can you say what your sales per employee ratio is? How about average salaries and payroll as a percentage of sales? What renewal rates do you stand on for contracts, ie stated as a % of clients (volume) and as a % of client value overall? Typical obsessions about WIP and gross margins are usually not enough – WIP should be minimised/invoiced quicker - and everyone has their own definitions of gross margins that make comparisons impossible.
1.7 Benchmarks – by the time you have over 30 staff and/or over £2m in sales you should be able to achieve15-20% profitability consistently. If not – you are either over engineering somewhere – or possibly just investing heavily in growth and client acquisition. If the latter – when doe s the burn period end and how quickly will payback come.
1.8 Only contracted clients are worth money – no matter what the bragging rights are for big glory deals – one off contracts are not a business. If you can point to contracts for every client and analyses of how the contracts mature, renew and change/cross sell – then and only then do the higher valuation multiples kick in. Collections of contracts can have some value, but usually the same as WIP – x40%-60% at best or arguably around x3 on profits.
1.9 In essence can you write on the back of an envelope now (a) the value of contracted business you had last year, (b) the business you had that you lost or discontinued, (c) the business you up-sold, and (d) the new business you acquired over the year?
1.10 Finally – how crucial are you to the business? Tight financially run teams can still be undermined by the top dog stepping down (you don’t even have to leave – just taking your foot off the gas can do it). If you are serious about building your team and the company’s value – one of the best things you can do is prove that your line management have experience and ability. If they’ve been able to hoover up a few small businesses themselves or have a track record in major tenders and product development – it significantly reduces risk to the buyer (and keeps them a little bit more honest).
Good buyers don’t shop when they’re hungry – so they’ll take the time to weigh up their chosen partners. There are a couple of good VCs active in the market currently, not to mention most of the usual trade players staying alert. The credit crunch is not going to hurt compliance driven markets – it will have weeded out the hungry feeders that made up the boom last year – but there are many more left. The point is these guys know their onions and both sides should be better prepared.
1.1 Can you list your sales and operating profit for 3-5 years back, current year to budget, and at least 1 year ahead of the current budget? Can you cross check sales by service line back and forwards? Do you know the relative profitability of each major service type?
1.2 Can you state your overall profit at gross profit, operating profit, normalised operating profit (ie adjusted for owner benefits, R&D etc), profit before interest tax depreciation and amortisation (ebitda), and post tax profit? For each of the above 5-7 years?
1.3 Can you explain in the accounts any years where sales didn’t grow or even dropped? Can you restate previous years on a comparable basis if business lines have been discontinued? Some 20:20 hindsight is allowable and best done by you – if you launched a service/product that you later pulled and it hurt the numbers - show both as it was and as it could have been.
1.4 Can you state your revenue recognition policy clearly, as well as quantify its impact on the relationship between profits and cash? In any business with long term client contracts (1year +) anything other than deferring client revenue evenly over the period of the contract is only going to cause problems.
1.5 Are you happy that your finance staff are qualified enough, supported by auditors and working on software which is up to the job? Discipline is key. Management accounting should be on rails with monthly headlines for all senior management and quarterly reviews of major issues. It’s finance’ job to provide cross checks and balances – list where they have to, and why.
1.6 Have you got your operational benchmarks at your fingertips? Can you say what your sales per employee ratio is? How about average salaries and payroll as a percentage of sales? What renewal rates do you stand on for contracts, ie stated as a % of clients (volume) and as a % of client value overall? Typical obsessions about WIP and gross margins are usually not enough – WIP should be minimised/invoiced quicker - and everyone has their own definitions of gross margins that make comparisons impossible.
1.7 Benchmarks – by the time you have over 30 staff and/or over £2m in sales you should be able to achieve15-20% profitability consistently. If not – you are either over engineering somewhere – or possibly just investing heavily in growth and client acquisition. If the latter – when doe s the burn period end and how quickly will payback come.
1.8 Only contracted clients are worth money – no matter what the bragging rights are for big glory deals – one off contracts are not a business. If you can point to contracts for every client and analyses of how the contracts mature, renew and change/cross sell – then and only then do the higher valuation multiples kick in. Collections of contracts can have some value, but usually the same as WIP – x40%-60% at best or arguably around x3 on profits.
1.9 In essence can you write on the back of an envelope now (a) the value of contracted business you had last year, (b) the business you had that you lost or discontinued, (c) the business you up-sold, and (d) the new business you acquired over the year?
1.10 Finally – how crucial are you to the business? Tight financially run teams can still be undermined by the top dog stepping down (you don’t even have to leave – just taking your foot off the gas can do it). If you are serious about building your team and the company’s value – one of the best things you can do is prove that your line management have experience and ability. If they’ve been able to hoover up a few small businesses themselves or have a track record in major tenders and product development – it significantly reduces risk to the buyer (and keeps them a little bit more honest).
Good buyers don’t shop when they’re hungry – so they’ll take the time to weigh up their chosen partners. There are a couple of good VCs active in the market currently, not to mention most of the usual trade players staying alert. The credit crunch is not going to hurt compliance driven markets – it will have weeded out the hungry feeders that made up the boom last year – but there are many more left. The point is these guys know their onions and both sides should be better prepared.
Tuesday, 13 February 2007
The way It Is
Why and how shareholders sell
Shareholders usually sell because they’re tired.
The trick to find what they’re tired of. Tired of working with the team that got them this far? Tired of working? Tired of being in the Championship when they could be in the Premiership? Tired of covering all the bases when they’d rather focus on the fun stuff? Tired of being pulled away to or from family issues too much? Tired of not having the resources or cash to really crack on? Tired of facing the same old track for another few years? Tiredness usually springs from a life event restoring a sense of proportion to someone’s life. Spouses, partners or children facing illness or death are extreme examples, and the range of triggers is infinite, but sellers usually sell only when their priorities have been challenged and changed.
A recent example: Having been invited to the CEOs office of a successful services company to discuss an approach by a major conglomerate, the meeting was dominated by a high energy pitch from the CEO on how successful they were, how energised he was and how much potential both he and the business had going forward. The office was enormous – one of the corner top floor mahogany play pens that are typical of businesses ten times the size. Most importantly one whole wall was adorned with sporting trophies, three deep and gleaming. Clearly the words were not matching the environment, and the business was definitely for sale - and now. This CEO was bored, frustrated; his mind was not on the job and he had started spending the proceeds already.
All the text books tell you that shareholders want to maximise their returns, which most people assume to mean get the largest amount of cash possible. It is never this easy.
Owner managers are usually aggressively clear about what they want, and the major issue as a buyer (and a seller) is not to get sucked into a number too early. The biggest fear of any selling shareholder is that no real offers materialise. The key point is that this is a “toggle” issue, not a sliding scale. Buyers will either stump up a lot (in the eyes of the buyer) or nothing at all, and most simply don’t stump up at all. It is immensely frustrating for sellers to go through a sale or flirtation process for it to result in no deal. The downsides are also enormous. Sellers will have revealed their business model to close rivals, they will have doubled the hassle for their internal reporting and management processes, and wasted an enormous amount of time.
The key to avoiding this nil all draw position is to get the basics done first – well before any numbers are called for. If the chemistry isn’t there, even if a deal is agreed numerically, it will still end in tears. For sellers, they need to know that the partner they are entertaining has the clout to make a credible offer. There is no such thing as a value for a business. There is only a price that an interested party is prepared to pay. The best handle on value that a seller can get is to have one or two interested players making offers formally.
Time and again I have seen smaller entrepreneurs sailing close to the wind going into the sale flirtation process to get an informal indication of value. This usually results in a useless range indication, but if they push their luck they can get some offers which they typically then ignore. This is fine in so far as it goes, and it is their prerogative to walk away. However, the seller has to be very careful that the supply of willing buyers or potential buyers is not limited. Jilted buyers usually fail to trust a seller who has been round the track in the past.
Sellers shopping around in this way should be aware that different types of potential buyer buy in different ways. Trade players typically don’t haggle much – they either make a bid or they don’t. They will know the sort of multiples their rivals use and will rarely shade over it by much if at all. Institutional investors and listed companies offering "paper" (ie their shares instead of cash) deals will typically offer at least twice what the trade players do initially, not because they mean to pay it, but because they think money talks. Bankers are used to the scenario where a bid range is asked for, and they then spend the next few months whittling it down to somewhere below the typical trade bid. Ask a banker and you may be told a ten multiple, ask a trade player and you may be told x5. Big deal – the secret shopper still doesn’t know any more than they did in the first place. The key issue is whether a bid will materialise at all – and usually they don’t when push comes to shove.
The net result is that a seller will end up going for an auction process managed by a local accountant who is given a list of past interested buyers. Most potential buyers will check the progress on the new set of numbers and then pull out or low ball. The reason is obvious – the trust is gone, and the seller has become the “high mileage” talking point at the dance that everyone claims to have knowledge of, but no-one wants to introduce to their mum.
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