IBA, as the premier business brokerage firm in the Pacific Northwest, is firmly established as a respected professional service firm in the legal, accounting, banking, mergers & acquisitions, real estate, and financial planning communities. Periodically, we will post guest blogs from professionals with knowledge to share for the good of owners of privately held companies & family owned businesses. The following blog has been provided by James Murray of Executive Outliers (https://executiveoutliers.com/).
IT Enterprise Value – Leaving Money on the Table?
A new client came to you today. He hadn’t planned to retire, but the situation suddenly changed. The need is sudden, and the change is necessary. It could be a sudden change in the owner’s health. It could be a financial change, such as the economy or the stock market. It could be that the old CEO has been kicked out of the bedroom until he sells his business. You know more stories probably better than I do. Traditionally selling fast will mean selling at a discounted price. Getting that premium price is a challenge. Fortunately, the fast pace of technology change now means buyers value businesses in non-traditional ways. Without an understanding of these changes, the broker could be leaving money on the table. Let’s start with a seller who almost left 30 million dollars in the trash can.
Entellium, a startup with two sets of books
This was the situation with a company I was working with. You may have read about Entellium. A new startup with a new approach to customer relationship management (CRM) technology. Unlike most CRMs, the Entellium system was loved by salespeople. Technology was not the problem. Instead, the problem was embezzlement. The venture capital company almost walked away from a 30-million-dollar investment. Let me share how we sold the business at a price over 30 times EBITDA.
Introducing the four modern buyer needs
Before continuing the Entellium story, let’s discuss the modern business buyer’s needs. In a recent survey, private equity bankers were asked, what are you looking for in the company(s) you will be buying next year? Some responses you probably expected, but some are new. The top four were
- Stable Technology
- Online sales systems
- New customers to expand market share
- New product lines that will allow us to sell more to our present customers
For the Entellium selling strategy, we looked for a buyer whose business strategy was to enter and compete in a new industry. We contacted ten major enterprise companies. Three of them were interested. The most interest came from Intuit.
Stockholders for companies like Microsoft, Disney, or Intuit demand a high return on their investment. The problem for the CEO of enterprise organizations is finding ways to grow without disrupting the industry where they are the industry leader. To satisfy stockholder demand, Intuit was developing an offering for a new industry. To be successful, the foundational need for Intuit was a custom CRM. At the time, Microsoft and Salesforce were the industry leaders in business CRM technologies. To disrupt and compete in this industry, Intuit executives determined a need for a cutting-edge CRM Database. They could build it themselves, but unfortunately, Intuit could not catch up and compete. Instead, they needed an industry-disrupting offering. When Entellium called Intuit, the timing was perfect. Not because the company was solid (it wasn’t) but because the technology was.
The cost for Intuit to build the technology itself would have been risky without an established CRM development team. Intuit’s strategy was to buy Entellium. Reducing the “Time to market” and R&D costs estimated at over 50 – 100 million dollars. All we had to do was pass the Intuit IT Due Diligence process successfully. The result was a price for Entellium 30 times the most optimistic EBITDA valuation.
IT Due Diligence and Optimizing Business Valuation
I assume you are a business expert rather than a technical expert. Translating 30 years of specialized experience, I’ve come up with two Key performance indicators you can use to analyze a seller in your pre-sales IT due diligence assessment.
- Key Performance Indicator 1 – Employee productivity
- Key Performance Indicator 2 – System Availability
Understanding these key indicators will help you identify if there is an opportunity to maximize business value using non -traditional strategies.
Indicator 1 – Employee Productivity
In my experience, buyers have one of two buying preferences. The first is to buy an underperforming company with the potential for overperformance. The second is a risk-averse preference, where investments are made in stable and overperforming companies. For either type of buyer, technology metrics to support the buyer requirements include,
- Business Scalability
- Business System Usability
- Business System Availability
- Business System Interoperability
- Business Data Security
Quantifying one or more of these technical metrics increases buyer interest. For buyers, technical risks affect the size of the EBITDA multiplier. The higher the risk, the lower the multiplier. These metrics help define technology business risk mitigation and raise the multiplier value.
As a business broker, show the buyer that the present technology mitigates the employee productivity risk during and after the transition. The next step is to further increase the EBITDA multiplier for the buyer. To do this, share the owner’s technology plan for business scaling. This can be done by comparing Industry productivity against the seller’s productivity. (Note: even manually, this report can be created in a few hours for private companies with publicly available information.) Demonstrating even a moderate potential for growth will improve the EBITDA Multiplier in the buyer’s mind. Improving the multiplier will improve the sales price.
Indicator 2 – System Availability
Mid-Market businesses succeed or fail based on technology availability and business continuity. Without technical availability, a company will lose (on average) $40,000/hour in lost employee productivity. Buyers are very aware of this risk. IT departments report on technical availability, defining them as 9s of availability. (i.e., 99% vs. 99.9% technology uptime or availability.) The more 9s, the more expensive the technology. These costs are balanced against the risk and costs of lost business continuity and again raise the EBITDA multiplier.
What buyers want to hear
The buyer wants guarantees for the highest employee productivity and availability while maintaining the lowest expenses for the business. The metrics can’t be guaranteed but we can re-assure risk-averse buyers with the right assessment. For example, with these metrics, the broker can provide assurances like,
- The employee productivity average for this industry (in this area) is $89,000/employee/year. Our technology helps our employees average $120,000/employee/year.
- Realizing that technology downtime costs companies $40,000/hour in lost employee productivity. The local industry average availability is 99.5%. This means competitors in this industry lose about 1.7 million in average lost productivity. The seller’s downtime is 99.9%. This means that company losses to employed productivity are only $320,000/year. Meaning that the owners (and the buyer) of this company have productivity seven times higher than all local industry competitors. (Note: Then even mention how certain technical investments can increase that productivity further.)
This way, your seller’s company will stand out as a unique buying opportunity, needing a higher multiplier evaluation.
This is how Entellium, a bankrupt company with C-Level executives in prison awaiting trial, was sold. If we could get a premium price for the investors, you can get a deal like this for your owners by understanding the buyer’s needs. In our case, Intuit saw a way to avoid the R&D time (at least 18 months) and risk (statistically, a 50% failure rate for developing technology from scratch) and deploy a branded and proven product in weeks (rather than years). For Intuit, on paper, the decision was a “no-brainer” win for them, even at 30 Million dollars. The same can be true for many of your clients as well.
James Murray has been working with technology for over 30 years. In 2008 he started his own business, Executive Outliers, and consults with mid-market to enterprise-level companies. His client list has included Microsoft, Disney, Washington Mutual (now Chase), Smith Barney, Cisco, T-Mobile, AT&T, and many others, including 100s of mid-market businesses around the Pacific Northwest and California. His company specializes in business analysis for mid-market organizations. He shows owners how to develop company equity to develop the highest possible price for their businesses. He has also worked for the government (The City of Seattle, The Washington State Patrol) and non-profits. He is the former president of the Business Transition Advisors, an association of business brokers in the Pacific Northwest.
For more information on the content of this article or information about the services offered by the company, James would welcome your inquires at James@executiveoutliers.com.
IBA, the Pacific Northwest’s premier business brokerage firm since 1975, is available as an information resource to the media, business brokerage, mergers & acquisitions, and real estate communities on subjects relevant to the purchase & sale of privately held companies and family owned businesses. IBA is recognized as one of the best business brokerage firms in the nation based on its long track record of successfully negotiating “win-win” business sale transactions in environments of full disclosure employing “best practices”.