Wake up! You are being manipulated.

This holiday season I talked to several people with different opinions from my own. I met a young 20-year-old woman that said she would never bring kids into this world because global warming meant we have no future… I chatted at a party with a Trump supporter that was convinced tariffs were good policy.  I listened to a young person (under 18) tell me that Socialism was indeed better than Capitalism. I’m not saying any of these opinions were wrong but I did notice that NONE of them were based on a broad set of knowledge—they were all drawn from a few headlines, things they heard or opinions they created themselves based on their belief system. You might say that this has been going on since the beginning of humanity (people formulating strong opinions without a lot of facts)—but it seems much more pronounced now.  (As you will read below this might be due to me having a slight Negativity Bias.)

I get it, we are human, and we have innate flaws that allow us to be influenced –but how and why? I thought it was time to do some digging, take some notes, and begin a list of all the ways I could be manipulated so I can defend against it in the future.

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Political ads, search and social media advertising, partisan cable TV and fake news content is constantly being pushed at all of us–While product designers create products that cause addictive behavior to distribute such content.  Design engineers read books like Hooked: How to Build Habit-Forming Products to understand how to build products & services that we have to constantly check for a little boost of dopamine. In the past, this wasn’t as big of an issue because the portals for distributing content were not as widely used (as our smartphones are today) for such a large part of the day and their influence was not as personalized (more on how much just a couple tech firms knows about you found here).

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To understand how we are being manipulated we need to understand one of our many glitches–Bias.

Everyone is susceptible to some form of Bias

Response to the survey question “Do you think human activity is a significant contributing factor in changing mean global temperatures?”

The first thing I’d ask is why less than 60% of the general public believe human activities are a significant contributing factor in climate change when >95% of the scientists that study climate change for a living (PHDs) are adamant about the fact.  Think about this for a second–These specialists have studied climate for their entire professional careers, yet a large majority of people that NEVER studied the climate don’t believe them—that’s just crazy!  Are these non-believers’ lives impacted negatively by climate change policy? Are these non-believers’ drawing conclusions based on how much snow they saw in their backyard this past winter? Take this a step further—these non-believers are voters and 40% is a lot of people (more on a related subject). Reference this video about bias and climate change:

Most (if not all) people have a “bias blind spot”. Humans are less likely to detect bias in themselves than in others per published research in Management Science. The reality is that people are susceptible to all kinds of bias (defined as a mental leaning or inclination; partiality; prejudice; bent).

  • We love to agree with people that agree with us—This is called confirmation bias. To compensate we should surround ourselves with a diverse set of people that have different backgrounds and experience than your own.
  • We jump to conclusions without having a lot of information – This is called Anchoring Bias. To compensate we can draw upon tools such as the Ladder of Inference to help us make decisions.
  • We may believe that after flipping a coin 5 times and getting heads all 5 times that there is an increased likelihood that the next coin toss will be tails and the odd would be in our favor.   They are not.  This is called Positive Expectation Bias and forms the basis of gambling addictions. To compensate, we need to look at trends from a number of angles versus just chronologically.
  • We blame others when something goes wrong. Perhaps blaming the other driver for being a ‘bad driver’ in a traffic accident versus blaming the weather. This is an Attribution Bias. To compensate we need to look at others as people and use empathy versus treating them as objects (use tools like Arbinger Institutes Leadership and Self Deception framework).
  • We overlook faults or defects with a large purchase of an expensive product or service in order to justify the purchase – this is a form of cognitive bias called Buyer’s Stockholm Syndrome
  • We might despise the opposing political party.  Negative feelings towards another group form from favoritism towards one’s own group – This is called Ingroup bias and forms the basis of discrimination.
  • We fear flying more than driving even though statistically, we have a 1 in 84 chance of dying in a vehicular accident, as compared to a 1 in 5,000 chance of dying in a plane crash [other sources indicate odds as high as 1 in 20,000]) – this is called Neglecting Probability Bias.
  • We start to see our new car everywhere after we purchase it—this is called Observational Selectional Bias and it causes us to actually believe this is happening with increased frequency.
  • We often say “If it ain’t broke, don’t fix it” – This is called status-quo bias
  • We think that things are getting worse in the world not better. – This is Negativity Bias and is the basis of Steven Pinker’s book The Better Angels of Our Nature: Why Violence Has Declined.  In general, people tend to pay more attention to bad news than good.

The human brain is easily deceived, and we have to be diligent in not letting others manipulate us because of its natural bias. After all, marketing professionals have been exploiting these fundamental human flaws for years.  Here is a great article outlining how titled “How marketers use 20 cognitive biases that screw up your decisions” by Paul Marsden.

Here is a link to all bias’s (specifically cognitive bias) in which we are all susceptible.

We must constantly ask ourselves if our personal bias is making us draw conclusions without all the data… have we listened to the other side?  Do we have empathy for the people on the other side of the dialog or are they ‘objects’ to us? Are we only listening to news that confirms our personal bias?  Are we being manipulated or are we thinking about all sides of an argument? –don’t be the nitwit that doesn’t believe in global warming when >95% of all climate scientists (who spent their entire careers studying the issue) believe humans are at fault.

We are vulnerable to The Sleeper Effect

This was first identified in U.S. soldiers during World War II. Scientists measured a soldier’s opinions 5 days and 9 weeks after they were shown a movie of propaganda. They found that the difference in opinions of those who had observed the movie and those who did not watch the movie were greater 9 weeks after viewing it than 5 days. This leads us to believe that our impressions have more influence on us than rational thinking over time. Maybe this is why drug companies place disclaimers at the end of a commercial because we won’t remember them over time. Could this be why the older generation wants to Make America Great Again…

Some are vulnerable to Group Think

The brain is always looking for approval from other people and this can be perverted in all kinds of unsettling ways. Our brains prioritize ‘being liked’ over ‘being right.’ so people will go along with a crowd and engage in activities they would never pursue by themselves for the sake of fitting in.  Terrorism is a great example—it occurs when ‘group think’ morphs into ‘group polarization’. For more on this subject there is a great study in the Journal of Social and Political Psychology titled “Social Psychological Perspectives on Trump Supporters”.

Some are vulnerable to Cognitive Dissonance

Not knowing things makes humans anxious. When we are not given adequate closure, we fill in the gaps to create a cohesive whole that makes sense to us. It’s why some of us believe in heaven, astrology, or ghosts. Humans fear the unknown, and intrinsically combat this angst by supplementing our limited information with things that fit a particular paradigm. It’s why we create religions and subscribe to them to our death to give us answers to life’s complex questions.

“When a thousand people believe some made-up story for a month — that’s fake news. When a billion people believe it for a thousand years — that’s a religion,”- Yuval Noah Harari.

Most may be susceptible to some level of hypnotism

I know… this sounds farfetched but it’s not. We know the result of hypnosis is real—but we don’t understand how it works.

“Follow the Lord!” says the priest. “Defeat the Enemy!” says the politician. “Place your Order within the next Ten Minutes for Double the Benefit!” says the sales person. These are all examples of mass hypnosis—used just the same way that Stalin and Hitler practiced it. Manipulating emotions is a way to seize control over someone’s body and mind.  The more we understand our subconscious mind, the greater our ability to make rational decisions.

Hypnosis is generally regarded as an altered state of consciousness—but since consciousness isn’t understood, alterations to it such as hypnosis, meditation and psychosis aren’t very well understood either. David Spiegel M.D. does a great job explaining what is known about hypnosis in this 9 chapter lecture titled “Tranceformation: Hypnosis in Brain and Body” found on NIH.gov.

Someone can learn how susceptible they are to hypnosis here.

It may be based somewhat on intelligence

Gordon Pennycook and colleagues published a paper titled “On the reception and detection of pseudo-profound bullshit” and found that people who are more susceptible to BS score lower for verbal and fluid intelligence, are more prone to “conspiratorial ideation,” and more likely to “endorse complementary and alternative medicine.”

A person’s intelligence is not set in genetic stone—Here are some ideas on how to increase intelligence.

It may be in our genes

Bradley B. Doll, Kent E. Hutchison and Michael J. Frank published a paper in The Journal of Neuroscience titled “Dopaminergic Genes Predict Individual Differences in Susceptibility to Confirmation Bias” that suggested that variants in the genes involved in the prefrontal dopaminergic reward system predicted the degree to which study volunteers persisted in responding to a test, following previous instructions, even as evidence against the veracity of the instructions accumulated. In contrast, variants in genes associated with dopamine function in the striatum correlated with the ability to learn from actual experience.

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Conclusion: We are not flawed, we are human.  The key is to understand how our brains work and to defending against others that try to exploit our human design.

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More information:

Your First 30 Days As CEO

Congratulations!  You have been brought in by investors to repair or scale a struggling tech company.  The investors still believe in the company and need an experienced operator to right the ship.

The investors likely brought you in because either the company is shrinking or not growing (see Figure 1 for likely scenarios) and the investors have decided the problem was leadership. Or, perhaps the outgoing CEO was tired or didn’t have the skills for the next level of growth.

Figure 1: Turnaround Scenarios

Regardless, you now have the job so you better have done your homework before accepting the role.  You hopefully understand the financial situation, why the CEO departed, individual board members’ views of the company’s opportunity/risks/expectations and the ownership (cap table).  You should have also fully digested all available news, analyst research, competitive positioning, and GlassDoor feedback. Oh, and find the date of the next board meeting. After all, you do report to them.

Figure 2

Your job is to lead the company, find growth, scale the organization (In figure 2–move the company from A to B) and do a stupendous job communicating to all the stakeholders.

You need a 30-day plan.

But Be Careful.  You must learn quickly, but you don’t want to bring down the entire organization doing busy work as you come up to speed.  Be respectful of people’s time and leverage the finance team as much as possible versus customer-facing employees.  Realize that you are an unknown to the ecosystem; all people know about you is what is online. In other words, they will have judged you before they have ever met you.   Be careful not to undermine your new management team by going a couple levels down in the organization without their consent, and be careful not to engage in speculative discussions (spitballing half-baked ‘what if’ ideas) that could easily be misunderstood.  And above all else, in the first 30 days, provide no directives unless you are forced to, and then only move forward with the thoughtful involvement of your team.

Note: McKinsey wrote a great article about the time between accepting the CEO role and starting the job.  You can find it here.

First Step: Broadly communicate your vision of a better company

Help the employees understand why you took the job and your approach. It’s too early for specific plans however you should convey the values that you will use as a framework for making future decisions. Be clear about your management style so everyone is not wasting energy trying to figure out how to please you.

Here is an example of Dara Khosrowshahi’s first message to employees at UBER.

Second Step: Get your team together

Face to face is best (because you want to take a temperature of the team dynamic) but if you are geographically dispersed then make the best of it.  Go around the room (or call) and ask the team to speak to the following in 5 minutes or less:

  • Introduce themselves (how long they have been at the company and something personal like what they enjoy doing in their free time).
  • The top 3 things they must get done in the next 30 days and who on the leadership team they are working with on the task- no detailed explanation for each or discussion (only clarifications if necessary).
  • Something they want to know about you.

You should go last and provide as many answers to their ‘something to know about you’ questions as possible and then explain how you will proceed with your next 30 days of learning.   Your goal is to get introduced to the team dynamics, understand some of the cultural norms and help lay some groundwork so they understand how you think and what the next few weeks are going to look like.  You might also find that there are a couple of surprises hidden in the team’s top 3 priorities that you need to understand more clearly in a 1-on-1 discussion.

Third Step: Schedule 1-on-1’s

Start collecting data ASAP. Start with your management team, then meet with as many individual sales representatives as possible as they will have the best understanding of the market, then meet a minimum of 10 customers and partners (see the ‘be careful’ section above…).   Try to get a true idea of the culture –not just what you read on https://glassdoor.com.  The culture is made up of all the stories employees, customers and partners talk about when you’re not around–so it takes time to understand.

Be consistent with the questions you ask–Here are some suggestions:

The remaining steps are in no particular order.  Your goal is to get enough information to begin to understand the culture, the people, the customers, the partners, the issues, the opportunities, and the risks.

— “Once the information is in the 40 to 70 range, go with your gut.” – Colin Powell

Finance: Dig into the financials and the KPIs

Go over all the standard financials (Income statement, balance sheet, P&L, budget, forecast etc.) in detail looking for anything that does not meet the standard KPIs. 

  • For Software as a Service (SaaS) businesses leverage all the well-known metrics and KPI’s (CAC, LTV, MRR, Churn etc..)–you can find all the metrics and KPIs here.  Specifically look for any KPI’s that are out of range such as a low LTV to CAC ratio (LTV should be >3x CAC) or when months to recover CAC < 12….  Great site for deep dive on SaaS financials here.
  • For traditional businesses leverage old school KPI’s found here.

Finance: Go deep on expenses

Review 20% of the expenses that make up 80% of the spend.   Tag each expense with its corresponding revenue impact and its significance as best you can… With an immature team, this may be difficult but give it a go.

Then chart out the expenses and prioritize quadrant’s A and B so you know what the team can cut if they either needed to invest in something more important OR had to ensure a minimum of 2 months of working capital available for payroll.

Finance/Sales: Go deep on current contracts

Look at the 20% of the contracts that equate to 80% of the revenues.  Dig into as many as possible and look at their profitability, % of business, terms, risks, upside and most important their significance to the company.

Chart the contracts out so you can visually see how they map to the organization.

Contracts in Quadrant A you should understand the issues and determine if there is any way to renegotiate.  Quadrant B – How can we get the cost down ‘per account’? Quadrant C – How can we get the cost down ‘overall’.  Quadrant D – Ask: How do we do more of these?

Finance: Go deep on AR and AP

Accounts Receivables (AR) and Accounts Payables (AP) – You want to ensure you understand any large outstanding receivables or payables that are behind and could impact near-term cash flow.

Finance: Break up the P&L

Break out the natural categories of a P&L and look into the company’s performance per sector, per vertical, per product/service.   If professional services are sold break out into separate P&L (more).  You need to understand where the company is financially strong and where they are struggling. 

Finance: Budget vs. Actuals

You need to figure out the budget process and how well the team has done. Are they always behind budget? are they always exceeding? Or are they on target?  Each result tells you something different.

Finance: Understand banking, legal, accounting, tax and insurance relationships

These third parties should be consultants to the company–you need to gauge if they are being used in this way.

Sales: Do a pipeline review

…of each appropriate segment (example: Enterprise versus Small & Medium Business (SMB))

For the Enterprise segment you want to figure out how well the team understands their customers’ business, the competition, how tight of a solution sales process exists and to get a general sense of the potential of the organization.

Try to review the top 80% of the revenue opportunity by account representative.  If possible also look at history (closes since start) to see how well they have done for the company and what types of discounts are being applied.  Comparing that history to the current velocity/deal revenue is also key.

Dig into the deal dynamics and see if the team understands (Pain) i.e. what is making the customer buy? (Power) How well does the rep know the person empowered to write a check?  If the deal is 40% or higher do they have a written commitment in email? (Vision) How well the rep knows how our solution would fix the problem and by when. (Value) Does the rep know how much our solution would this save (or make) the customer? (Control) What are the next steps w/dates? …and if the company is using Solution Selling read a few of the ‘Sponsor Letters’ & ‘Evaluation Plans

For the SMB segment, look more at velocity and the process surrounding the business.  Compare the rep history to the pipeline.  Spot check a few of the bigger deals.  Understand the link between marketing and the SMB sales team–are there any gaps (example: when a prospect fills out a form how long before an action).  Understand the automation, the CRM and all the tools surrounding the process.

For channel deals you want to understand the registration process (if one exists) and how well the channel opportunities are managed and if there is ever any negative competition between the channel and the sales teams.  Compare the history to the current deals and stack rank the top partners to ensure you know who they are and setup exec to exec meetings as soon as possible.

Sales: Pipeline Post Mortem

Identify why we are losing/winning and find the trends… Understand customer churn. Understand the number of deals (and revenues) we lost in the past 12 months and why.  Understand who (competitor) we are losing to (or winning against) consistently.

Marketing: Conduct a simple Customer, Employee, and Partner anonymous satisfaction survey

Have your marketing team pull together 3 quick surveys using Google Survey or another tool like SurveyMonkey.  Add your own personalized message to each of the outgoing messages introducing yourself.

If the company already does these surveys that is a great sign.  If so, there is no reason repeat these surveys just dig into the feedback AND also understand how the feedback is incorporated into leadership/management strategy, product planning and HR/Sales/Marketing/Support process changes.

Marketing: Marketing Review (Product, Place, Promotion, and Price)

It will take time to learn how well your marketing team is managing the website, the social networking presence, event marketing, landing pages, and paid advertising. However, it is always eye-opening to find the gaps in the data (“we don’t track that…”).

Find out how traffic is getting to your website and what is it costing the company:

Understand the social networking activity:

Understand how much events are costing the company and how the team is tracking success:

Understand Google/Bing ad spend and ROI:

Understand what landing pages are the most successful and why:

Sales/Product/Marketing: Understand the market

Understanding the Total Addressable Market (TAM) is key to any business.

Here is an example of how one group measured how many companies in the USA were potential targets (dark blue) based on employee count and vertical industry–just using US Census data.

Sales/Product/Marketing: Understand the competition

Read everything you can about your competitors.  If you can afford Gartner research buy it…  You need know your enemy.

Know your strengths and weaknesses: if you know the enemy and know yourself, you need not fear the result of a hundred battles. –Sun Tzu “The Art of War”

Product: Product Review

Learn as much about the product(s) as you can… Take training, use the product(s), read any patents etc… There is no need to be an expert, but you should understand the nuances of what your customers are purchasing, complaining about and why.

You need to also understand the product development and DevOps processes as they currently exist (high level).  What tools (Atlassian, Jenkins, Kubernetes, Docker etc…), what hosting providers (AWS, Azure, Google etc..), what languages (C, golang, etc..), what third-party services are integrated into the solution (CRM, Database, OpenSource projects etc..).

Assuming the team leverages Agile (if not, you need to dig into why) you should understand the sprint cycle (1 week, 2 weeks etc.), burndown, and velocity.  Does the team use LEAN startup practices such as the MVP concept?

You should understand how well the team is performing Agile (how long are standups, are they documented, how retrospectives are done, does the team use business value points). You should also get a view on how well the team is doing continuous delivery and if they are measuring items such as ‘Commit to Deploy’ metrics.  It’s important to also understand how the team manages with defects and bugs.

Finally, if some of the team is offshore, or part of a third party, it’s important to dig into how well those groups are integrated into the teams to get a sense of productivity.

Product: Review Product Backlog with Product Owner

Now that you understand the product, go deep on what the Product team is working on and why.  Try to get insight on how well the plan correlates to the market needs. If the team is using Story (Business) Value points validate these with what you are learning from the rest of the team and from customers (If not, then clearly understand how they are prioritizing the market needs as this is SUPER critical for success).

Support/Product/Sales: Review Customer Support Issues

Customer support excellence can be the key to customer renewals, product backlog prioritization and upsell/cross-sell sales if used appropriately. Dig into the issues, the timeliness and quality of resolution and understand how those issues are used in the organization.

“Your most unhappy customers are your greatest source of learning.”  — Bill Gates

Human Resources: Understand Employee Performance and Rewards

Your Human Resources team should be able to provide you a list of roles in the company and their compensation bands and then a list of employees for each role with their date of last performance review (and rating)–if not, you have more work to do…   You’re looking for how mature the HR processes are… How people are rewarded… Are you paying market rates… and most importantly turnover rates.

Human Resources: Understand Recruiting

Hiring qualified employees is hard and hiring the best is difficult.  Hiring the best is going to be key to future performance gains.  How well is your team set up to hire the best?

Human Resources: Understand HR Policies and Procedures

Review the employee handbook and all policies and procedures.  Some examples: Logical access policies, Incident response plan, disaster recovery plan.  If the organization is SOC 2 certified review the audits.

All Teams: Understand the risks

Risk management is something that must be done continually.  Doing it well can be the key to success if you need to make a quick pivot in the future.  If the team is not doing this already you need to add it to your 60 to 90 days list.

You: Report card

After 30 days you’ve learned a great deal and hopefully formed some opinions about the people, processes, and product(s).   It’s a good idea to record it all on a report card–not to be shared but to refer back to periodically and reflect.  Write down why you rated each group the way you did as it will be helpful to use this as you continue your journey.

Now it’s time to lead! You and your team now have to determine what actions are required to grow the business.

Reference the figure below–You’ve likely been brought into the company in the ‘production stage’ either in A (the company has not achieved Product-Market Fit and is surviving on Professional Services revenues or Other People’s Money) or in B (the company has reached Product Market Fit and it’s time to tune the organization for growth).   Likely it’s going to be somewhere in between, however, the key is to now have a good idea on where to focus your energy for the next 60 days because you can’t do everything (A. Innovation management and Product/Program management or B. Leadership and Sales/Marketing management).

–“People… Process… Product…” — The Profit

It’s easy to be overwhelmed at this point–the business is going to start coming at you fast.  Customers, prospects, managers, partners, analysts, board members, bankers, attorneys etc… will all want a piece of your time.   The issues at hand will require time… Scheduled event and meetings will require your time.  Your job–not to become reactive to the demands on your time (remember the ‘Big Rocks’ story from Stephen Covey?)–project manage your schedule to where you continually reprioritize the demands on your time and STAY PROACTIVE.  Remember, you have a job to do and that is to ignite growth in a company that has not been growing–that means doing something different and if you become reactive to these demands you will become part of the problem. I’d recommend 2 actions now–Schedule a leadership team offsite and get into the right frame of mind by re-reading that old book on your shelf called The Five Dysfunctions of a Team.  You’re also going to feel like diving right in and starting to provide guidance and poking harder at the items you rated low in your report card–just recognize how disempowering this may seem to the team.   You have to get your hands dirty–that’s required but at this point in your journey, you need to lead vs. manage. The next 60 days are going to be difficult.  You may need to tighten up the people, processes, and temperament of your leadership team.  You and the team will need to determine what to prioritize and de-prioritize… and then change management comes with its own cultural challenges.

A preliminary view of the next 60 days in the role…

  • Communicate with the board – As you develop your boardroom relationships, you must view the directors as neither friends nor confidants, but as bosses who hold you personally accountable for the success of the company. By actively investing in director knowledge and relationships—through one-on-one contacts, e-mail updates of corporate progress, and distribution of background material, for example—the best CEOs turn board meetings into participatory discussions rather than show-and-tell sessions by management. A new CEO who is open with—and creates the opportunity to collaborate with—their directors will be more likely to garner support from these bosses. – HBR 
  • Help your managers understand your expectations in regards to ‘leadership’.  If Management is about systems, processes, policies and resources and Leadership is about vision, inspiration, values, and people then the basic premise is that ‘Leaders deal with management shortfalls’. Basically, leadership is required when the systems & process do not work…. Leadership is required when the policies are not applicable or do not exist… Leadership is required when there are not enough resources to accomplish the task… (more)

“You are entirely responsible. It all comes down to you.” Extreme Ownership

  • Begin to introduce your team to strategic planning (if necessary)

You will quickly begin to understand how well the troops understand what the company’s Vision and Mission are and if it means anything to them (example: Microsoft’s Vision/Mission is “We believe in what people make possible. Our mission is to empower every person and every organization on the planet to achieve more.”). You will also quickly find out how well the teams know the goals they are trying to achieve, their strategy for achieving the goals, and how they are measuring success toward those goals.  If you find gaps up and down the chain it may be time to do a bit of work on your strategic plan.

  • Begin to introduce your team to innovation planning (if necessary) — Perhaps leverage Blue Ocean Strategy

If you find that the company is competing head to head with others and losing share it may be time to look at creating uncontested market space that can create new demand or break the value-cost tradeoff.

  • Depending on where your team scores on the report card it may be time to begin to introduce a new way to approach the business.  Here are some of my favorite tools:
  • Introduce your team to SCRUM (not just the product team)
 

Good luck, I can’t wait to see you ringing the NASDAQ bell someday soon!

Other articles you may find of value:

  • AN ACTION PLAN FOR NEW CEOS DURING THE FIRST 100 DAYS (here)
  • Now you’re in charge: the first 100 days (here)
  • Five Myths of a CEO’s First 100 Days (here
  • Assuming Leadership: The First 100 Days (here)

Selling a 5M-30M Revenue Private Tech Company in 20 Steps

By Scott Suhy and Ryan Fuller

 

If you are a company founder and/or controlling equity holder in a technology/services company that is under 30 million in revenue and you are deciding whether or not to sell your company, this post is for you.   We have documented our experience with a 20-step sale process to support the founders who might be at the base of this mountain looking up.

First, the basics

Over time, a small tech company will do one of four things:

  1. Grow and become a medium/large business (and possibly go public)
  2. Become a lifestyle business
  3. Go out of business or
  4. Sell to another successful business and be merged into another company.

For a company to continue to grow successfully, founders or managers need to make incremental investments that enable the company to get to its next stage of growth.  For example, small companies that start to hire employees usually have to pay the employees prior to them being 100% productive.  Then, a company needs to invest in a back office infrastructure, such as HR support to work with the employees, a recruiter to find new employees and accountants to measure performance so the business can function. These investments in growing a company are fairly straightforward when a company is young.  If all goes well, the day comes when you hit a wall.  In order to grow the business you have to make much bigger investments.  Typically, you see a large, addressable market but to obtain a share you need to make a large investment.  the basicsThis, in turn, can put the company at risk if not executed well or if it was the wrong choice and/or the wrong time.  Some of those investment decisions look like the following:

  • Add a national or worldwide sales/marketing team to get at all the opportunity
  • Invest heavily into your products to take on a bigger part of the market
  • Add new offices to scale nationally/ internationally or
  • Acquire another company.

At this point in a company’s growth, the owners/founders/board have a choice to make: either trade a portion of the company for private equity, take on debt or merge into a company that has the infrastructure to allow the company to capitalize on the market opportunity.   Either way, for the owners of the company this is a huge decision.  This post was written for the owners that may want to sell a controlling interest in their company.

Before you go any further, you need to know that this is going to take a lot of time, usually 4-6 months, and cost between 1%-7% of the company’s valuation, if you use an investment banker

Before you sellbefore_you_sell

Before you start the sales process, you’ve got to be clear about what you want to achieve.  Considering what you want to do with the rest of your professional life after a transaction should be independent from the question: “Is it fundamentally time to do this transaction?”

Let’s look at some of those fundamentals:

  • You have taken the company as far as you can and it needs new leadership skills to take it to the next level.  This self-rationalization of What Got You Here, Won’t Get You There (Goldsmith, Marshall) is a VERY large hurdle for many small businesses and they often screw it up.   You must ask yourself if you need to sell to gain new management or if you are comfortable enough to step aside and let someone that has ”done it before” step in and run the company.
  • If you don’t grow, your competition is going to ruin you and you will have nothing to sell

Let’s make it more personal:

  • You have been slaving away building the company for a number of years, you’re tired and it is time to take some chips off the table.
  • The company has hit a wall and you know you need to invest big to get to the next level of growth but you don’t have the risk tolerance for investment or debt.
  • The company has co-founder conflicts that are inhibiting growth.   You may not enjoy working together anymore.

Now, let’s make it real personal:

What are you going to do after the transaction?

  • Stay with the acquiring company? (you might have to for a while)
  • Move to the beach?
  • Start another company?

Be aware that staying with an acquiring company can be touchy.  Founders that have been running their companies for years face large cultural shocks going into a new bureaucracy where they are not the top decision maker.  However, the acquiring company may not be successful with the acquisition if you are not there for at least a year or two.  Most company founders want their baby and employees to be successful so they do stay on with the acquiring company.  However, if the founders have brought in professional management prior to the acquisition, it may be more important that the management go with the acquisition than the founders.   The point is that this will be a negotiated term–Maybe staying with the acquirer won’t be required, but it’s something the founder(s) need to be prepared to have a position on and to negotiate.

Taking it to the board

Once you are motivated to sell and have made some personal decisions, it’s time to get the board of directors to agree that selling the company could be the right thing to do.  Of course, in many companies the founder doesn’t have majority voting rights and the process may stop at this point.  It’s a matter of getting 51% of the shareholder voting rights  together, or 76% if a super-majority is needed.

Once the board agrees to explore a transaction, you need to decide who to bring into this highly confidential discussion.   Think CTO or CFO initially.  It’s rare that the founder can sell a company without the team’s help.   However, confidentiality is crucial during this exploratory phase to avoid widespread employee stress, organizational chaos and possible defections before you have even confirmed that you will go through with a sale.

OK, now what’s the process?

Step 1: Understand the buyer’s motivation

 

Will another company buy you?  Will a Private Equity firm invest in you?step_1

As much money as it costs to sell a company, it costs a lot more to buy one.  For a buyer to agree to start up its acquisition engine and invest in a company, the opportunity has to be worth the cost and effort.   The exception is the “acqui-hire” in which a company just wants to buy talent because it’s less expensive than hiring it.  That’s something we’ve seen in Silicon Valley, for example, but it’s not what we’re referring to here.  Note: An “acqui-hire” still requires a certain amount of due diligence and contracts.

What motivates a buyer to purchase a “pre-revenue” company?

  • You have Intellectual Property (IP) that they want and it’s less expensive to buy it than build it or you own the rights that preclude others from getting into this field.
  • You have IP that they want and they don’t have the time to build it.
  • You have IP that they want and they don’t have the skills to build it.

What motivates a buyer to purchase a post-revenue / pre-profitability company?

  • You have a proven business model and it’s apparent that all your profit has been invested back into the company for growth.
  • You have exploitable assets.
  • You have a great management team that is capable of a lot more if capitalized sufficiently and focused.

What motivates a buyer to purchase a post-revenue / post-profitability company?

  • You are in a market they want to be in (buying customers).
  • You have key talent that they need.
  • They want to remove your company as a competitive threat and they want to control the market.
  • They need more products for their channel.

Most companies that are motivated to sell (outside of the Valley) are usually in the last camp.  So how much profitability (usually how a deal is valued) does there need to be for a Buyer to agree to turn on its acquisition engine?   It depends, but it is usually more than 2.5M in adjusted EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization).   Company valuations also differ a bit for companies that are 5M and then 10M in adjusted EBITDA.  By the time a company gets to 10M in adjusted EBITDA it is usually > than 100M in revenues and all the bigger companies have it on their radar.

Take a step back for a minute, a lot happens in the life cycle of a company between 2.5M and 5.0M+ EBITDA.

At 2.5M EBITDA:

  • The company has grown or is in the process of growing out of the lifestyle business.  The first line of G&A and Overhead infrastructure is in place.  Accounting is measuring performance, a human resources manager is hiring key positions for product growth and, most importantly, the CEO is developing an investment path channeling the profits to maintain and grow the business.

At 5.0M+ EBITDA

  • The company has created a lot of policy and likely has grown out of the management team used to get to the 2.5M EBITDA level.  The CEO should be looking at the quality of his management team and creating an organizational chart that scales.  Typically this means firing a lot of people that created the path to the 2.5M EBITDA level.  In the eyes of the buyer there is a lot of inherent value in this position because integration theoretically will be easier.

As you put together the list of potential acquirers and or private equity firms, you need to understand their motivations clearly before you invest your time as each one of these discussions is both risky and costly.

 

Step 2: Private Equity or Cash?

 

Selling for Cashstep_2

Most companies don’t get sold for 100% cash.  The reality is that most transactions are a combination of cash, stock, employment agreements and earn-outs.  If you are not flexible when it comes to the structure of the transaction, you could have difficulty selling your company or will be paid considerably less than if you had been more flexible.  From the investment banker’s point of view the company can name the price and they will dictate the terms.  Flexibility could help to get a deal done.

What motivates a buyer to pay all cash?

  • They have to because you are the only asset they can buy,  they want you badly and it’s the only deal you will accept (rare).
  • You are a small investment.
  • Cash is king and they can get a cheap price.

Private Equity – A second bite of the apple

Founders who go down the private equity path may be able to maintain control of the company if that is their desire and, ideally, they are capable of delivering. When a private equity (PE) firm buys a portion (30%-70%) of the shares of a company, usually at below industry valuations, it’s called the “first bite.”   This allows the company owner(s) to reduce their risk by taking some money off the table.  The PE firm wants the owner to retain a high percentage of ownership so they are motivated to help the PE firm grow the asset.

The PE firm will usually then try to merge or “roll up” the target company with similar companies   to increase the EBITDA and encourage cross selling to each companies’ customers with the goal of selling the bigger company within five years.  As a partial owner of the larger company, the original target can then sell for a larger multiple.  Thus, the second bite of the apple.. The theory is that the individual companies would not have qualified for this higher multiple without the PE firm.

 

Step 3: Understand how long this will take.

step_3

Welcome to capitalism.  Selling a company depends on supply and demand.   If what you offer is in low supply but high demand it will go fast.   However, if this is not the case, it will really depend on the economic environment and how many offers you want to entertain.   Keep in mind each offer takes a lot of time and effort to investigate and increases the risk of hurting your company’s brand with employees, partners and customers.

How long it will take will also depend on how well prepared a company is in advance.

Things you need to do today, if you ever plan on selling your company in the future.

Organize the easy stuff.

  • Everything in electronic format, all contracts, NDAs, TAs etc.,
  • Stock price valuations, document the methodology in detail and include in BOD minutes,
  • Board minutes,
  • Policy handbooks,
  • Employee files including a salary history and job functions,
  • Taxes, up-to-date with a strong known firm and
  • Well-documented business plan, past and, more importantly, that will make sense from the elevator speech to the contract waterfall.
  • The right management team including quick answers as to their level of involvement in the company (Internal facing and customer facing);
  • The right financials, especially EBITDA and more importantly ADJUSTED EBITDA e.g., non-reoccurring items like one-time founder bonuses;
  • The right company policies;
  • The right customers; and
  • The right IP protection.

Tackle the hard stuff and ensure this consistent with presentations.

The reality is that the easy stuff has to get done or due diligence will be a nightmare and the hard stuff is what drives up valuation.  Many founders will bring in professional management two years before the start of the acquisition cycle to get the hard stuff right so the valuation of the company goes up.  In many cases it is worth the investment.

 

Step 4: Understand how much this will cost.

step_4

So here is the gamble:  If you prepare well for a sale but you don’t sell, you are going to be out a lot of money.  However,  if you do sell you can add what it costs back in as ”adjusted” EBITDA.  The hard costs are made up of legal fees, accounting fees and the investment banker’s fee.   The soft costs are made up of opportunity cost—what you and your team could do with all the hours you are going to spend getting a deal done.   Other soft costs are the risk you expose your company to if your partners, customers and employees think you are selling your company.

Investment Banker Cost

There is normally a retainer, about $50,000 for out-of-pocket expenses, a minimum fee of $200,000-$2 million for the big guys and/or a percentage fee such as 1%-5% of the total purchase price.  These fees are negotiable!  Busy firms are unlikely to negotiate fees much, but you have to give it a try.  Ask them to shift fees to a success basis to align goals and increase motivation–give them an initial fee at the low range and a higher fee as a reward for success. For example pay them 1%  below $XX million, 1.25% from $XX + 10%, and 2% above $XX +20%. They may say no, but it will never hurt to ask.

Your Team’s Time & Effort

Selling a company can easily take 20+ hours a week of your time and as the process progresses this will be a full-time job for your CFO and legal counsel.  Furthermore, in the late stages you will have to pull in more and more internal staff to answer questions and meet with the buyer’s internal staff.  The unintended impact could increase as more employees know about a potential acquisition and start wondering if their jobs will continue to exist and  if they need to exit.

Taxes

A deal’s tax consequences could be large and complex, depending on the structure.  It’s worth investing in trusted professionals who can break down a deal into favorable terms you can understand.  It is very likely that the accounting and legal firms that you used to grow your company will not have the dynamic capabilities to structure the best possible transaction.  Flexibility and complete understanding of deal structure is important because some of the merger, reorganization and recapitalization can be structured to defer some taxes  or transfer them in the form of an acquirer’s stock.

Effective accounting practices are equally important at the formation of the company, for example   classifying sale income as long-term capital gain rates versus ordinary income rates.  Often missed is the impact of the option holder payouts that can be in the form of ordinary compensation if options are not executed.  If this is paid by the selling company, then a large expense resulting in a tax loss and potential tax loss carry backs means a tax refund for the option holders.

A Sample Deal

What might a 20M Company transaction look like in terms of costs and your team’s time if you are paying your lawyers $400/hr and your accountants $300/hr?  It could look something like this:sample_deal

 

Step 5: Hire an investment banker.

step_5

Great investment bankers have both access and experience in getting company founders what they want and what they are worth.  Without an investment banker you may not be seeing every company that would pay a great value for your company and you might not get the best deal.

Unless you know your market cold, what you are worth and who is going to acquire you, it’s wise to engage a good investment banker.   Be sure to  confirm that  the investment banker will have sufficient time to work on your deal when it needs to be done.

Find the best investment banker.

Pick the firms you want to talk to, send each a confidentiality agreement, your financials, your projections and your business plan.  Have them to present to you.    Look for chemistry because you will spend a lot of time with this person and eventually they will be everything from a moderator to a negotiator and even a psychologist.

Some ”more generic” firms will build a detailed “book” on you and then shop it to 100+ companies and then begin to narrow down the companies that are interested in a pitch. Other “more narrow in focus” firms will have a great idea of the five or so companies that they know are both acquiring companies and will see what you have as a value.   The danger with going to the ”more generic” firm is that the market, including your competitors and employee networks, will know you are for sale.

 

Step 6: Build the pitch.

 

When it’s time to present your business to potential buyers, bring in the pros.  Get a professional PPT designer to create your deck.  Keep it concise with lots of illustrations.  A pitch includes:

  • Agenda
  • Vision, Mission and Goals
  • History
  • Overview, including legal entity, ownership structure, number of employees/ICs, locations, and org chart
  • Value to clients and your differentiators
  • Addressable market, such as size, current %, potential % over time and growth inhibitors
  • Customers and related revenues, contract values, profitability and period of performance
  • Offerings
  • Technology
  • Demo
  • Patents
  • Partners
  • Opportunities
  • Forecast and
  • Current Financials.

Practice with your team and investment banker.  Get the timing down to less than an hour.

 

Step 7: Target the buyers.

step_7

A great investment banker has sold many companies and has a broad network of CEOs and executives in corporate development groups within companies.  If you have chosen well, your investment banker’s network is a great place to start.

Then, consider your industry partners.  Ask yourself:

  • What partner has the ability to purchase your company?
  • What partner has the most to lose if you sell your company?
  • What partner would be able to take your company to the next level?

Naturally, you’ll want to consider scoping out industry competitors, but proceed with caution.   Questions to ask competitors include:

  • What competitor has the ability to purchase your company?
  • What competitor has the most to gain if you sell your company?
  • What competitor would be able to take your company to the next level?

Be careful with both partners and competitors.  Once your reach out to them you can never put that cat back into the bag.  Understand the consequences if you go down this path.  It’s best to let your investment banker handle these discussions with the right confidentiality agreements in place.

Other potential buyers include:

Companies in the same core vertical

Look for companies that may want to expand within the vertical your company is in but not in your specific area.  Check if they are equity backed or have a large amount of cash on their balance sheet—these are great targets.

Companies with similar cultures

You want the acquisition to be a success for both your employees and potentially any long-term earn out scenarios.  You also want to have a successful acquisition on your resume if you plan on ever building another business.  So it’s important to ensure that whatever company you are considering selling to has a culture that your employees can successfully live with.

 

Step 8: Understand your valuation.

step_8

Don’t confuse what you are willing to sell for  with what your company is worth.   This step in the sale process is about what a buyer is willing to pay for your company.  You will hear people say things like “it’s all about the Multiples”—well that’s not really right.   You may hear “A growing software company is worth five times their trailing 12-months revenue,” or “10x profit.”   Those general rules are good things to know if you can get the data on many similar deals in your market during the same economic climate.  However, in the end it basically comes down to supply, demand, fit and motivations.  What amount will the shareholders accept to sell their company and does the estimated purchase price match those expectations?

Supply / Demand is straightforward.  In a down economic climate, the acquisitions that are done are those in which a company flush with cash is trying to take market share.   In an up economic climate, it comes down to how many buyers are out there and how many companies like yours exist.   This is where the Net Present Value model comes into play.

The Net Present Value Method (NPV) for business valuations is one of the most theoretically sound methods for valuing the potential cash flows from operations of most businesses. It takes into account the weighted-average cost of capital (WACC) and assumes constant effective tax rates and capital structure going forward. This method also takes into account as much public information on comparable sale prices, corporate betas and potential terminal growth rates as possible.

Keep in mind that even though these broad models drive the basics of the deal fit, motivations are what drive the end price and terms of the deal.

  • Fit—How well do you fit what the company is looking to acquire and how badly do they want it?
  • Motivations—How badly do you want to sell, is the number what you want and can you live with the terms

Side note:  If you are a C-corp you were required to apply a valuation to your stock and record that number each year during a board meeting.   Did you use a consistent methodology over the years?   If not, this can be a major concern of any buyer.

Placing a value on a technology company is a very complicated process.  There is a great write-up by Bridges and Dun Rankin at http://bridgesdunnrankin.com/valuing-a-software-company/ that we suggest you read.

Timing

Here’s a great example of timing from a recent IHS.com article:

Thursday, January 2, 2014 6:00 am EST

“Following record high deal value of more than $250 billion in 2012, and more than $600 billion of acquisitions during 2010 to 2012, many companies pivoted their focus to the development of recently acquired reserves, resources and acreage.” After years of deal-making and robust merger and acquisition (M&A) activity globally, oil and gas companies shifted their focus in 2013 to developing their vast inventories of previously acquired reserves, resources and acreage, says information and insight provider IHS (NYSE: IHS).   As a result, transaction value for global oil and gas M&A deals fell by almost half during 2013 to $136 billion, the lowest level since the 2008 recession. According to IHS energy M&A research, worldwide deal count declined by 20 percent from the 10-year high in 2012, and after a very sluggish first half of 2013, deal activity accelerated during the second half of 2013.

What is”adjusted” EBITDA?

EBITDA (Earnings Before Interest Taxes Depreciation Amortization) is an approximate measure of a company’s operating cash flow based on data taken from the company’s income statement.  It is calculated by measuring earnings before the deduction of interest expenses, taxes, depreciation and amortization.

Since the distortionary accounting and financing effects on company earnings do not factor into EBITDA, it is a sound way of comparing companies within and across industries.

Adjustments or “add-backs” are made to the EBITDA. These might include, among others, excess owner compensation, non-recurring business expenses and expenses personal to the current ownership.

The ADJUSTED EBITDA calculation is of interest to company owners, bankers and business buyers since ADJUSTED EBITDA is the normalized free cash flow that a company has to service any proposed debt.

 

Step 9: Create your ”Pre” due diligence package.

step_9

If the meeting with a prospective buyer goes well, they will ask you to send over your latest financial statements (TTM – Trailing Twelve Months and FTM – Future Twelve Months).  Have this package already prepared and keep it updated.  Your investment banker will be highly involved at this point and controlling the messaging between you and the buyer.  This marks the line in the sand at which the next exchange is either an offer letter or the buyer walks away.

Based on the temperature at this phase, data room preparation should be in full-force (Step 13).

 

Step 10: Get a preliminary offer: The Letter of Intent.

 

OK, you have impressed the prospective buyer enough to make you an offer.   Now the key is to determine if you want to accept the offer and its terms or want to negotiate those terms.   Here is the basic framework of a Letter of Intent (LOI):

Dear [Business Owner]:

This letter is intended to summarize the principal terms of a proposal by BUYER, to acquire directly or through a subsidiary, one hundred percent (100%) of the stock of SELLER. (the “Company”), from OWNERS, and all other shareholders (the “Sellers”).  ……..   The Parties wish to facilitate BUYER’s due diligence review of the Company’s business and the negotiation of a definitive written acquisition agreement (the “Agreement”).  Based on the information currently known to BUYER, it is proposed that the Agreement include the following terms (examples below):

  1. The purchase price for the Acquisition is X.
  2. The Parties will agree on a Closing date target amount for the Company’s working capital (the “Working Capital Target”). 
  3. At the Closing, KEY PEOPLE will enter into retention and non-competition agreements in favor of BUYER for a XX-year term. 
  4. BUYER agrees to continue to provide Company employees with benefit plans that are either existing or comparable to those now provided.
  5. BUYER and the Sellers shall each pay their own expenses in connection with the Acquisition.
  6. To assist BUYER with its continuing confirmatory due diligence investigation, the Company shall provide (the list will be long).
  7. No Shop Period.  They won’t want you on the market during the due diligence period.
  8. Confidentiality clauses
  9. Clauses that ensure you refrain from any extraordinary transactions, such as distributing.

I personally look forward to developing a strong long-term relationship with the officers and key management of SELLER and am pleased to be able to make this offer.  Please sign and return this letter at your earliest convenience.

Sincerely yours,

BUYER CEO

Confirmed and agreed to by SELLER

Assuming you sign the letter and return it to the prospective buyer you are now off the market.   If you want a counteroffer make sure you get it before you sign the LOI and return it to the buyer.

There is a great write up on Letters of Intent here:  “Mergers & Acquisitions Quick Reference Guide,” McKenna Long & Aldridge LLP. Retrieved 19 August 2013.

 

Step 11: Shop the offer.

 

This is a delicate dance.  You don’t want the current offer to go cold but you should see what others are willing to offer.   If you are successful in getting meetings with potential buyers, you will have a few of these pitches going on at the same time.  You will have multiple offers, or at least a group of companies that have not yet said “no” to which you can go back.  Tell them you have an offer and if they want to beat it they need to do it with in a certain time-frame.  Take a deep breath.

 

Step 12: Accept the offer to move forward.

 

It’s time to call a board meeting.

 

Step 13: Start building the data room for due diligence.

step_13

Before you begin the hard work of building the documents necessary for due diligence, you must work out the best place to store them. You need to find a secure place where multiple people from different companies can gain access to relevant company documents.  SharePoint, DropBox, Skydrive are all possibilities but have limitations.  If your investment banker doesn’t have a secure server that offers this service, you might want to question why not.

So what documents are you going to need?  The list is long—here are some good examples:

  1. Basic corporate documents
    • Legal entities with corporate docs
    • Board minutes.
  2. Stockholder information
    • Cap schedule
    • Current owners
    • Option agreement documentation for each employee.
  3. Loan agreements
    • Line of credit documents.
  4. Commercial contracts
    • Customer contracts
    • Third-party contracts
    • Teaming agreements
    • Non-disclosure documents (NDA)
    • Subcontractor contracts.
  5. Intellectual Property
    • Patents
    • 3rd Party licenses.
  6. Litigation (Rulings, pending litigation with applicable estimated liabilities and how it was accounted for in the financial statements, ITAR rulings, audit rulings, patents, et al)
  1. Employees and Management
    • Employee census
    • Employee benefits and handbooks
    • Incentive plans
    • Vacation accruals
    • Employment agreements.
  1. Financial Information
    • Forecast Waterfall – This is essentially a spreadsheet with all the following columns and will be the basis for your multi-year forecast:
        • Contract number
        • Status (Current/Finished/Renewing)
        • Contract Name
        • Customer
        • Contract Type (Fixed Price/T&M)
        • Prime/Sub
        • If government (Set Aside? (Y/N))
        • Start date
        • End date
        • Contract value
        • Probability of win (100%, 80%, 60%, 40%, 20%, 10%)
        • Weighted value
        • Funded value
        • Revenue as of today’s date
        • Total funded Backlog as of today’s date
        • Total contract Backlog as of today’s date
        • Direct labor costs
        • Subcontractor labor costs
        • Other direct costs
        • Fringe
        • Gross profit
        • Gross margin.
    • Income statements and balance sheets.
  1. Treasury and insurance
    • Bank accounts
    • Insurance agreements.
  2. Compliance (Any audit from a 3rd party: DCAA, Government agencies, banking, accounting firms, et al)
  3. Real Property
    • Real estate and Lease agreements
  4. Taxes (All returns since the beginning including any notices and remedies received.)
  5. Security
    • Security Clearance documents.

 

Step 14: Build the Q&A tracker.

step_14

The acquirer’s lawyers and accountants are going to be asking hundreds of questions as they go through the documents in the data room.  Create a shared spreadsheet as a record of all questions asked and the answers that all the entities can access.   It will have at a minimum the following columns:

  • Date submitted
  • Who asked the question
  • Priority level (high, med, low)
  • Category (map to folders in data room)
  • The question
  • The answer
  • Clarifying questions
  • Status (open, closed)
  • Date answered.

Keep updating the data room and reference in the data room where they can find the answer.

You can expect several hundred questions if not more.  Your investment banker should be monitoring and involved in answering questions.  Answers should be concise and answer only the question asked.  If there are “issues,” and anticipate that there will be, speak to the facts.  If the question results in presenting a piece of information that you know will lead to several more questions, answer the question asked and then starting working on your damage-control plan in the background.  Be prepared to address it.  Part of selling your company does not mean the problems leave when the transaction is over.  You still handle them during your earn-out period, however, you are a lot richer!  Demonstrating problem-solving skills is an asset.

 

Step 15: Build the schedules.

 

Disclosure schedules document the representations and warranties contained in the Securities, Purchase and Option Cancellation Agreement (SPA), covered in the next section.  The seller uses disclosure schedules to reveal exceptions and provide information that would be too lengthy for inclusion in the SPA agreement.

Who builds the schedules?  Your CFO and Lawyers.

If you do a great job building your data room, the schedules are easy to prepare and possibly done by the lawyers for SPA presentation.

A list of schedules you may be asked to provide includes:

  • Company stock, including name, outstanding, share type and, in the case of multiple companies, clear articulation of what they need to buy;
  • Company options, specifying name, size of grant, exercise price, grant date, expiration date, vested %, unvested % and # vested shares;
  • Subsidiaries, specifying entity name, jurisdiction of incorporation and ownership;
  • Subsidiary capital stock;
  • Rights of first refusal;
  • Conflicts;
  • Financial statements:
  • Trailing and future 12 months;
  • Detailed current and annual budgets for subsequent calendar / fiscal year;
  • Quick monthly financial closing updates to review during diligence period versus budgets.  Try to mirror the cycle for which the acquirer closes its statements;
  • A waterfall detailing existing and potential contracts / customers.  How does this tie into future customer relationships and strengths?  Highlight value and blue oceans based on information from buyer’s web site;
  • Working capital calculation and detailed understanding of historical and future balance sheet relationships;
  • All material contracts other than customer;
  • All current customer contracts;
  • All outstanding bids;
  • Company tax returns; and
  • Any tax audits.
  • If you are doing federal work, include the following:
  • A list of any government provide equipment
  • A list of all security clearances and all pertinent information for each employee
  • Any agreements you have that are restricted or limited rights
  • All employee information
  • Intellectual property (owner, patent, jurisdiction, application number, filing date, patent number, issue date)
  • Any domain names the company has registered
  • Registered trademarks and copyrights
  • Unregistered intellectual property
  • All software the company has purchased
  • Leases of real property
  • Insurance (name of the insurer, policy number, period, amount, scope of coverage)
  • All sub-contractor contracts
  • All current accounts receivable.

These schedules will be called out by line item in the SPA.

 

Step 16: Create the Securities Purchase and Option Cancellation Agreement (SPA)

step_16

What is the SPA?  The SPA is the contract between both companies and defines all the terms of the contract.

Here is a sample SPA

http://www.slideshare.net/Freddy56/stock-purchase-agreement?from_search=1 

This is the step in which your lawyer makes money.  The SPA is a long legal document that contains difficult language and each word is very important to understand.   A great investment banker will  help you negotiate all the conflicts between what you want and what the acquiring company specifies in the SPA that it is willing to do.  Most of this should have been worked out prior to the SPA but there will always be surprises that need to be addressed.

Most SPAs will include sections for each of the following:  (Many references are made below to expert documents on each subject that we suggest you review.)

Escrow

Escrow is an arrangement made under contractual provisions between the buyer and seller whereby an independent, trusted third party receives and disburses money for the transacting parties.  The timing of such disbursement by the third party depends on the fulfillment of contractually agreed conditions by the transacting parties.

Options (if you have them)

Options can be very complicated.  We couldn’t have said it any better than this great write-up by Mintz Levin called “The Treatment of Stock Options in the Context of a Merger or Acquisition Transaction” at http://www.mintz.com/newsletter/2011/Advisories/1170-0511-NAT-COR/web.htm

Representations and Warranties

Representations and warranties are statements made by a party in an agreement referring to facts or matters about the party making them. They speak both negatively—e.g., “there is no litigation pending, or to the knowledge of the company, threatened;” and affirmatively—e.g., “each of the company’s employees earning more than $100,000 per year is listed on Schedule A.” These representations, or “reps,” are negotiated over issues such as whether individual reps are qualified by the “knowledge” of the person making them or whether an individual rep is made only as to “material” matters. A vital counterpart to reps and warranties is the disclosure schedule.–From Matt Schwartz’s article “Mergers and Acquisition: The Basics”.

There is a great article on Representations and Warranties by Stone Business Law at the following link: http://www.stonelawyer.com/resource/business-sales-and-acquisitions/guide-acquisition-agreements-representations-and-warranties

Covenants

Covenants exist to assure the buyer that the acquired business will not change significantly during the period between signing the acquisition agreement and closing the acquisition.–From Matt Schwartz’s article “Mergers and Acquisition: The Basics

Conditions to Closing

Conditions to closing recite things that must happen, or not happen, for each party to be obligated to close the acquisition.–From Matt Schwartz’s article “Mergers and Acquisition: The Basics

Indemnification

Indemnification refers to who must pay for liabilities resulting from the acquisition and incurred by the buyer after the closing.–From Matt Schwartz’s article “Mergers and Acquisition: The Basics

Key employees and Employment Agreements

“Key employees” are those employees that are necessary to ensure the asset will be successful post acquisition.   Examples: The head of the application development group, the execs that own the largest customer relationships and the business group leaders.

The more “key employees” a buyer flags, the more risk there is to getting the acquisition done as these people will all be given non-compete agreements with compensation tied to them staying on for 1-3 years.  Usually the seller holds back money to incentivize these people to stay so it’s also costly to identify too many “key people”.   All key people will also need to be brought into the acquisition discussion so there is risk there too.   There is a great read on finding key employees in your organization by Shari Yocum, Tasman Consulting LLC.  “Will the real key employee please stand up? “

Non-compete agreements

In order to ensure that the value of the asset acquired is fully transferred to the buyer, the seller (and possibly other employees) might have to be placed under an obligation not to compete with the buyer for a certain period of time.  For key employees transferring to the acquirer these agreements usually come with some sort of compensation paid out in the future.  There is a great write-up on Non-Compete agreements here:  “Mergers & Acquisitions Quick Reference Guide”. McKenna Long & Aldridge LLP. Retrieved 19 August 2013.

Earn-out

Earn-out refers to a pricing structure in mergers and acquisitions where the sellers must “earn” part of the purchase price based on the performance of the business following the acquisition. In an earnout, part of the purchase price is paid after closing based on the target company achieving certain financial goals.

Here are two great articles on earn-out:

Working Capital

Merger and acquisition transactions almost always include a provision for a working capital adjustment as part of the overall purchase price. Typically, a buyer and seller agree to a target working capital amount which is documented in the purchase agreement. Buyers want to ensure that they are acquiring a business with adequate working capital to meet the short-term operating requirements. Sellers, on the other hand, want to get compensated for business that they have already performed and not give away excess working capital at closing.–From the Mclean Group, http://www.mcleanllc.com/pdf/Valuation Newsletter/BVWinter10.pdf

The Wall Street Journal did a nice piece on some of the elements of the SPA that you can find here: WSJ M&A 101: A Guide to Merger Agreements

 

Step 17: Sign & close.

 

Signing and closing are two distinct events:

  • Signing — Depending on the number of shareholders it could take a number of days to get all the signatures and documents in place.  After these are signed, THE DEAL IS DONE.
  • Closing — At this point you will have vetted out numerous versions of the merger consideration spreadsheet and a detailed flow of funds is presented to buyer to start moving the money.  EVERYONE GETS THEIR CASH!

 

Step 18: Build a communication plan.

step_18

Maintaining good communication with customers, partners, subcontractors and employees is key to the company’s continued success.  It is important to create an effective communication plan.

Speaking to Customers – Your customers need to know that their contracts and the people supporting those contracts will not be changing.  Your most important customers need to meet the acquiring company.  Most acquiring companies will make this mandatory during due diligence.   Depending on the contract terms, some customers might even need to approve of the acquisition.

Speaking to Partners – Review all your OEM contracts, teaming agreements, MOU’s etc. and look for terms prior to meeting with each partner.  The partners will wonder how this will impact their contractual relationship with the company.

Speaking to Subcontractors – Contractors will want to know if they have a home in the new company and if the terms of their contracts will change.  When meeting with each of them you need to make sure that you are clear with how those contracts will transition and who their points of contact will be in the new company.

Speaking to Employees – Your employees are your company.  Your legacy is that you’ve created a way for these people to prosper.  They rely on you and this change can shake the fundamentals of everything they trust about the company.  They will first want to know if they have a job in the new company.  Then they will want to know if their benefits will change.  Then they will want to know if their jobs/titles/compensation etc. will change.  They will also want to know about additional opportunity for themselves in the new company.  If you can help each and every one of them through these questions in a very thoughtful way you will have done your job and can feel good about the transition of your legacy to another company.

Speaking to the new company employees – The new employees will look for things that they can leverage with the new acquisition, such as new products they can sell to their customers.  New quals they can put in RFP responses etc.   In most cases they will be excited.  The people at the new company that will be less excited are the ones in HR and Finance who have to do a lot of work to make the acquisition a success.  The key to engaging the broad set of the acquirer’s employees is to get them involved early on and ensure you do town halls and “meet and greets.”  The key to supporting Finance/HR is to ensure they have the bandwidth / resources to handle the acquisition and make sure they have a plan (timing/activities/owners).

Press Release – The Press Release should be mutually agreed upon between you and the Buyer.

 

Step 19: Celebrate!

 

Have the investment bankers buy you a nice dinner, they will be marketing for the next deal.

 

Step 20: Integrate your company into your new parent.

step_20

Entire books have been written on this subject because the success or failure of a merger or acquisition often depends upon integrating two entities successfully.  Here are a couple of interesting things we can point out:

The CFO challenge – Usually the CFO is incredibly engaged in an acquisition and gives many 80 hour weeks to making the acquisition happen.  However, the challenge is that most buyers already have a CFO and there really isn’t room for your CFO.  You need to have a conversation with your CFO about this potential issue long before you start this process and determine what incentives need to be in place to ensure an effective transition if the new company does not have a home for your CFO.

The HR challenge – Usually a buyer has an HR team and it’s normally more sophisticated than yours.   The key is to talk to the buyer through the deal about this issue prior to engaging your head of HR in the acquisition discussions.  You need to have a joint plan with the buyer on how to handle the issues here as the HR team will be key to both due diligence as well as a successful transition.

You and the buyer should have a tactical plan (what is done, who does it, when, what are risks) for how the following will be migrated:

  • Payroll
  • Timekeeping/Expense reporting
  • Accounting – Someone from the acquiring firm must be assigned to build a tactical plan for absorbing each contract into the new companies accounting system.   The acquiring firm should be able to keep a close eye on the financials from the time the contracts were in the old system through when they are in the new system without any lack of visibility to revenues and profits.   The test the acquirer should ask –‘can we do a reforecast of the business we just bought?’.  If the answer is ‘no’ then they are not doing an adequate job and someone is not going to get paid or a check is not going to get collected.
    • Accounts receivable
    • Accounts payable
  • Contract transitions
  • Benefits and 401k programs
  • Performance reviews / raises
  • Taxes
  • Budgets, forecasts
  • Email migration
  • Website
  • Any employee titles that will need to change – This can be a delicate issue given smaller companies have a tendency to over inflate titles and when migrated into a new organization a VP may now be a Director but still have the same responsibilities.
  • Working with employees that will have job responsibilities change.

As you can see, your current HR and CFO are very important to the success of the integration.  Don’t make the mistake of losing them.

It is important to avoid questions like “Who do I report to?”.  Both companies are still in play and individually successful, however, a detailed mapping of the organizational chart must take place and be clearly articulated to every employee more than once.  The mission statements are merging and expanding; this is not easy and should not be understated in importance.  Messaging must be created at the senior levels and frequent touch points articulated.

It will be important to get involved early in the company’s employee communication tools.  If the company does town hall meetings then make sure the acquisition is discussed and the people are introduced.

 

Things that can screw up the deal: pre/post-closing

 

Pre-closing

  • Contracts that require pre-closing consent to assignment
  • Teaming agreements/Contracts that lock you out of markets
  • Product ITAR issues if the acquirer plans on selling your products to international markets
  • Employment contracts with key employees that do not fit into acquirer’s compensation model.

Post-closing

  • Internal integration that is ignored and losing the voice of the employees that made it successful
  • How the buyer is going to measure the seller in subsequent periods (Typically the earn-out provisions require measurement and will determine how that is going to be calculated and what burdens are going to be used)
  • Responsibility for post-closing working capital calculations (Do the definitions in the SPA make sense or leave a little flexibility for reality?)

When a company is preparing for an exit they are usually trying to make the EBITDA as good as possible.  Many deals have adjusted EBITDA as the driver of how big the deal will end up.  Hence, many executives in the selling company will starve the company for investment in the last year or so.  The Acquirer has to recognize this and they have to not only come up with the money to buy the company but they also must be willing to invest to truly achieve the value of the deal.

References:

  1. “Mergers & Acquisitions Quick Reference Guide.” McKenna Long & Aldridge LLP. Retrieved 19 August 2013.
  2. LaGorio, Christine. “How to Structure an Earn-out.” Inc. Retrieved 19 August 2013.
  3. “How To Survive An Earnout.” Businessweek. Retrieved 19 August 2013.
  4. “Earnout: Short-Term Fix or Long-Term Problem?” Stout Risius Ross, Inc. Retrieved 19 August 2013.
  5. Barusch, Ronald. “WSJ M&A 101: A Guide to Merger Agreements.” WSJ Deal Journal. Retrieved 19 August 2013.
  6. Business Enterprise Institute. “Using Short-Term Key Employee Incentives to Increase Sale Price White Paper.”
  7. Yocum, Shari. Tasman Consulting LLC.  “Will the real key employee please stand up?
  8. The Mclean Group. “Working Capital – An Important Detail Not to be Overlooked.”
  9. Stone Business Law.  “A Guide to Acquisition Agreements – Representations and Warranties.”
  10. Schwartz, Matt. “Mergers and Acquisitions: The Basics.”
  11. Goldsmith, Marshall. “What Got You Here, Won’t Get You There”

** All graphics provided by WORDLE

 

Professional Services – The first few stages of growth…

I was on a panel last night at a MoDevDC event (this Meetup is a group of amazing DC Metro entrepreneurs focused on the mobile applications space).  Many of the people in the audience were either on contracts as 1099 consultants or they were building mobile applications with the hope of building a sustainable company.   A topic came up during the panel about the different stages of growth an entrepreneur can expect as they grow their business.   I raised the point that the stages of growth are different for a services business than they are for a software business.  I also raised the point that running a company with both product and services can be complex as well.

There is a ton out there on the stages of growth a product entrepreneur goes through—just read one of the following and you will find all you will need:

If you are building a Product + Services company there is also a great book by the 37 Signals team called “Rework”.  However, if you are a one person shop and thinking about building a professional services technology consulting business I found that there is very little for a startup founder to read so I thought I would detail just a few thoughts below from the panel discussion on those stages.  Hopefully we can build on this as time goes on…

So here goes…

The Indie Stage…
You are en extremely talented programmer… company’s hire you on a 1099 basis to get the job done in a high quality way…   they pay you a high rate for your talents… you are a mercenary of sorts.

Your income could be in the range of $150k to $200 US depending on your rate and the number of hours you work (your utilization).  For example, if you bill $125 an hour and work the standard 1410 hours per year you can make ~$176,250 a year before taxes.  Not bad.  (Calculated as: 260 work days (52 weeks in a year * 5), minus 10 days unpaid vacation, 5 unpaid sick days and 10 unpaid holidays that leaves roughly 235 maximum billable days and hopefully you will never be under 75% utilized for a minimum of 176.25 billable days or 1410 billable hours.  At an average bill rate of $125 per hour one person is $176,250 in revenue.)

Your overhead is also minimal.   Get an LLC or S-Corp setup– Use a company like Legal Zoom to easily set it all up for a low cost…. Open a company bank account (Ensure they do ACH transactions)–  PNC has a great program for small businesses however a local bank may be a better choice once you start needing a line of credit.   Get your own domain and invest your time in free tools such as Google Apps

The dip your toe in stage…
The next stage many Indie services professionals go through is expanding their current contracts by hiring other 1099’s for $75/hr and billing them out at $125+/hr.

  • Income

You: ~$176,250
Adding additional people to projects:

revenue  =  $176,250

cost at $75/hr * 1410 hours/yr = $105,750

Net $70,500 per

  • Overhead (Your goal at this stage is to keep overhead as low as possible and work out of your homes and coffee shops)

Trademark the company name
Start investing in tools such as Basecamp
Get a good part time Quickbooks accountant ($500/month)
Invest in a SaaS Time Keeping system that integrates into Quickbooks
Get a good lawyer with standard professional services contracts
Allocate some weekend time to:

Build your bid / scoping methodology

Understanding the P&L – Score.org and SBA.gov are great resources

Building some marketing decks & PDFs that outline your company’s capabilities, case studies and differentiators

MAKE YOUR CUSTOMERS HAPPY!

The Management & Overhead Stage (A giant leap of faith)
So you worked your tail off and billed 100% of your time last year while still somehow hiring  5 1099’s and put $250,000+ ($70,500*5 minus taxes and hiccups) in the bank and you want to use that to scale.   This will by far be one of the hardest stages to get your new company through… It’s called the “Management” Stage because most of your work will require a lot of YOUR great managerial skills and a little leadership.    It’s call the “Overhead” Stage because this is the stage where you will have to invest money to make money—as well as take on personal risk (Line of Credit).

  • Obviously this is a stage where Profit and Loss management are key….   Get to know the “70, 20, 10 Rule”.  Your P&L should always balance out to a 70% maximum Cost of Goods Sold, a 20% maximum overhead and a 10% minimum profitability.
  • This is the stage when you go from billing yourself out to managing a team full time (you are overhead!)
  • This is the stage where you can begin to craft the company’s values (hint: Integrity must be at the top for a professional services firm—it better be true or you are in the wrong business).  You should also take a stab at a company Vision, Mission, Goals, and Objectives & Strategy.
  • This is the stage where you turn your 1099’s into W2s… (There are laws)
  • At this stage YOU are the sales person.   This is the stage where you have to determine what type of customer you want—not all customers are good customers… What size of deal is sustainable?  What is a good project?   It can’t cost you three months of sales calls and a week’s worth of someone’s time writing an RFP response to get a $25k gig.
  • This is the stage where YOU have to build out and document all of your companies Quality Assurance, Design, Project Management processes and methodologies—Why? –because you will be producing a low grade product inefficiently without them, and your customers are going to ask to see them…
  • Income

10 people is $1,762,500 in revenue

260 work days (52 weeks in a year * 5)
Minus 10 days paid vacation
Minus 5 sick days
Minus 10 federal holidays

235 billable days at 75% utilization = 176.25 billable days or 1410 billable hours
At an average bill rate of $125 per hour one person is $176,250 in revenue

Cost of Goods (62.4%)

$1,100,000 – Your consultants probably get paid roughly $110,000 per year
Overhead ($400,800 or 22.7%)
$176,250 – You
$    2,000 – Insurance (Workman’s comp, Liability, Errors and Emissions)
$ 39,600 – Benefits ($300 per employee per month)

Consider starting a relationship with a PEO (Administaff or Trinet)

$  6,000 – Tools: Email, Highrise CRM, Unfuddle ($500/month all up)
$ 12,000 – Marketing ($1,000 per month)
$ 12,000 – Computers for your staff (12 * $1000 = $12,000 or ~$1,100 per month on a lease)
$  5,000 – Line of credit ($5,000 enrollment fees and a lot of personal liability)
$ 88,000- Payroll Expenses (Salary * .08)
$ 60,000 – Rent

Net: $261,650 (14.8%) — Wow, not much better than last year and it was a great deal harder… but this year is going to allow you to successfully scale for many years to come…

Grow the contracts… Grow the people… Increase the bank account… Increase your Line of Credit…  MAKE YOUR CUSTOMERS HAPPY!

The Stable Growth “Leadership” Stage

This is the stage where your revenues and net income allow you to invest in more overhead.   You begin to fill out an organization structure.   This stage is referred to as the “Leadership” stage because you will have to grow leaders that you empower to run major portions of your company.
This is the stage where you begin to offer “solutions” with prebuilt intellectual property (IP) so make sure you write your contracts in a way that you at minimum ‘share’ ownership in the IP.
I cannot write much more about this stage and those beyond that has not already been well documented in detail by David in the book at this link http://davidmaister.com/books.mtpsf/ .

How tech companies behave depends on where they sit on a value chain

Lately I’ve been working with a number of small technology companies all of which have niche vertical solutions.  The common denominator across each of the companies is that they all are struggling with how they should behave in order to scale to the next level of growth.

As I work with each of these companies I’m going to document here the learning’s and try to find a framework that will provide others running similar companies value.

The framework I’m starting with is one of a value chain.   Here is how I am currently thinking about categorization and behavior in regards to where a company falls in the technology value chain.

Please let me know what you think…

In today’s world of Enterprise Computing motivation and behavior of companies is different depending on where they sit on the Value Chain?

Over the last 20 years I’ve had the opportunity to spend a great deal of time with many technology companies (Systems Integrators, ISV’s, OEM’s, Resellers, Training Providers and Hosting Providers) large and small and I’ve often wondered why many act as they do.

One way that has helped me to understand these motivations was to put companies on a value chain.

If chip manufacturers are on the bottom, right above the chips are the desktop and server hardware providers that use those chips… Right above the hardware providers you will find the platform providers like Microsoft with the operating system at the very bottom of that stack.

Then there is a hard line of demarcation on this value chain where IT value ends and business value begins.   Unfortunately, the traditional platform product vendors, not at all unlike “dial-tone” in the telecommunications industry, are on the IT value side of that equation.  Hence, most of their sales are targeted to the IT directors in the CIO’s office.

On that line demarcating where IT value ends and business value starts you will find IP that is built on, and requires, that platform dial-tone.   These are the typical “management” applications:

  • Supply Chain Management
  • Enterprise Content Management
  • Identity Management
  • Customer Relationship Management (CRM)
  • Enterprise Resource Planning and Management (ERP)
  • Document Management
  • Records Management
  • Knowledge Management
  • Asset Management
  • Forms Management
  • Systems Management

Platform providers typically don’t produce much IP in this area, but they enable other companies to build on their platform.

It is this very area where software as a services (SaaS) has had the largest impact.  Hosted CRM, ERP, Content Management and other services have become a reality and customers have re-evaluated the way they think about investing in technology.

Next on the value chain above the horizontal business rules are the vertical business rules.  These are applications that run companies/agencies/department/institutions business.   These vertical business rules are the solutions that customers invest in to solve their business problems.

The companies that sell at this level of the value chain have a deep understanding of the business problems as well as business process reengineering.  These companies are considered “Thought Leaders” and are companies such as Systems Integrators (examples: IBM Global Services, Northrop Grumman, Lockheed Martin and Accenture) and vertical ISVs (example: Curam Software).

Customers want to “partner” with companies at this level that understand their business problems and provide “solutions;” any company not fitting this profile is just another “vendor” selling commodities.   This can put the vendors below the vertical providers at a competitive disadvantage right from the beginning because some of the most important horizontal, platform and hardware decisions will be made by these vertical solution providers.

Companies may indeed sell across multiple levels of this value chain but where they are positioned on it depends on where they make the majority of their revenues.  For example, Microsoft still makes a majority of its revenues from Operating Systems and Office software.  They do have horizontal intellectual property (IP) such as CRM and ERP and they also have vertical software such as HealthVault but Microsoft is primarily a platform IP provider.

Cost of Sale

Another interesting element of the Enterprise Computing Value Chain is that the farther up the stack your company’s products are the more expense it takes to make a dollar.

Comparing IBM, Lockheed Martin, SAP and Microsoft you will see that IBM and Lockheed Martin both make a majority of their revenue from solutions consulting at the vertical IP level, SAP is primarily a horizontal IP company, and Microsoft is a platform provider.

IBM and Lockheed Martin are primarily people centric companies filled with thousands of consultants.   Microsoft on the other hand primarily has software developers building the next generation platform software  This if fundamentally why platform providers struggle–Microsoft’s customers would love to have them solve their business problems but their shareholders like the high profit margins and low expense.   To make the transition to a company that solves business problems they would have to increase their consulting force, deal with longer sales cycles, focus on areas such as business process re-engineering and build vertical IP such as 911 solutions for state government and student information management systems for schools.

You might say, revenue is revenue… but it’s not.   Just look at the valuation of a software company vs. a services company in the marketplace.  Services companies are valued at less than 1 times earnings where software companies are valued at 3 or more times earnings.   The magic of software has always been you can build it once and sell it many times (an exponential growth model), but in the consulting world the main way to grow revenue is to add more warm bodies to the company (a very linear growth model).

Horizontal IP is above the line…

An interesting aspect of Horizontal IP is that it is sold vertically.   Companies and government do not buy Identity Management or Customer Relationship Management (CRM) products per se.  They do however buy solutions that require Identity Management and/or Customer Relationship Management engines.   This is primarily why horizontal IP is a higher cost of sale (COS).   The COS is not however as high as a vertical IP provider–why, because the engine is reusable on other applications the customer made need the engine for and they don’t have to buy it over and over again.

Any account manager working for a company that has a CRM product will tell you that they don’t try to sell the value of the their CRM product to IT… They do however sell scenarios to government agencies for example to track bad guys, Army recruits, 311 calls and security clearances.   The underlying CRM engine is just a tracking workflow development environment that comes along with the configuration code that will be built to track that specific scenario.

Services

There are many sources that say that for every dollar of software a customer buys they also spend greater than 10x that dollar in services.

The services spend per dollar of software equation increases the further up the value chain one goes…

With vertical IP there is business process reengineering (BPR) and possibly vertical application development to configure the solution specifically for the client.  There is also a need to implement some sort of “management” engine at the Horizontal IP level to support the Vertical IP.  Then there is also a need for updated databases, middleware, operating systems and hardware.   At all these levels there is a need for services.   Let’s take one of the earlier examples.  If an Intelligence agency were going to buy a solution to track security clearances they would need to hire people to understand the current process, make recommendations on the new process and train agencies on how to use the new solutions.  They would also have to develop the vertical application on top of any Horizontal IP CRM engine.   They would then have to hire people to install the Horizontal IP CRM engine.   If the CRM engine requires new databases, operating systems then people may have to be brought in at the platform IP level to consult there as well.

All in all, the premise is that the farther up the stack you go the more services that are required.