August 22, 2019

GrowthPoint Technology Partners
Trusted Counsel (Ashley) LLC. All Rights Reserved.

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Speaker 1: It's time for In Process, conversations about business in the 21st century with Evelyn Ashley and John Monahon. Presented by Trusted Counsel, a corporate and intellectual property law firm. For more information, visit trusted-counsel.com.

Evelyn: Welcome to In Process, conversations about business in the 21st century. Today, I'm joined by Valerie Barton, who heads the M&A Practice at Trusted Counsel while John Monahon recovers from a child inflicted virus.

Welcome to the show, Val.

Valerie: Thank you.

Evelyn: In the studio today, we have managing director, Vijay Rawat of GrowthPoint Technology Partners, an investment bank that provides financial and M&A advisory services. They are based in Menlo Park, California. Vijay joined GrowthPoint Technology Partners in 2015 and has led numerous M&A transactions at GrowthPoint. His technology knowledge is broad across many sectors, such as software, cloud, hosting, machine learning, AI, cybersecurity, and technology/IT services. Some of the transactions Vijay has led include: the sale of Wise.io to GE Digital, the sale of GDS to Stroz Friedberg, the sale of Xcentric to Right Networks, the sale of Shoot Proof to Providence Equity, the sale of Onboard Security to Qualcomm, the sale of MarianaIQ to 8x8 Inc., and the sale of Altaflex to OSI Electronics.

Vijay, welcome to the show. You're clearly very busy!

Vijay: Thank you, Evelyn. I'm really excited to be here.

Evelyn: We're really delighted to have a chat with you today about the market and what businesses should be looking at when they want to sell, kind of what the process is, where they should actually be in their development, and what they should be thinking about as part of leading up to the retention of an investment banker and kind of what that process is like on the other side.

Vijay: Well, I'm really excited to share my experience and my interest in helping companies prepare for M&A and then, as you know, we've been very busy and look forward to having a good conversation.

Evelyn: Talk to us about the market, Vijay, because we know that we see lots and lots of clients and business owners that are a little freaked out right now because maybe they're not sure if they should be selling or maybe they're thinking, "If I don't sell now, I'm going to miss an opportunity." Because we know there seems to be a lot of money looking for a home still. Just talk to us a little bit about what you're seeing and kind of what you think about the market.

Vijay: Absolutely. So I think this is a fantastic time to consider sale for most type of companies. There are a number of factors that sort of driving technology M&A. One is that the PE that you mentioned, private equity, have raised records amount of money. They need to put that money to use. The second driver is the public market. They're fantastic. They're near an all-time high despite trade tensions that we have with Mexico and China. Large companies have never had more cash on their balance sheets. There's trillions of dollars of cash on the balance sheet, which is earning very low return. They need to put that money to use either through M&A acquisitions or through organic investments or in a lot of cases buying back their stock because they can put that money to use. So if you think about the broader drivers of M&A, this is about as a good time as any for borrowing. Certain companies are more affected by the tariffs, particularly as related to China. So, companies in the semi-conductor industry in particular are a little bit more impacted, but other than that, the companies that don't have the China exposure, this is a fantastic time to consider a sale.

Evelyn: Let's talk just a little bit about private equity because typically PE funds weren't looking at smaller businesses. What are you seeing there? Are they? Kind of what is the range that you're seeing from a kind of a revenue and profit base? And do you feel like they've actually, shall I say kind of gone lower in the way that they might look at companies that they're not quite as large as they typically and historically have been?

Vijay: So PE companies. PE firms broadly have raised a lot of money. As a result, many of them have very large funds, and if they have large funds, then they need to put a lot of money to use. But they can't spread that across 30, 40, 50 transactions because they don't have the ability to manage all those transactions. So broadly they have moved up market, and they're doing bigger deals. Having said that, it's not always the case. Some PEs have actually built what they call these “heritage funds,” which are primarily focused on lower-middle market type of transactions, and they are companies that have had perhaps five to 10 million type of revenue, even company with the growing fast and they're not profitable and they're investing in those. So I would say that if PEs look for certain type of business characteristics, particularly as you mentioned recurring revenue, more resilient business models. It's more about that, and if they like the company in a right market, growing at the right rate, they're happy to take a look at it and pursue it to the extent possible.

We have seen companies like for example Accel-KKR, which is a very successful billion dollar fund, now they have created a small mini $150 million fund particularly focused on lower-middle market type of deals because they see a big opportunity there.

Evelyn: Talk to us about what you believe makes a company ready for sale.

Vijay: This is a question I get asked a lot of times. I mean, I think there are many factors that go into it. Also, the fact that what applies to one company in one sector is a little bit different than what applies to another company. If you're looking at unless they're a software company, clearly the business model, are they doing SaaS, software service? You need to focus on the KPIs, which is extremely important. Understanding, what is the RPO, what is the retention rate. For example, how long does the customer stay with you? What is the lifetime revenue? What is profitable? What is lifetime profitability on a per customer basis, what does that look like? So many factors. But broadly speaking, what applies to almost all technology companies is what sector are they and if the sector is attractive. Is it growing? Do they have a market leadership? Do they have a detention-able market position? Do they have any customer concentrations?, which is a negative or lack there of? What does the financial portfolio look like? Is this is a business that has high gross margins, which speaks to the quality of services they are offering or does the business have low gross margins? Eventually as the business is evolving and growing, what sort of profitability do you expect in future?

So there are many factors that go into valuating a business, but it's really different for different type of companies. We just talked about software companies. But for services companies, it's more about what type of customers do they have? Has the customer been with them for long time? Do they have customer concentrations or not? So there are many factors that you need to look at and it will vary from business to business.

Evelyn: So is there a profile company that GrowthPoint likes to work with over another kind or company?

Vijay: So we classify our clients in sort of three buckets. One bucket is we call high risk, high reward type of bucket, which is companies that have built some phenomenal technology which somebody's willing to pay a lot of money for. It's valuable to large companies. That's the companies like Wise.io. I mean, we have many examples where companies have only one or two million dollars in revenue but sold them for $50 to $100 million because of their technology, so that's one sort of bucket. Then we call sort of the middle of the road type of company, a company that has $10 to $15 million in revenue, particularly software, perhaps growing at 20-40%. It hasn't achieved profitability but it has all the indicators that it'll become profitable in near future, and that's the bulk of the companies we work with. Then we have large companies. Companies that have more than $20 or $30 million in revenue, they're profitable, they're a little bit more mature, but they're not growing as fast. And so that's the sort of third, larger type of companies we work with.

But the vast majority of companies we work with are somewhere around $10 to $20-$25 million in revenue and they're growing at 30-40% and they're mainly software driven. Sometimes they could be services, and these are types of companies we sell to companies like Microsoft or Google or Apple or Amazon.

Evelyn: So that's actually a good segway. So what's the difference between a financial buyer and a strategic buyer?

Vijay: Yes. There could be many objectives with a strategic buyer. One, they could be looking to consolidate the market. They could be trying to add certain adjacent capabilities to expand their market opportunity. They could be buying to build more skills. So there are many factors that go into a strategic buyer. Strategic buyers tend to take a little bit more time in evaluating the company. For them, the management may be or may not be that important, particularly if they have a deep bench of people who can help run the business. They are more likely to buy the company 100%.

When you go to private equity, they're looking to see “how do I increase, multiply this, and increase the value by two to five X over the next three to five years?” For them, it's important that the management stays incumbents to it. It's likely that they may acquire only a majority stakes, perhaps 60-70-80%. So for them, it's about how do I minimize risk and maximize my return. So in that regard, they may, the way they structure transaction could be that they take a preferred share, which has a certain coop associated with it. Whereas the investors may have a common share. So there are lots of differences between a strategic and private equity.

Even there, one private equity might be different than another one. For example, if they own an asset to another company in that market, they could be looking to consolidate. In that case, again, they may not want the management team. Again, they would probably buy 100% of it. So again it's really situation specific, and it's hard to give it one answer, but it's really depends on the company and the sector they're in and sort of what sort of activity happening in that market.

Evelyn: Can you make any generalization on kind of values between the two?

Vijay: It used to be that generally the strategics used to pay more, but given the amount of money that's available nowadays to private equity, in many cases now they're paying a strategic value. They're actually in some cases even higher. If you look at the number of software, large software transactions that have happened, the PEs are paying in some cases seven or eight times revenue, not [inaudible 00:12:03] of revenue, which is a big change from the past. Now valuation again depends on what the company does, what sector it is, it's the business model. A services company, let's say for example that's growing at perhaps 15-20%, is profitable, more likely to be treated perhaps eight to 12 times [inaudible 00:12:27]. Again, I'm generalizing it. But if you're looking at software company growing at the same rate that's recurring revenue, a SaaS business model could be three to five times revenue. It's very specific to the company situation, and what we do is to make sure that we try to understand the company as much as possible, understand the business model, understand the competitive position, understand what transactions are taking place, who is buying it, and based on then prepare a valuation that we can stand behind. We generally tend to be quite conservative to make sure that we are over achieving. What we promised to a client, we deliver and more.

Evelyn: That also raises kind of the thought of how educated does a seller need to be on the process, and how do they actually get there? I mean, it sounds like GrowthPoint really spends a lot of time kind of with that background. It's clearly a very complex process to go through. Kind of from an educational perspective, what makes a really good seller in your opinion?

Vijay: Yes. So clearly it's all about preparation in my view. I think that the company should take about one or two years to really prepare for an M&A process. They need to do many things. One is work with someone like GrowthPoint, and we're more than happy to just get an NDA, get some information for you, and talk to you and give you feedback in terms what it takes. What you need to do in order to be prepared. But there are many aspects that need to be looked at. For example, do you have employer agreements or employer agreements with all the employees? Do you have customer agreements? If something has lapsed and you continue to provide service, you need to fix that. Do you have contracts with all your suppliers? If you are in a multi-state company that does business in many states, do you pay a sales tax? Do you have employees in many different states, do you pay the employee taxes, so FICA and so forth?

Valerie: We love you, Vijay, you're really plugging this for us. It's really good.

Vijay: Thank you. Then you broadly need to look at your business. You need to understand what the business trends look like. Do you have any customer concentration areas that you need to address? Do you have customer retention rates that are moving in the right direction? If you have a SaaS business model, a software business model, which many of people here would have, are your RPOs increasing or decreasing? Is your customer retention rate, is that moving in the right direction? What's the lifetime revenue? How much does it cost to acquire a customer? How long does it take for you to break even? So again, there are many different aspects of business that you need to look at. And what we do is we act like a buyer. If GrowthPoint is a buyer, what questions would we ask? What do you need to do in order to make sure that we can quickly answer questions and get past the basic questions and talk about value.

Evelyn: So basically create kind of a strategic plan, if you will, of how to actually execute the operation for purposes of getting it ready for sale. It sounds to me that that's kind of you providing that kind of guidance, and then the business owner goes and implements those elements.

Vijay: Oh, absolutely. This is why we will have a meeting. We'll learn about the business and provide you perspective in terms of priority. These are the things you should work on before we go to the market. As I mentioned, the time we spend preparing the business, looking at all these things, and fixing things, pays a huge dividend when we run a process because the process can be much quicker, much faster, and we are able to answer buyer's question in a more timely manner, at least to a more efficient process, a more successful process.

Evelyn: You mentioned management team a little earlier. What are your thoughts on, and I understand that depending on kind of what the inclination of the buyer is, perhaps the team isn't that important. But is it more often than not relatively important to have a management team that is in place that really knows the business? So if you say you have a founder or the CEO that might not actually be picked up as part of the transaction, that it can continue forward?

Vijay: Again, I think the management team in most cases is very important. Then maybe some cases where the buyer is already active in the marketplace. They understand the business. They have a deep bench they can pull from. In that case, it becomes a little bit less relevant. But in most cases, it's really important that the management team wants to stay with the business, even the founders want to stay with the business, and it often is a... people associate risk with that. That if that founder is leaving and the management team is leaving, what are they buying? What are they buying? And what are the risks with that? If you don't have the management team, it also could be possible that you get a lower valuation. It could be that they don't want to buy 100% of the business because they worried about that the business could go down when the management team isn't there.

Again, it's situation specific, but in broadly speaking the management team is really important. And that's important from a risk management perspective for the seller as well as for the buyer.

Evelyn: And typically important that they have agreements in place that actually will keep them there after a transaction or-

Vijay: Yes. I mean, I think that perhaps more important the incentives are in place. In fact, in most cases, if you're a founder-owned company, they would put some sort of a management incentives in place to keep the management there. Alternatively, a seller could do the same as well. The seller wants to make sure that you're there for a long time. Particularly if it's a private equity seller, they would put in an incentive plan, which allows you to participate in value creation. It can be hugely lucrative for the management team to stay there and perhaps if the company gets sold over many times, they continue to participate and will build a lot of wealth as part of these processes.

Evelyn: Overtime, yes. You have talked about the important elements inside the business for it to be ready, but I know that you get this question all the time. Typically the seller just wants to know, "How much is my business worth, Vijay?"

Vijay: We get that question asked all the time, and look, we really work with you as an expert to try to give you the right advice. The valuation depends on the business model, on what you do. If you're a software company, there are variations in software. What sector do you focus on? Is that sector growing? How are you growing relative to the sector? Again, we talked about those KPIs for SaaS businesses. Companies that are not SaaS within the software, the multiples tend to go down if you're doing license and maintenance type of revenue. If you're a services company, it's more driven by how profitable you are. Perhaps in some cases if you're dealing with something like cloud, maybe the multiples a little bit similar to where the software multiples are. So we really spend a lot of time trying to understand your business, but then we go back and look at to see where other transactions are taken place, where your public competitors are trending, where sort of valuation market assigned to them, and based on that, we triangulate and come up with a range of value that we think is reasonable for your business.

I ask you a question, if you have a company with $10 million in revenue, growing at 100%, that means it gets to $20 million next year. Another company has $10 million but growing at 20%, that means next year it has only $12 million of revenue. Clearly the company that gets to 20 is a lot more valuable than the one at 10, and one that has let's say 100% recurring revenue versus one that has a project based revenue perhaps, very small return of revenue, but clearly the valuation would be lower. So we do a lot of work to educate you and tell you how we arrive at the valuation. What are the concerns, and what you can do to enhance your valuation, which is why the preparation is really important because if we are going to market in several months, you may not have a lot of time. But if you take time and go into market a year from now, then you actually have time to change your business.

Evelyn: So we work with your profile client but we also work with smaller businesses that generally are more of a mind perhaps where they can't afford to hire a banker as an intermediary. And sometimes, and I know that you're seeing this, there's lots of cold calling going on from potential buyers where a seller will take a call, suddenly they are in negotiations to sell their business in an environment that they've never been in before, and kind of in that kind of scenario. What would you recommendation be on how they should actually determine what is a reasonable price for my business?

Vijay: Yeah. This is really interesting questions. For all, I think what they need to do is sort of do some homework in terms of where their competitors getting acquired, what sort of valuation for those competitors, also if there are any public companies in that sectors, also understand that this is a small business versus a large public company. But at least you can get some sort of an idea in terms of where those companies are trading. Smaller companies are obviously... It'll focus a lot more on a profitability multiple pieces. They are less likely to give you a very high revenue multiples. It'll be focused on profitability. So it's more about educating yourself, talking to people like us, but there's no cost to talking to us. I'm more than happy to spend 15, 20 minutes, 30 minutes just to learn about the business and give you some feedback, a sense of where it might be.

I think you need to educate yourself, and if you're not educated, then you're not sure exactly what is the right value. Perhaps it is, perhaps it's not.

The other thing is you definitely need to have people who understand the legal risk and can help you from that perspective. There's this saying goes in banking, "You choose the price, let me pick the terms." And what that really means that you could... The headline price might be really high, but the actual price to you might be actually low, significantly low. It could be some combination of a earn out, some deferred payments. It could be that there's a large escrow, the working capital can be a lot of leakage in that regard. So there are many different ways a buyer can extract value. So you need to protect yourself from that perspective, which is where advisor is helpful. I understand smaller companies sometimes can't afford that, but certainly try to get some help, particularly from a legal perspective so you're protected. Lawyers can learn a lot about business as they do deals, and they can be very helpful and they can take you halfway there from a business perspective.

Evelyn: Talk to us a little bit about I've retained you to sell my business. We've had our preliminary conversations, maybe you've given me some direction as to what I should be executing. Time goes by, I've done those things, we're ready to go. What is the process then, Vijay? What happens next?

Vijay: So the process typically is that we need to prepare a management presentation, and we need to build a financial model. Depending on the company, it could take anywhere between two to four months, sometimes a little bit less if you already have it, sometime a little bit more if things aren't available. So that's called a preparation phase. So we want to make sure that we have a really good story. It's about what markets do you play in, a company overview, why are you a differentiated company, what are you technology strengths, who are your customers, some analysis as why I stayed with you, a little bit about competitive landscape, how do you compete, why do customers stay with you, how do you differentiate yourself between your competitors, and about the financial story, what is the historical financials as well as the forecast looks like. That's what a management presentation sort of encompasses.

So along with that, we prepare something called a teaser, which is what we send to buyers on a no name basis. So once we have the preparation, then we need to... The same time we identify a list of buyers, it could be a list of 40-50 companies or it could be 100 companies. If you're going to private equity, then it could be several hundred private equity firms. Then we go to market. We start out with the teaser, try to get people interested, talk to them to understand why they should look at this deal, and then get them interested. And the next step would be to sign an NDA with them. Once we have an NDA in place, then we share with them the management presentation and the financial model. The goal at that point is to get them interested into a next call with the management team or a meeting.

Once we have sufficient interest, then we set a deadline to get what is called an LOI or letter of intent. That process somewhere takes about two to four months, depending on the company. So if you think about it broadly, two months to prepare, two to four months to go to market, so that's about six months. Then about anywhere between 30 to 60 or 75 days to close the deal. So once we have an LOI, then we want to negotiate with these parties typically and then we want to go into an exclusivity. The exclusivity maybe for about 30 or 45 days, and that is when they're doing legal and other legal, HR, and other diligence with the intention that we'll close the transaction roughly about 45 days thereafter on average.

So the process typically takes six to nine months. Sometimes the process can be shorter if you're well prepared. If there's a buyer on the table already, if we're trying to only check the market instead of go to a broad set of buyers, so it's a situation specific. We have seen situation where we have a meeting and a week, four or five meetings, and then we have four or five offers a week later because the companies are really interested. We also have seen where the meeting, one meeting happened, and they're not sure. And they want to have another meeting. And the process can drag on. So how much time you spend up front in terms of preparation will really help us on the backend when we actually go to market.

Evelyn: Are you seeing deals close faster than in past years or are they typically on the same kind of timeline?

Vijay: I would say they're broadly on the same timeline. I don't think they have accelerated. Again, I think it's company specific. We did a transaction last year from the day we got engaged, we closed the deal in four months. And then there's situation where the buyer, there's a limited set of buyers, and they're not really moving fast. And then it's taken us 12 month. But generally speaking, I think for a vast majority of our transaction, somewhere between six to nine month is a good time. Certainly perhaps 80% of transactions fall between six to 12 month timeframe.

Evelyn: Why I think you've probably already explained all of this, but I want to give you an opportunity to truly do a pitch for your services. And tell us why you should be hired by a potential seller.

Vijay: Well, they should hire me because they like me. No, that goes a long way. I think you should look for a banker who actually understands your story, who is actually and they're going to spend a lot of time evaluating your business and giving you the right advice, someone who's experienced. There are lots of bankers out there who will come say, "Hey, come and I will work with you," then a month later they sort of push that project down to the junior team and let them execute. We don't do that at GrowthPoint. I strongly believe that you'll spend 10, 15, 20 years building your business. Perhaps all of your wealth is tied to the business, and it's my responsibility to make sure that we'll do a really good job for you.

I would say that one of the ways you can get comfort and see if that's the right banker for you is to get references. Talk to some of their former clients. What do they have to say? Did they deliver? Did they under promise, over deliver? Where they there for you? Were they listening to your concerns and addressing your concerns? I think that will really give you a good idea in terms of who you want to work for. We at GrowthPoint, we're a small investment bank, about 20 people. At GrowthPoint every single transaction is led by a managing director. I'm there for you every step of the way. There's nothing more important to me than to have a successful transaction where we have a current client referral. We want to make sure that we achieve an optimum result for you, and you are someone who becomes an advocate for me going forward because that's the only way we can build our business.

In my view, broadly look for experience, talk to references, and get an idea is this someone who is really motivated to work hard for you.

Evelyn: We like to say that we're a relationship partner, and I think you guys are too.

Vijay: Oh, absolutely. This business is all about relationship, and we work hard to earn our clients trust. We want to make sure that sort of continues as we grow our firm.

Evelyn: Go forward. Well, thank you, Vijay, for joining us today. This has been a great conversation. Thank you for telling us more about GrowthPoint, and if you're interested in learning more about GrowthPoint, please go to their website and GPTpartners.com. And thank you for joining us.

Valerie: After the podcast, we had a few more questions for Vijay. So we called him up by phone. Vijay, hey. It's Valerie Barton and Evelyn Ashley, and we're calling to hear your war stories. Tell us about your most difficult transaction. What is it about a transaction that really challenges you and tests your skills?

Vijay: That's a really good question. And one thing I'll tell you is that all transaction are different. I've never seen another transaction which is handled the exact same situation as another transaction. I'll give you some of my experiences in what I have seen. In one transaction we were doing last year, the company CFO came and told me a week before closing that they're running out of cash. Nothing that they anticipated for some reason, but they burnt through more cash than they had. So we had to go arrange a financing exactly a week before closing the transaction, and we were successful at that and we closed that transaction.

Another story where we actually were not successful and rightly so was a case where the buyer discovered some financial irregularities. In fact, this was international company, and the way the company was based, it was a high taxed country. So there was a high payroll tax. So the management decided that they'll take some of the payments through a tax haven through another country. Because of that, they didn't have to pay taxes. As you can imagine, once the buyer found out, that was not something they were willing to move forward, and the transaction did not happen. Also, we as an investment banker would never want to be in that situation. So we also terminated our engagement because of what was found there.

Another case that we recently deal with where the buyer literally about two or three weeks before closing, the company had soft numbers, and the buyers decided to reduce the price by 30%. And they were the only buyer on the table. And we worked with them in that situation to show that this was just anomaly and they expect to have significantly better performance in the next quarter. In fact, once we showed them... We delayed that transaction by a month, and once we showed them the monthly performance for the latest month, they agreed to go back to doing the deal at the terms we had proposed.

So yeah, every transaction has it's own difficulties. There's never a straight path. We work with the sellers and the buyers to make sure everyone understands the situation and find the best way forward.

Evelyn: Hope you enjoyed In Process today. If you have any questions on the topic, please reach out to info@trusted-counsel.com. Thank you for joining us.

Speaker 1: This has been In Process, conversations about business in the 21st century Evelyn Ashley and John Monahon. Presented by Trusted Counsel, a corporate and intellectual property law firm.

Are you interested in being a guest on our show? Email our show producers at inprocess@trusted-counsel.com. For more information on Trusted Counsel, please visit trusted-counsel.com.