Building a business is a tough gig at the best of times, especially when you don’t have access to the right sort of money or expertise. Here, David Dungay asks some Channel experts about the best build to sell strategies.
The Channel has always been a hot bed of activity when it comes to M&A activity. It is not unusual to see a true Channel entrepreneur build up and sell on a business multiple times over their career, this had lead us to a vibrant market of buyers and sellers. However, to get to a point of sale you need to be actually able to build a business in the first place. I asked a number of Channel experts what they thought of the current situation around growth, a different stages of the Channel business lifecycle.
Firstly, funding has always been an important area for any Channel business and has been a common link between all the great Channel success stories we have seen over the years. But what kind of options are available to the Channel to help them take their businesses to the next level?
Adam Zoldan, Director at Knight Corporate Finance, commented, “Funding for new businesses has traditionally come from shareholders own resources and Angel investors. As a channel business, you really need to back yourself initially to prove the concept. However once you have demonstrated you have a viable business, there are now more funding choices than ever before.
Equity investment is plentiful and for companies focussed on growth is generally the most appropriate form of funding as investors understand that you are investing in growth and this means that any profits are immediately re-invested back into the business. As a channel business, you should be able to fund your own organic growth and so there has to be a compelling reason for the investment such as a pre-qualified acquisition or investment in a new product area.
Debt is also available but is generally limited to business that have a track record of historic profits. Once your business has demonstrated annual profit of £0.5m upwards there will be a number of debt options open to you. As your business grows and becomes more profitable, lenders become more comfortable and are able to offer larger facilities.”
Campbell Williams, Founder and Director of Sunfish Advisory commented, “An established business looking to scale up will have more options open to it. Owner/managers who are looking for small-scale M&A without diluting their own equity should find it straightforward enough to raise acquisition capital through senior debt based upon a leverage multiple of EBITDA. There are plenty of TMT specialists in the UK banking sector who will be happy to lend to a growing business with an established operating model and a broad base of recurring customers.”
Roger Gooden, CEO of iFace Solutions, added “There hasn’t been much funding available until recently. fund:tmt noticed a funding gap in our industry and have pulled together an exceptional team with experts in our sector to assist. The issue we faced when trying to grow my last company Globalnet was there was very little support from the banks, so you are left having to grow your business out of cashflow.”
Mark Borzomato, Investment Director at fund:tmt, commented, “The different types of funding available for Channel businesses is largely driven by their lifecycle stage. At the earlier start-up phase of their business, they will require funding from a mix of shareholder funds and angel investors. As the business develops, gains new customers and increases revenues, they are likely to attract investment from debt or institutional equity partners. The debt vs equity split each carries its own pros and cons, and should be explored in full in line with the wider business strategy.”
Modern GrowthThere is no denying the Channel is a very different place than it was in the 90’s. Digital Transformation has impacted customers and their wants and needs have also evolved to suit new market dynamics. In this modern market, do partners need to approach the subject of growth differently?
Williams said, “Growth in a modern market – and we can be honest here and say “mature market” – is a very different proposition to entering a new, rapidly growing market. Data networking is flat, the voice market has been shrinking for many years, and the IT market is growing but very slowly overall. The key is to understand the overall dynamics and target the segments within the market that are growing, either because they are new or they are a replacement market. Moving from PBX hardware to hosted IPT means you are in a market with double-digit growth and you are also moving from one-time non-recurring revenue to contracted and monthly recurring revenue – both of these things make the business more valuable.
You wouldn’t dream of starting a business that does client/server hardware and looks to sell one-time Microsoft software on DVDs. But a cloud business, with focused expertise in growth areas, is a different proposition. A company looking for funding needs to be able to explain that it understands the mega-trends that are driving change globally, the macro-drivers that are shifting the tech landscape, and the micro-level market dynamics that affect buying behaviour in the UK. You simply won’t get off the start line if you don’t understand this and it’s the start of every good fund-raising pack. Crucially, you need to know how you’re going to make your customers’ businesses better, as dial-tone and bandwidth alone won’t cut it any more. “
When asking Gooden he commented, “Yes I believe so, our industry is changing so quickly. You now need to ensure that you can categorically manage change and have your business plan aligned to that, have your funding line in place from the beginning to keep on track and execute your plan.”
Zoldan added, “Growth will always drive value in your business. Organic growth is an increasingly rare attribute and those companies that are able to deliver double digit organic growth as a result of an effective sales team combined with a forward looking product proposition will find that they will attract a good deal of attention. More commonly we are seeing businesses that have relatively flat revenues and this creates more of a dilemma from a value creation perspective. Its certainly worth comparing the value of continuing ‘as is’ versus raising money for growth versus realising value today – there is no right answer, it’s a result of personal situation, outlook for the future and their appetite for risk.”
Building towards a sale
Are you looking to get out of the market? According to CompTIA 40% of you will look to exit over the next 8-10 years. That is a huge number of Channel businesses looking to sell up and move on. So what advice do my experts have for businesses building up to this point?
Zoldan advises, “Articulate your aspirations as a shareholder and build a strategy that will enable to reach your goal. Depending on your aspirations this may or may not require external funding, it may or may not lead to investment in a senior management team, and it may or may not result in an acquisition strategy to top up organic growth. However the one fundamental item, necessary for a successful sale is have good quality management information about your business and an ability to deliver consistent accurate financial information.”
Williams adds, “There are two major pieces of advice I’d give here: firstly, take the long-term view; and secondly, get the commercial not just financial details right. On the long-term view, this means thinking about exit at least three years out, if not five. It won’t do any harm to start getting the business ship-shape so that if an interested party comes along early with the right sort of offer then you’re able to pursue it. And the process will be much smoother if you have 3-5 years of data and insights that meet the expectations of a buyer.
On the second point, there are four main types of due diligence: financial, legal, commercial and technical. Vendors tend to rely on advisors to get the numbers straight so that FDD (financial due diligence) should be fine and LDD (legal due diligence) usually takes care of itself one way or the other. But on the CDD (commercial due diligence) and ITDD (technical or IT due diligence), it’s all too common to see only a light-touch approach here. This is a major mistake. As a buyer, I’ve walked away from plenty of deals where the numbers were bang on but I couldn’t get comfortable with the commercial side of things. Usually, it was either the company couldn’t explain their own go-to-market, pipeline building, conversion ratios, etc, or they didn’t understand anything about the external market and the sustainability of their proposition therein.”
Borzomato commented, “Build a business that really adds value to its customer base. The market is crowded with new entrants coming in constantly, so the inherent value is with those who can retain and grow their client base quicker than the market rate. Furthermore, getting the right team around you is essential, particularly as the business goes through the £1m barrier – build a quality employee base, advisor and funding partner to ensure the strategic goal of the business is always the key driver for day-to-day operations.”
Acquisition Process
Once you have spent all those hard years building your business it is not unusual that some Channel folk wish to hang up their gloves and enjoy the fruits of their labour. However, the final hurdle, i.e. the acquisition process, is not an easy one to navigate.
Zoldan said, “The acquisition process is fairly intense but the real work starts on the completion date. Planning is important and your integration strategy will be key to making the deal a success. So many acquisitions fail on the back of poor integration. There is no correct strategy but it’s important to understand what you need from the deal in terms of financial performance, how to ensure staff on-board with your plans; and what is the communication plan for customers. Most acquisitions are based on delivering cost savings but there can be fine line between delivering savings and affecting the value of the business that has been acquired and each acquirer must find that right balance for their organisation.”
Williams commented, “It’s essential to remember the financial metrics and commercial KPIs that either an acquirer or an investor will be looking for. Those would be organic growth, recurring revenue (and MRR v NRR), EBITDA (quantum and margin), cash conversion, monthly ARPU and retention/churn. Depending on the business and market, there are a host of other things being looked for, but these are the “must have” ones.
After that, it’s about doing the best job you can at selling your business. Understanding how it would fit with an acquirer, understanding how a trade buyer differs to a PE one, knowing your market inside out and back to front, having a truly differentiated proposition, being a coveted brand and asset in the industry, and so forth. Again, the message is clear: this requires a certain level of strategic sophistication and go-to-market maturity, and you may not have it in-house. Bringing this to your board, or as a part-time member of the team, or to do some project heavy-lifting is essential.
“You also need to think about what sort of exit is right for you, do you want an earn-out, what’s the right sort of buyer for your team, and so forth. It’s not just as simple as the highest price wins. You need to reference the buyer, as a lot of people offer an initial high price then chip the deal at the last minute. You need your senior team prepped and ready to take over; vendors who make it all about them or follow the “Cult of the CEO” path will find it difficult to find a buyer. If it’s all about you, how can the business keep going when you’re gone? So putting ego to one side, focusing on your own future and those of your team, and bringing in expertise even if it means hearing things you don’t want to hear, are all essential to maximising value on exit.”
Ed Says...
Many of you reading this will be having thoughts of a successful exit at some point in the future. Building a business and selling up is not an uncommon pathway but careful planning along the way is essential. Make sure you realise early what your objectives are and then build accordingly, if you change your mind when the time comes then fine but don’t leave yourself without the option.