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Monday, July 24, 2006

Selling Your Business

What's the perfect takeover target for the world's largest tech companies? And why could your choice of VC funding put them off? Keith Rodgers reports from San Francisco

If your long-term game plan is to sell your tech company to a vendor like IBM or Oracle, you've got to think big - but not too big.

For seasoned corporate acquirers, the profile of the ideal tech target seems to be 'small but imperfectly formed'. What the likes of IBM are really looking for is solid technology and the first vestiges of customer acceptance: what they don't want is a company that's spent time and resource building a large manufacturing and sales infrastructure which is only going to get dismantled when the deal's done.

This was one of the conclusions from a panel of corporate acquirers at the 16th annual Venture Capital Investing conference in San Francisco in early June. In a discussion peppered with pointed attacks on venture capitalists from one speaker - 'you can't believe [the worst of them] actually function as humans' was the choicest remark of the afternoon - five senior representatives from acquisition-hungry vendors mapped out the factors that can make or break a deal.

One of the more sedate voices belonged to David Johnson, worldwide head of corporate development at IBM. The company recently analysed the performance of 25 acquisitions it's made over the last two years, determining that in the last twelve months half of them far exceeded the targets laid out in the original business case for acquisition, with a further 25 per cent hitting target and the final 25 per cent falling short. Johnson pointed out that IBM's success rate has been highest at companies where the product was proven and there were two or three customers on board to demonstrate proof of market acceptance (or more if sales are made through partners). But 'if they've developed manufacturing, sales, and G&A [general and administrative expense], quite frankly that's somewhat redundant to IBM. It's the development team we want, the product, the technology.'

That view was echoed by Doug Kehring, senior vice president of corporate development at Oracle. While the company's acquisition record is dominated by its controversial, 18-month long hostile pursuit of rival PeopleSoft, it can also point to this year's takeover of Oblix, a relatively small IT developer specialising in identity management and web services management, as proof of its taste for smaller businesses. Kehring identified tech companies with revenues of $2m to $20m as the 'sweet spot' for Oracle. Over $20m, there's a danger that the company will be over-investing in sales because it doesn't have the scale of distribution that a vendor like Oracle has or may be chasing a mature market where similar companies are up for sale.

Similarly, Adam Spice, vice president of business planning at Broadcom, a $2.5bn turnover communications semiconductor company, pointed out that of the 30 acquisitions he's been involved with, only one had significant revenues (of over $100m). The rest had turnover of less than $10m, or in some cases none at all. One thing they did have in common, however, was working product.

Other key criteria identified by the panellists for acquisition targets included:

� Culture. IBM identifies this as a significant part of its due diligence process
� Choice of platform. The right fit will minimise integration issues, while the wrong fit will usually rule a deal out
� Ownership of intellectual property. This is a particular concern in the open source environment
� Importance of speed to market. This will influence their decision whether to buy product or build their own

So what about the vitriol poured on the VC community by one of the panellists? In some respects, it's simply a question of different objectives: IT vendors have strategic motives for investments and are prepared to pay a price, while VCs focus primarily on the financial outcome.

But for Broadcom's Spice, there's more to it. 'I've rarely seen VCs add value,' he said. 'When we acquire, typically they get in the way.' He believes many VCs fail to talk to customers, get caught up in CEOs' sales stories and fail to manage the earn-out expectations of tech companies' senior management. Similarly, he's experienced conflicts where one VC sits on the board of two prospective targets that Broadcom's looking at in the same sector. Perhaps not surprisingly, of all the investments made by the company over the last five years - including two companies in Cambridge - not one was brought to Broadcom by a VC; rather, its own customers or engineers flag up potential deals. 'We've worked with some very reasonable [VCs],' Spice concluded, 'but at the other end [of the scale], you can't believe they actually function as humans.'

There's little technology companies can do to temper any friction between their VC partners and potential purchasers, but it's worth bearing in mind some of the possible fallout. IBM's Johnson, while not commenting on Spice's views, pointed out that technology acquisitions are all about simplicity and speed - so the moment you have multiple VCs in a deal, each with their own sets of lawyers poring over contracts, you're likely to have a problem. Get more than three VCs in a deal, he says, and it will add three to twelve weeks' delay to the completion process.

Keith Rodgers is content director of Webster Buchanan Research (