A little while back I wrote a post called M&A Opportunities in the Economic Downturn. It was based on information that I read in a paper published by McKinsey & Co. The paper reviewed research that McKinsey had done regarding what actions/steps companies took during the downturn, that either enabled them to accelerate their growth when things turned around, or doomed them to become laggards when the market picked up again. Anyway, I had a great question from Matt Cope, regarding what things could less established players be doing to better position themselves during the downturn.
Rather than me pontificating on that point, I thought I would pose the question to Dilip Wagle, one of the authors of the paper, and a partner in McKinsey’s high tech practice.
1. Dilip, what steps should small companies be taking to weather the economic downturn?
The answer is somewhat nuanced on this depending on the sub-sector the company plays in, its cash position and geography. For example small IT providers to the health-care industry will likely be well positioned as demand for their services continues to be strong. Similarly, companies providing services may be better positioned relative to hardware vendors. In general however, small companies do face more capital constraints than larger ones and need to think carefully about conserving cash, while looking for judicious opportunities for growth. There are a few steps small companies should consider. 1) This is a good time to think about aligning with a larger platform player (e.g., Microsoft, Oracle, IBM, HP), who have deeper pockets and are looking to build out their ecosystem strengths. Trying to remain “platform agnostic” may be a more suitable play during less trying times. 2) Look hard for talent now. The silver lining to the deteriorating economy is the rich talent pool that has come available 3) If you can afford it, look for M&A opportunities. Tough times lead to inevitable shakeouts in which about half of the leaders in a sector will change over. 4) On the flip side, be wary of selling out your own company in a distress sale. If there’s a way to hang on, think about raising capital as valuations will increase as the tide turns.
2. What actions should they be taking now to have the best chance to accelerate growth and gain leadership as we start to recover?
Again, the answer is somewhat situation dependent, but generally speaking, invest in sales talent (even if it is counter intuitive to do so); cement partnerships with other players - there’s strength in ecosystems that sustain the group even when individual companies may be hurting more than others; and conserve cash where possible - seek to extend payables, drive harder bargains against receivables.
3. What are some of the more costly mistakes that start-ups make in a downturn?
Selling out too cheaply is perhaps one of the bigger errors - distress sales are to be avoided when possible. Cutting back on sales and marketing just to meet benchmark numbers (always be suspicious of numbers that don’t have deeper rationales attached).
4. Over 90% of the time a successful start-up’s exit will be M&A vs. IPO. How can start-ups position themselves for better valuations and smoother transactions?
In general having a coherent strategy is important. No matter how tough the times or how much in distress the company, having a coherent game plan and an adequate cash position will raise valuations. Marquee customers help lot too. While all customers count, some count more than others - as a signaling device.
5. Are their obvious pitfalls that a company looking to be acquired should try to avoid?
Having an opportunistic model with no coherent strategy is to be avoided. Similarly, unrealistic projections with little basis in facts don’t help. In general, credibility is better established if a company is conservative with assumptions and transparent with risks in a business plan. And can demonstrate what it plans to do to beat expectations and what steps it plans to take by way of risk mitigation, than showing a rosy picture that investors will see through. Expect to negotiate hard over the next year or two as there is capital seeking deals on the cheap.
6. You work with a lot of the biggest names in technology – how has, or how will this recent meltdown impact their views on M&A.
Like all investors that have capital available, they are looking for good deals. We do expect there to be roll ups in the industry broadly speaking - though this will vary by sub-sector and function. It is inevitable. However deals are likely to be negotiated hard as today cash is truly king.
7. Are there particular areas in the tech space that you think will be more active in M&A.
Fragmented sub-sectors are more likely to see M&A activity. Thus applications software, IT services, SaaS among others could see more activity than (say) hardware. Although a lot will depend on the individual players and the likely length and depth of the downturn.
Many thanks to Dilip, for taking the time for this interview. For all of you out there, I would also love to hear your thoughts on this topic.
Oh yeah, and one more question for you, if you were to walk in to Ethan Allen Furniture, and everyone who worked in the store hugged your wife/spouse, would that worry you?