Merger Mania

Zack Urlocker
Friday, August 17, 2007

Related News: Unofficial HP Merger FAQ Entrepreneourosis Angel Investing

When to Merge And When To Purge

If you're in a high tech company for a long time, say more than 6 months, it's likely that you'll go through one of the key high-tech rites of passage. No I don't mean the annual pilgramage to Comdex, but rather, the high tech merger. A merger or acquisition involves one company selling it's assets to another so that the first company's investors can stop fretting about what a lousy job management is doing. That role is taken on by the second company's investors.

Mergers are as common in Silicon Valley as marriages in Hollywood, and often last just as long. Nonetheless, there's a rich tradition of mergers and acquisitions in the valley dating back to when Dave Hewlett and Walter Packard traded last names and became a team. And of course the tradition for mergers and acquisitions has continued for more than 50 years as demonstrated by HP's recent acquisition of Compaq. (Ed: If Carly goes to prison, we should update this example.)

Many companies have grown very successfully through acquisition, but the only one that's still in business today is Cisco. This has largely due to the fact that no one understands exactly what they do. Nonetheless, I'm pretty sure it has something to do with the Internet. John Chambers, CEO of Cisco, which has acquired more companies than customers in the last five years, has developed a methodology around acquiring companies. This worked for years until the SEC decided that you couldn't depreciate employees. At the height of Cisco's acquisition binge, savvy Venture Capitalists would simply announce companies and see which ones Cisco wanted to buy before even staffing them.

John Chambers methodology was based around 5 simple rules for acquiring companies. Later they acquired a sixth rule, but later wrote it off during a period of consolidation. The rules are simple to learn and impossible to implement, but here goes.

Rule #1: Vision: Why Having One is Not a Bad Idea

If having a vision is a good thing, many companies assume if they acquire someone with a different vision that's even better. Unfortunately, that usually leads to so-called "double vision" which prevents anyone from getting anything done in the merged organization. So you get dragged into a lot of meetings that degenerate into discussions about what kind of business the company should be in without any actual conclusion. The alternative, having no vision, is no better. In this case, you end up having a lot of meetings that lead to endless discussions about the need to have a vision, but never actually formulate one. Sometimes it's easier to just stay single.

People like to work for companies that have vision. The only problem, is like pornography, it's hard to define, but you know it when you see it. Nonetheless, you should avoid taking the pornography analogy too literally. This is definitely frowned upon by the board. A vision should be bold, transformative and a challenge to the organization. But it needs to be more than just a pipe dream. A good vision has to be backed up by solid engineering, usually done in the form of a far out sounding code name and 3-5 powerpoint slides.

Rule #2: Chemistry: Alcohol, Offsites and More

Establishing positive chemistry between both companies is critical to the success of the merger. If one company comes from a three-piece suit environment and the other is best known for it's hawaiin shirts, then you're in trouble. Either that or you're at an AOL Time Warner board meeting, which is probably the same thing. No two companies will have identical values, so it's important to nurture the chemistry by working towards common goals. The best way to do this is to throw a big party with a lot of alcohol. However, shareholders might not like this, so it's best to call it an offsite integration meeting.

Offsite meetings often have challenging "Outward Bound" exercises or "Ropes Courses" to help establish a common experience between all participants. This can be very effective since it helps bond participants with a common fear of having to team up with the new CEO. However, if you fail to "spot" one of the company executives in a Ropes Course, you may want to consider alternative employment. And definitely send get-well flowers.

A good offsite meeting will feature plenty of "brain storming" exercises where participants can come up with great ideas for which there is no budget. But if there's enough alcohol and loud music, you'd be amazed at the great ideas people come up with. An offsite is a great way to get the team motivated to "party down" against the competition. Although drinking alcohol during staff meetings is sometimes frowned upon, Jell-o shots can be equally effective and are usually not explicitly forbidden in company handbooks. The best outcome from the offsite is that everyone will be working towards a common goal: the search for the perfect hangover cure.

Rule #3: Short Term Win: Avoiding Prison

Although it's tempting to have a lot of write-offs when acquiring a company so you can goose your earnings per share, the SEC has become somewhat stricter in this regard. In effect, some of the techniques companies used to "spring load" their earnings are, well, technically anyways "illegal." And generally speaking, it's usually best for executives to avoid prison as this can have a negative effect on investor perception. Of course, if your investors are from Merrill Lynch, Enron or Arthur Anderson, then it might make board meetings easier to arrange, particularly if you're all in the same cell block. Nonetheless, while executives often talk of doing "whatever it takes" to get a deal done, you should avoid tactics first developed in, say, The Godfather.

Rule #4: Long Term Win: Staying in Business

Most high-tech mergers have shorter lifespans than hollywood marriages. So if you're still in business a year later, that's really not too bad. In fact, if performance is terrible, the CEO will probably start handing out huge retention bonuses, which is somewhat ironic. Staying in business is definitely a good thing. It means you can keep your job. At least until the next round of mergers.

Rule #5: Geography: Something You Should Have Thought about Earlier

Geographic distance between two companies can be a significant factor in determining the success or failure of an acquisition. The odds of success are much higher if the companies are within 20 miles of each other. In fact, in that case you probably have employees who are currently interviewing at the other company. If the distance is more than 20 miles, then the odds of success will decrease significantly. Bi-coastal mergers in high-tech are particularly challenging as you not only have to deal with the physical distance involved, but also the fact that people will be rooting for entirely different professional sports teams. On the other hand, acquiring an international company can work out quite well, particularly if it's in a desirable location for offsite meetings and the people have quaint foreign accents. For some reason, European companies in particular are much more adept at working through long-distance management relations. But this could just be because they are well into the cocktail hour when most sales teleconference calls are being held.

Buying and Selling

There are good arguments for being on either the buy side or sell side of a transaction. If you're the acquiring company (known on wall street as the chump), then you most likely keep your job. For a rank and file employee, this is a good thing. Because now you can continue to make mortgage payments, send your kids to college and surf the Internet with a high-speed connection on company time. If you're an executive, this is even better since you get to do all that and you have six months time period during which you can blame just about anything on the acquisition. Why? Because you'll be in merger integration meetings that will prevent you from getting any real work done. Revenues, project ship dates, market share goals, all get tossed aside during an acquisition. It's like a "get out of jail free" card.

The only problem is that now you'll have to deal with a lot of people who never really signed up to be part of your company and will take every opportunity to remind you of how much better things were before the acquisition. It's a little like getting married and finding out that the girl of your dreams has moved her entire family of kentucky cousins in to your house. So not only do you get the bride, you also get her family, her deadbeat brother, their double-wide trailer, a bunch of snot-nosed kids, their whiny parents and so on. If you're lucky, someone will still know where the source code is and how to build the product from back up files that may or may not be up to date. Many high tech executives talk about how people are their most important assets. After an acquisition, you'll see just how much of an asset some people can be when they find out how much money the executives made on the deal.

On the other hand, if you're part of the acquiring company, well, let's just say that you may want to consider your options carefully. It's important to keep an open mind when you're exploring new opportunities. In effect, you'll be interviewing to keep the job you already hate. It's important to stay positive and focus on your eagerness to contribute to products and ideas that fit into the new company's strategy. Groveling works well also.

Setting a Price

In the old days (e.g. 1980s) software companies usually sold for 2-5x revenues, assuming they were profitable. In the dot com era, since companies did not want to be distracted by revenues or profits, they basically sold for the flat price of $1 billion, or up to $5 million per engineer. Of course, that assumes each engineer had their own Aeron chair, it would be considerably less if they just had the cheap stuff. If a company had an actual working product, the price could be double or triple that. Since then, valuations on acquisitions have fallen considerable. Now if you can get a couple of hundred million for a growing revenue stream, you're doing great. If the offers come in for less than the payments left on your car, then you may want to delay until the market picks up.

An excellent scenario for a startup company is to sell to a very large company while remaining independent as a "wholy owned subsidiary." That way you can thumb your nose at the corporate bureaucracy but continue to get the benefits of their backing. Note, in this case it's best not to refer to the acquiring company as your "Sugar Daddy" in staff meetings.

When To Merge

The following is a list for executives to consider as good signs to consider a merger or acquisition:

• The board keeps looking at you whenever they say "drastic action" is required
• You've started to look at what kind of ROI your fire insurance would generate
• The board is asking about "Plan B" and you're already on "Plan C"
• Your "consistent financial performance" has been eight quarters of losses
• Your PR strategy consists of coverage on F---edCompany.com
• People say "Oh, are they still around?" when you tell them where you work
• Your last product review put you in the "where are they now?" section
• You're considering installing parking meters to meet quarterly revenue targets
• Engineering has said that losing the source code would be a bit productivity boost

And here are some "not so good" reasons for a merger:

• You're all out of ideas and this one came to you in a dream
• You're hoping to date the other company's CFO
• Your logos are very similar
• You'd like to spice up your current tag line
• The bankers are willing to give you bonus air miles on the deal
• You've always wanted to go to Tokyo and they have an office there
• You lost a golf bet

Merger, She Wrote

In order to work out the details of a financial transaction, you'll need to enlist the support of investment bankers. Investment bankers love mergers since it enables them to apply their core expertise which is collecting 6% fees on the transaction. As with real estate agents, it's always "a great time to buy" or "a great time to sell" depending on which side of the transaction you're on. Investment Bankers also like coming up with good code names to shroud the deal in secrecy. If you're speaking with multiple potential companies to acquire, eventually the codenames becoming too confusing and everyone just posts it on the company bulletin board anyways. Generally code names are simple mnemonics like "Batman and Robin", "Smith & Wesson", "Spam & Eggs" and so on. If they refer to the deal as "Oil & Water" or "Piss & Vinegar" you may want to consider hiring some marketing consultants also.

Finally, while no deal ever goes exactly as planned, here are a few comments you definitely don't want to hear from your board of directors:

• You paid how much?
• Is that in millions or in thousands?
• What do you mean by dillutive?
• I hope you've got D&O insurance!

About the author
Zack Urlocker is a pseudonym for a Silicon Valley software executive. He has successfully merged and/or purged half a dozen software companies.