By Peter Kroeger

Most innovative businesses are founded on a shoestring. Time and effort are put into designing and building new products or services, and then the business acquires a customer, perhaps even two. A sales team is formed, and as things expand, a support organisation, a management team, a bank overdraft, or even an angel investor might be introduced. With a bit of luck a profit will be made and, hey presto, a business is created!

Expansion then usually follows established lines, ideally by increasing market share to achieve sector dominance. Companies may acquire new products, or re-develop and re-market old products. They may expand into new geographic areas or buy out the competition.

Fuelling this expansion demands money to grow the right resources. But right now, raising expansion capital for a small and medium sized enterprise (SME) is hard. There's plenty of investment capital out there, but little that is focused on SMEs. Mergers and acquisitions can provide an alternative route to bringing the missing ingredients to a business.

Having developed an original product, getting it to market effectively - and quickly - is a challenge. It may make more sense to combine with a company with existing channels to the right customers. Avalan Technology, Inc. for example, a US-based developer and vendor of PC remote control software, had good but limited success as an independent company. The Catalyst Group helped it to sell to Computer Associates International, Inc. a company with unrivalled worldwide market access, and Avalan's product became a key element of CA's "TNG Unicenter" software suite. Avalan's founder and owner benefited from both a considerable initial acquisition payment, and further payments based upon continuing sales of his product. His business gained access to the enormous sales, marketing and technology resources of CA.

M&A can also provide cash resource to build the core business. Resolution Group Ltd decided to sell its integration services subsidiary, Resolution Systems, to generate cash to focus on its legal sector software. Catalyst introduced Resolution to the UK systems integrator First Stop Computer Group and negotiated the cash sale for Resolution.

Acquisition might also be the route to making a business big enough, or complete enough, to interest financial backers. Catalyst is working with a German software company wanting expansion capital to enter the US market, but the business is below the radar of equity investors. We're now negotiating the acquisition of a similar US company, with backing from one of the venture investors who passed on the opportunity originally, because the merger takes away a lot of the time to market risk of the business.

When it comes to the valuation of your business bear in mind that, in the technology sector at least, the high valuations of 1999 and 2000 are a thing of the past, and unlikely to return in the foreseeable future. Valuations are back to 1998 levels and may well fall still further.

That said, a share/paper based merger will value both businesses on the same set of criteria, so relative to a merger partner, valuations will be broadly unchanged.

Preparation, research and positioning will lead to a premium valuation. The aim is to have as many of the following attributes as possible: profits history and growth plans; strong recurring revenues and cash generation; outstanding skills, products and services, IPR, brand or competitive position; excellent management skills; blue chip customers; extensive geographical footprint; and when putting two businesses together, demonstrable medium term cost savings, and the ability to quantify the "halo effect" of the combination.

Overseas buyers should never be ignored. Not only may valuations differ from one country to another because of differences in local tax regimes, the state of the economy, and market or analysts' sentiment, but they may pay a premium to reduce the start-up risk and time to market in a new geography. The EDMS business unit of the UK software house Systems Team was acquired by the South African document management company Top Info Technology Holdings, providing Top Info with a platform to launch its European market entry. A premium price was paid and the purchase price was justified against the cost of a cold start, and the time it would take to generate revenues.

Identifying and negotiating with a foreign buyer is fraught with difficulties, including language, social culture, legal, tax and accounting differences. The business cultures must also match. When they do a successful merger can follow.

To prepare for a transaction, accurate and achievable forecasts are needed, and the reasons for the deal should to be clear to the whole management team. Internal due diligence should be done to make sure that the merger partner will find exactly what he expects. At least one of the board members will have to be assigned to the project, but not at the expense of losing momentum in the business. Good external advisors can and should take a lot of the load.

Raising finance is only one way of acquiring the resources necessary for business growth. Merger and acquisition is another, more effective in many circumstances, particularly when fast time to market matters.

About The Catalyst Group

Peter Kroeger is a principal of The Catalyst Group. John Scholes is a founding partner of The Catalyst Group.

The Catalyst Group provides international corporate development solutions to Information Technology and Telecommunications companies.

With operations in the UK, France, Germany & the USA, and affiliates in other countries, we advise on and implement mergers and acquisitions, divestments, financing, and strategic alliances.

Catalyst uniquely combines strategic advisory services with corporate development transaction capabilities. Our services are based on direct involvement by seasoned IT operating executives, technology expertise, extensive international business contacts, and transaction-closing experience.

Catalyst helps companies to map out a strategy and then smoothly and effectively execute the transactions needed to carry out that strategy.

Mergers and Acquisitions
December 2001 issue