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Recognizing
the pre-tipping point of a market space
is critical if a company wants to sell for the optimum price. Why is
this important? Because market timing is the primary driver of price
when selling a company. Whether it is a high price, medium price or low
price, the market timing has more influence than any other factor.
The market may be on a different time schedule than your company's
growth curve. If a company waits to sell until its revenues have
peaked, there may be little growth left in the company. The company has
maxed out. Buyers will realize this and will not pay top dollar. Paying
attention to the reality of the market is not only a good survival
skill, it is the primary requisite for realizing the optimum price.
The best time to sell is when the big companies decide to move into a
market. That is when they are willing to pay top dollar. Large
companies need to acquire technology, market knowledge and expertise in
a hurry. They want to acquire the technology, rather than develop their
own technology in order to make a speedy market entry. They also need
to acquire a company that has a team of people that understands the
market, the customers and the customers' challenges.
Large companies are rarely early movers into a new market. Big
companies want to go into big markets, and new markets
are almost always small markets. So, until a market has clearly
demonstrated that it will be big, the large companies sit on the
sidelines and wait until they are sure that the market will be
significant. Once these larger companies do decide to move, the
pre-tipping point is at hand. Now the clock begins to tick and the
tipping point is not far behind.
The biggest exit mistake that technology companies
make is that they decide to sell too late in the game, after the
tipping point. They want to
sell when the company has peaked. The problem is that this is usually
unrelated to market timing. This is an internal focus and an internal
focus rarely leads to the highest price. Many technology executives
ignore market timing. The highest value is achieved by looking
externally and capitalizing on the optimal market situation.
Market Stages
The life cycle of a market
consists of several
stages that are typically illustrated by a graph showing industry
revenues over time. These stages are introduction, growth, maturity and
decline. A similar graph can illustrate the best time to sell. However,
instead of the vertical axis representing total revenues, it represents
the relative selling price of acquisitions. It is critical for a
selling company to view the market stages from this viewpoint
–
from the perspective of how much a buyer is likely to pay. The stages
break out like this:
- Early Development
- Growing Nicely
- The Light Bulb Goes On
- The Slide
- Consolidation
Early Development
In the Early Development
stage a number of
smaller companies are developing technology and scrambling to get
customers. The market is new, so there are not any medium-sized
companies in that specific market. The large acquirers don't yet know
if this market will be a significant market. If a buyer is willing to
make an acquisition at all, it will be for a moderate price at best.
Medium-sized buyers are the only buyers at this stage because small
acquisitions of less than $20 million are meaningful to them. These
buyers are situated on the edge of the market or in an adjacent market,
not in the core market.
[Click
to enlarge]
Growing Nicely
Small companies are expanding from $5 million in
revenue to $20 million in revenue. At this stage an intelligent buyer
will pay a reasonably good price for technology and people who have a
familiarity with the market. However, most large buyers will not make
acquisitions at this stage. They will wait until it is proven that the
market is large before moving in.
One of the problems with the Growing Nicely stage is that most smaller
companies prefer to continue building on their own rather than be
acquired. They think the timing is premature. Most entrepreneurs are
quite independent and the idea of selling early is anathema to them.
Discrepancies can arise between the goals of the entrepreneur and the
objectives of the shareholders. The company must be clear what its
goals are – to build a business and stay independent
(sometimes
at all costs) or to build a business and sell at the optimal time.
If a company is growing nicely, it usually wants to continue down this
path. The entrepreneur and his team are doing well and having fun. They
have overcome hurdles and obstacles. They want to continue enjoying the
ride and view selling as "game over." If they were to
consider selling, it would be after just one more good quarter of
revenue, one more new product release, one more industry trade show,
etc. There is always something.
An ironic situation can occur at this point. A second-tier company may
not be growing quite as nicely as the company described above. It may
be having difficulty making headway in the market so it decides to sell
to a larger company on the periphery of the market. Now the second-tier
player has access to the financial strength and the sales and
distribution capabilities to make major inroads. Their technology may
not be the best, but with strong sales and marketing power they can be
a potent force in the market.
The Light Bulb Goes On
At the Light Bulb stage the big companies finally
get it. They recognize that the market will be substantial in size.
They make acquisitions and are willing to pay top dollar. Acquisitions
are the best way to grab a foothold in a short time period. Competitive
pressures dictate that they participate in this market, so they follow
each other into the market. They do not want to be left out. Even a
company on the edge of the market who is not a major player may make an
acquisition in order to procure software or technology that can be part
of their overall product solution.
The apex of the graph represents the point in time when the first large
company makes an acquisition to enter the core market. This is the
pre-tipping point. A second company will soon follow with another
acquisition. Companies are realizing that this will be an emerging and
vital market. Sometimes a third company joins the fray. Rarely,
however, will there be more than three big players making acquisitions
at this stage. Sometimes a major player will make several acquisitions.
The first medium-sized company to sell often obtains the best price, a
kind of “first seller advantage.”
The Slide
The Slide begins after the tipping point, after
the large players have moved in. The only reason an acquisition would
be made during the Slide phase is if a large company chose to acquire a
medium-size company in order to add mass and potentially shore up some
of its product offerings. In this phase the big companies are firming
up U.S. operations and possibly moving into a few foreign markets. The
acquisition of an overseas company is about the only good possibility
in this stage. The large companies have already made their acquisitions
and any remaining smaller players must settle for a smaller piece of
pie.
Consolidation
In the Consolidation phase buyers will make
acquisitions only to add customers. The price will not be a high one.
Buyers do not need to acquire technology or engineering teams because
they already have their own teams and technology. Even if a smaller
company has truly better software or technology, the costs of switching
are too high to make an acquisition attractive or worthwhile. A buyer
may seek to acquire a company in a new geographic location. However,
almost all acquisitions made in the Consolidation phase are motivated
by a desire to add to the customer base.
Mapping the Market
Market maps are an excellent way to visually
represent the state of the market and the movement of that market.
There are three states: the present state, the movement and the future
state. What can we learn from looking at these diagrams?
The Present
This market map depicts the present market
situation, typically consisting of a handful of small players. The
technology is not cast in concrete; no standards have been set. There
are no big companies because the market is too new and too small for
them. However, there are a few big companies in adjacent markets who
are keeping an eye on the pace of growth in the core market.
Many CEOs have a myopic viewpoint, focusing only on their core market.
Their viewpoint is black and white – a buyer is regarded as
either in their market or not in their market. However, the gray edges
of the market and the adjacent markets can be fertile areas for good
acquirers.
Market Movement
The Market Movement Map is a dynamic map
illustrating the movement of companies into the market, making
acquisitions, as well as companies moving away from the core. This is
where the market begins to morph. Some companies are moving in, some
are making acquisitions, and some are doing both. A big company in an
adjacent market is making an acquisition. A smaller firm is moving
toward the edge of the market, deciding to focus on a particular
vertical niche rather than cater to the market as a whole.
Many companies do not see this picture very clearly. The management
teams are busy running their companies and have their heads down,
focused on developing technology and selling product. Their focus is
operational, trying to “peddle faster,” rather than
thinking about the broader strategic picture.
Medium-sized companies rarely make acquisitions during this morphing
phase. The likely target companies are their competitors and they may
not particularly like them. They think their own technology is superior
so why would they acquire another company?
Market bitterness may also play a role. They may have lost sales to a
competitor or heard remarks at a trade show that the competitor was
badmouthing them. These reasons may seem petty but they inhibit a
growing company from seeking an acquisition. So, they choose to grow
only organically. The downside is that a bigger company in an adjacent
market can acquire a small player and very rapidly gain a strong market
position, sometimes eclipsing the medium-size company that was doing
fairly well in the market originally. The lesson here is –
when
the market begins to morph, when the big players begin to move, a
medium-sized firm needs to take action and make an acquisition in order
to grab a bigger piece of the market. A smaller company should seek to
acquire or to be acquired or it will be left to languish.
The Future
The Future Market Map looks almost exactly the
same for most market sectors. There will be one or two market leaders
and one third-place company. If a fourth or a fifth company exists, it
will be small and will not be particularly profitable.
There are a few other observations to make from the market maps. Notice
that Company A does not make an acquisition. It grows from $15 million
to $20 million, which is respectable, but now it is a third-place
player. Company H and Company B have grown through acquisition and have
eclipsed Company A. Notice that this market has tripled in size from
$60 million to $180 million in total revenues and is still growing.
What started out as an insignificant market is now a very respectable
market.
Recognizing the Pre-Tipping Point
The first major sign that the pre-tipping point
has been reached is when one of the large companies makes an
acquisition in the core market space. Large is a relative term
–
it could be a $1 billion revenue company or it could be a $200 million
revenue company. It depends on the market, the size of the market and
the relative size of the companies in that market.
When a second large company makes an acquisition in the space, it is
time to get moving. The tipping point is near at hand. The time period
between the first acquisition and the second acquisition could be
short, within six months, or maybe a little longer, up to 18 months.
But rarely is the second acquisition any farther down the road than
that.
A good example of the pre-tipping point is the online advertising
industry. Google recently bought Double-Click for $3.2 billion. A month
later Microsoft acquired aQuantive inc. (which owns Avenue A and
Razorfish) for $6 billion. This deal was disclosed less than 24 hours
after WPP Group's $649 million acquisition of 24/7 Real Media. In the
time span of less than two months the three major players have made
three acquisitions. The tipping point is at hand.
Another clue is when a large company develops technology internally in
order to enter a new market space. If this is the case, articles and
news releases will report about the company's move into the market
sector. For example, Microsoft developed its own software for its music
player, Zune.
A large company may contact you out of the blue about acquiring your
company. Do not dismiss the idea too readily. It may be the right
market time. If a big company has acquired, or is acquiring, one of
your competitors, it may be wise to be proactive and explore a sale to
another large competitor.
Summary
If a company wants to sell for the optimum price,
the best thing it can do is pay attention to the stage of the market.
This goes against the instincts of many tech people who are overly
focused on their own technology. The stage of the market is the primary
driver for realizing the optimum price for the sale of a company.
###
This
article is a chapter of Mr. Metz’s book entitled "Selling the Intangible Company" published
by John Wiley & Sons in 2008.
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