Milestone Group Quarterly: July 2005
Articles
Jeff Karan on M&A Activity in the Tech Sector
OK, we’re not in Kansas anymore, but where are we? The bubble has come and gone, the world is flat, IT departments are averse to buying anything from start-ups (any firm less than seven years old), corporate America is hoarding cash while simultaneously seeking revenue growth, and private companies are keeping their noses to the grindstone and executing against plan. Is anything wrong with this picture? Personally, I think we are about to see a lot of flat noses in the Valley.
To go out on a limb, the Valley fundamentally misunderstands and under-appreciates the value of experienced marketing execs, real CFOs, and good investment bankers. Is anyone in charge of tracking the environment to truly understand the shifting sands of customers, markets, and ecosystems, and proactively allocating the right capital and resources to achieve optimal future positioning? What would an optimal, forward-facing position look like, and how would it translate into future market capitalization (or any other form of corporate valuation)?
With few exceptions, we continue to be focused on sales of current products, regardless of homilies to the contrary, and are quietly losing our capacity for creativity and imagination in everything but sales and engineering. Paradoxically, the net effect of such an unbalanced focus on current activity is to structurally undermine the company’s very ability to maximize its long-term growth and potential to create significant value.
Contrary to popular belief (or at least what is practiced in the Valley), the day-to-day work of corporate strategy is not a Board’s, or even a CEO’s primary responsibility. Often you will hear a CEO or Board member say “that’s my job.” But do they have the requisite skills, resources, and/or time to do an adequate, much less extraordinary job? Structurally, neither “office” is equipped to deal with the ongoing requirements of the challenge. A prior, well thought-out vision and/or armchair quarterbacking is probably more dangerous than helpful. Rather, systematic, ongoing thinking and processes engaged in by dedicated, senior executives who report to the CEO and Board is what’s required.
Unfortunately, when senior management gets stretched – the natural state of affairs for most high growth companies – ongoing attention to corporate strategy is typically the first thing to go, or is simply overlooked in the rush to action. If it is conducted at all, it is usually around a funding cycle and designed more for investors than senior management. Elsewhere in the country, key aspects of corporate strategy are driven by the VP Marketing (framing the debate, keeping the value proposition current and relevant, constantly moving towards long-term strategic positioning, reformulating product roadmaps to get there, etc.) and supported by the CFO or VP Finance (resource and capital allocation, strategic allocation of talent, financial planning and scenario analysis, communication, and, more importantly, listening to investors, etc.) -- precisely the roles that are least developed in the Valley (public as well as private). Marketing executives end up supporting engineering and sales, and the role of the CFO has been reduced to that of glorified controller-accountant and SOX expert. Is anybody demanding more from these individuals?
To this we must add the sorry state of investment banking. Up until the last two decades, investment bankers were trusted advisors to CEOs and Boards, and not just hired guns. Their role was to offer independent, unbiased judgment from the perspective of the financial markets, as it related to corporate strategy and the business milestones necessary to achieve key valuation objectives. Today, the role of investment bankers has been reduced to that of “power-networker,” and their primary job that of chief deal processor.
In the real world, the Boards who complain the loudest often contribute the most to this behavior. Because it is assumed (often sadly but correctly) that the investment banker will never understand the business as well as the CEO and the Board, it is therefore believed that their value add is primarily based on their relationships with likely buyers. Thus the question, “Who do you know?” becomes of paramount importance and hence, the skills of power-networker are critical to success. “Who do you know that can buy our company; who do you know that can buy our securities; how many deals have you done in our space?” But is this really the core value add of a good investment banker? Is this the best way to maximize value of a company? In its bleakest form, I once had a VC friend tell me that when they call an investment banker to sell one of their companies, they believe it is akin to calling an undertaker. Now that’s a call worth looking forward to! The benefits aren’t even as good. At least in the mortuary business you have the advantage of a truly dead client and a (mostly) certain future.
So what’s going on? Is there a common thread driving our love for near-sightedness? In my mind, like most things in organizational life, it comes back to Corporate Governance. Most Boards are quite good at focusing on last quarter’s and next quarter’s revenue, and are getting better at dealing with the regulatory and accounting requirements of Sarbanes Oxley. But can you remember a Board meeting where the majority of the time was spent addressing the Company’s core value proposition and related customer response? Or about taking a systematic approach to measuring one’s progress against non-monetary, long-term strategic objectives? Even if our current product(s) were wildly successful, would the business be valuable enough to justify the time and energy being invested? What would make the investment dramatically more valuable?
To have this type of meeting, you need not only the commitment and desire of the Board, but a management team with the requisite internal and external skills to deliver the goods. It doesn’t help, of course, if the skills internal to the company are missing. Its worse when the external ones serve primarily to reinforce what’s missing (for instance, by amplifying poor thinking instead of challenging it). But it is absolutely deadly when the Board doesn’t make it a priority in the first place. I won’t dwell on the obvious implications for the original mortuary analogy.
Is there a way out of this mess? It is said that awareness of the right problem can often bring one two-thirds of the way towards a solution. Part II of this article will suggest specific actions to address the remaining third. The goal is not to provide an “answer,” of course, but rather to point to one of the many possible alternatives.
Jeff Karan is the Managing Partner of Woodside Capital Partners, a boutique investment bank that provides merger and acquisition advice, capital raising, and financial strategy to high growth companies. Jeff's background includes twelve years of prior investment banking experience, six years each at Morgan Stanley and Goldman Sachs. Among his many equity financings, Jeff worked on the initial public offerings for LSI Logic, Stratus Computer, and Reuters plc. At both firms he was responsible for corporate development and participated in the execution of over $5 billion of debt and equity financings, and merger and acquisition transactions. Jeff holds an MBA from Dartmouth's Amos Tuck Business School (Tuck Scholar, 1980), a BA in Economics from Dartmouth College (1979), and an MA in Comparative Philosophy and Religion (1996). He serves on the Advisory Board of the Commonwealth Institute, and is a past Board member of the VC-Angel Roundtable of Silicon Valley.
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