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  • Mark Addison | From a $30M Exit Offer to $100M
    POSTED 10.20.20 M&A Masters Podcast

    What motivates Mark Addison, CEO of X Rocket.io? He’s seen too many entrepreneurs, especially first-timers leave money on the table when they exit.

    His firm helps optimize key valuation drivers during M&A negotiations to maximize the money owners and founders take home.

    In one case, he and his team were able to reengineer a $30 million offer… into a $100 million offer. We talk about the three things they did to make it happen and the audits they perform on clients, as well as…

    • The key metrics that predict higher valuations
    • Acquisition trends with PE firms you should be watching
    • Two insurance products you should have in place for any deal
    • The biggest misconception many founders hang on to
    • And more

    Listen now…

    Mentioned in this episode:

     

    Transcript

    Patrick Stroth: Hello there. I’m Patrick Stroth. Welcome to M&A Masters where I speak with the leading experts in mergers and acquisitions. And we’re all about one thing here, that’s a clean exit for owners, founders and their investors. Today I’m joined by Mark Addison, CEO of xrocket.io. X Rocket provides valuation engineering for M&A exits.

    They optimize the key valuation drivers used in M&A negotiations to prepare companies for larger exits. Now, while personally, my focus is providing a clean exit for owners and founders, Mark’s goal is to get larger exits, which makes even more people happy. So I’m pleased to have Mark join me today. Mark, welcome to the podcast.

    Mark Addison: Thank you, Patrick. Enjoy being here.

    Patrick:  Now before we get into X Rocket and value optimization and all that fun stuff, and again, this is targeted toward technology companies, both hardware, software, etc. Let’s set the table and tell us what got you to this point in your career.

    Mark: Well, depending on how far back you want to go, a couple decades ago, I started as a data quad for SRI, that’s out of Stanford. And I was doing multivariate statistical analyses. It was sort of a precursor to what we call data science today. And I got swept up in the technology. And so I had an early career win where I help the online chat community go to IPO. I’ve co-founded three companies.

    One, a wine importer and direct consumer retailer. Two, a tech marketing company, which is the core of my business. And then three, the M&A business, which we’re talking about today. You know, I’ve been motivated, because I’ve seen firsthand entrepreneurs pouring their sweat and equity and tears and passions and lives into building companies. And then I’ve also seen entrepreneurs exit those companies and sometimes leave a lot of money on the table.

    You know, helping people understand the difference between financial valuation, which is a multiple of EBITDA versus strategic valuation is, which is really where you get the extra value. You know, we recently helped a CEO reengineer a company, they had a $30 million exit offer. And we reengineered that into more than 100 million dollar exit offer. So that was really where we got, where I got to today, where we decided to double down and offer this kind of hands-on consulting to help companies and investors increase valuation. That’s where we are.

    Patrick: Every company in Silicon Valley is for sale. And if you’re in technology, you’re not limited to Silicon Valley. You’re around the world and you’re ideally, looking for an exit. So owners and founders have an eye on an eventual exit, that’s in addition to what they’re already doing. Let’s talk about the difference from what owners and founders expect in reality. Why should they engage specialists to best position them for a larger exit?

    You Want to Be the Worst-Kept Secret

    Mark: And I think early-stage investors will probably tell founders, hey, don’t worry about the exit, just focus on building the company. If you build it, it will come. And, you know, that’s certainly the ethos among a lot of more engineering-led companies, just build the technology and the rest will happen. I think as companies mature, they start to realize that there is more to it.

    And, you know, I think companies, most Silicon Valley companies go through some stages and so there’s usually a founder, CEO, who’s usually an engineer and he’s very product-driven and they’re just trying to find, you know, market fit and engineer the product. And then oftentimes, sometimes it’s the same CEO, but oftentimes, there’s a new CEO who’s going to be in charge of the growth and the scaling. And then as they get even more mature, and getting starting to approach exit, sometimes you’ll see a third tier of CEO come in.

    I call him the Exit CEO and that’s the CEO who’s got a big Rolodex of contacts and that’s the CEO who understands strategic valuation and that’s the CEO who starts to really look at the operations and ready the company for exit. I think this sort of this dichotomy that you are asking about, you know, what’s the founder’s expectations versus the reality. When you start a company, you know, at the seed round, you think you’re just gonna build a cool technology and the world is going to beat its way to your door.

    And, you know, seven to 10 years later when you’re on your C and D round, it’s just a different animal and you start to realize that wow, you know, I have to now be a sector leader and a thought leader. And it’s in, this sector that I started this technology in seven years ago, I invented the technology. but now it’s a noisy, crowded market sector because, you know, I proved that there was money to be made there, right?

    Think about AI, right? Think about early startups there. Now it’s a very noisy market. So now, the reality is, you have to distinguish yourself from all the other competition out there and you have to rise above that noise and you have to establish yourself as a sector leader so that you get the acquisition offer so that you don’t become, you know, the best-kept secret. You don’t want to be the best-kept secret. You want to be the worst-kept secret.

    Patrick: You mentioned when we talked before about there are some key valuation drivers or things that specifically can be done to drive value up. Let’s touch on a couple of those.

    Mark: Yeah, so one of the things that we did when we set up this M&A business, X Rocket, is we interviewed a whole bunch of M&A bankers and brokers and we asked them, What are the key metrics that predict best towards higher valuations? And what we were hoping to do was create this, literally an algorithm that we could just, you know, hammer down into a science, and, it’s unfortunately, not quite, it’s still a little more of an art than it is a science.

    But there are certain metrics, we call them levers that buyers pay attention to, and they’re things like, you know, operational levers and sales levers and marketing levers and customer levers. And we built a proprietary audit around those. So we walk companies through that valuation audit to highlight where the potential weak spots are and where the opportunities are to increase the valuation.

    Patrick: Well, you mentioned before, when you’re talking about one of your success stories there where you took a company that had an exit at 30 million, and you tripled that with the CEO with what you guys did. Let’s talk about that in little bit more detail. And, you know, give us a couple case studies on where X Rocket came in and literally changed the game for the client.

    Finding the Valuation

    Mark: I can give you one case study in healthcare because it’s like textbook, right? So small company, they built onboarding software for physical therapists. The company was 25 years old, founded by three doctors. They were ready to move on and sell. They actually originally came to us for marketing help and put that on hold because they got an acquisition offer. The acquisition offer failed in due diligence, right? Per the conversation that we had earlier and I’ll explain some of the reasons why.

    They came back to us and said, Hey, we get it now, right? We get it that there’s stuff you need to do to attract an offer and survive the due diligence and then attract a good offer. So we set and we looked at the business and this is where it’s easier for us as outside consultants to kind of see the business. They were trying to figure out how they were going to improve the valuation of their onboarding software which ran on a tablet and was sold to physical therapists.

    And that was all fine and dandy. But we discovered, like, literally in the first week, that they had this database with some 22 million healthcare records. In the healthcare world, it’s called morbidities and modalities and outcomes, right? And so morbidities is what’s wrong with the patient. Why’d they come in to visit the doctor? Modalities is what did the doctor do to make them better? Then outcomes is, you know, what metrics did you measure to say that the patient got better?

    And how many sessions did it take and things like that. And what we discovered was insurance companies were starting to come to this company asking to look at that data because they could better underwrite insurance deals. They could better figure out that, oh, you know, if the patient is a 24-year-old athlete, and they’ve got a torn Achilles, it’s this many sessions to get them better. If it’s an 80-year-old sedentary adult, with a torn Achilles, it’s a whole different, you know, sort of therapy, right? And a whole different cost structure to that.

    So the lightbulb went off in our head that, Hey, you guys aren’t a piece of onboarding software for physical therapists, you’re a data analytics company. right? That’s the nugget. That’s the valuation. That’s the big pot, right? And so then we started to do all the things to position the company as a data analytics company. Like we completely wipe the website, right? Because the website was selling to physical therapists. And so we just wiped it clean and stuffed it full of keywords around healthcare and data analytics and predictive data carrier analytics and things like that.

    The sales pipeline, we need to keep that going. So we hired an on-demand sales team to just do a bunch of digital sales and stuff that sales pipelines for that look good. We went through all of the valuation metrics, the valuation levers, and sort of one by one said, How do we optimize this, right? And so our house was tidy and clean, squeaky clean, right? And they were going to survive due diligence this time, because, you know, they knew, they learned. But then the big nugget that unlocked the value was how you position the company. What’s the real valuation of the company?

    So that’s one example. And so within nine months, Carlyle Group came knocking on the door and they were looking to do a roll up and they needed a healthcare data analytics piece and this company fit the bill perfectly. And there we go. So it was a textbook example of going from a failed acquisition and failed due diligence and probably, lower than anticipated valuation to more a successful offer that kind of just, you know, game-changing, repositioning.

    But more often than not, there is a strategic nugget that’s sitting right underneath the founders’ noses. They just don’t recognize it for the value that it is because they’re running the company, they’re fighting the fires, the daily fires. And it’s so much easier for us as outside consultants to kind of hover it 30,000 feet and look in on the business and go, Okay, I see it. It’s plain as day. It’s right here.

    So the second example, it was an ecommerce company, the one that we took from 30 million to over 100 million. That was pretty interesting because it was a founder-led company where the founder actually had been pushed aside by the investors who had brought in a new CEO with a specific mission of getting the company sold. That CEO did bring in a bid. The board rejected the bid as being far too low. The board rejected both the bid and that CEO.

    Founder CEO comes back into the hot seat and now, how do we get the company sold? How do we increase the valuation? So I think we did three things really, really well. One, in the absence of any branding and marketing under that other CEO, things that really languished a bit and the competitor’s sales guys were taking advantage of it. So they were putting FUD in the marketplace that, hey, things aren’t going so so well.

    And do you really want to hitch your ride on to the ecommerce company? So that was either outright killing deals or slowing them. So that’s one where we had to go in and tell the market that no, we’re here to stay and we’re here for real. Two, was on the positioning. In the ecommerce space, there’s open-source software available that’s free and then there’s some very large competitors that focus on the mega-market. And this company is focused on the mid-market but really wasn’t comfortable there.

    The sales guys were trying to go after deals both higher and lower. And we decided no, we’re gonna own the med market there. It’s a very respectable market sector to own. We double down on that, we really built the reputation around we serve mid-market retailers. And that served us really well. And then the third was around this CEO, he’s very charismatic. He was an underutilized asset. To the first point about rebuilding the brand reputation, what we did was we trotted the CEO out and we got him a lot of visibility.

    And we made him a spokesperson for that sector, for the ecommerce sector. He was a natural for it and he had really good content to share. And we got him, you know, guest columns in media and speaking opportunities and things like that. And we really built him up so he was a thought leader and so that the company by association, became a leader in the sector and therefore attractive to M&A buyers.

    Patrick: See now I’ll show off my age, but what you do with the CEO is you almost, you turn them into Lee Iacocca from Chrysler, where people weren’t buying Chryslers, they were buying Lee Iacocca. And that, you know, that’s one of those value propositions that you can bring in where you’re not necessarily changing the culture and making people within a company forget everything they did. You’re just enhancing them and opening them up to new opportunities.

    Mark: Yeah, I mean, our case, our CEO was a little more charismatic. But yeah, people sometimes will buy into that, you know, that credibility and that story,

    Patrick: Well, now the reason why I wanted to talk to you is not only because of what X Rocket can do for owners and founders of companies but also you’ve got a whole swath of mid-market private equity firms that have been buying these companies. They’ve been cleaning them up. They’ve been doing what they can.

    But their challenge now is they need to find a bigger buyer. And now it’s not just EBITDA that you can bring to the table, you can bring some other things that can really enhance the value because that’s the purpose of private equity, you know, find bigger buyers. And the market for bigger buyers is actually expanding because, you know, the traditional issue was while you would try to take your company IPO.

    If you don’t do the IPO, then find a bigger private equity company or find a strategic. And there’s a whole new class of strategic acquirers out there’s facts, and they have nine and 10 figures to spend. So there’s definitely a market for mid-market, lower middle-market private equity firms to stage up their babies to get them for bigger exits. So let’s talk about what you could do for those types of candidates.

    Bigger Exits for Mid Market and Lower Mid Market

    Mark: Yeah, well, as you said, the PE model is buy low, sell high, right? And do something in between to make the price justify the higher price. So I think among the mid-market, PE’s, what’s interesting is they’re buying inherently smaller companies to begin with. So those smaller companies, they don’t have 5000 employees and a bunch of fat, right?

    And so the classic PE model of buying three companies, consolidating operations, getting rid of all the HR directors and all the redundant positions to cut costs and add value, that’s just not quite as effective. I think at the mid-market, we have to find ways to actually add value, not just subtract costs. And that’s really where the X Rocket methodology comes in. We look at how to add value and create value beyond just the EBITDA and find strategic value that the M&A buyer is going to recognize as strategic value.

    Patrick: Specifically, what some of the things you can do? You were talking about creating thought leadership and so forth. Let’s talk about either scalability marketing, what are some of those levers that you could bring in because the private equities, they are outside of the portfolio, but they’re not that far outside, and a lot of them are probably embedded with their portfolio company so they don’t have that outside view. So let’s talk about that.

    Mark: Yeah. Well, so part of it is being able to scale this. So I know that there are some PE firms that will put in house staff into the portfolio companies to help with certain key aspects. But that’s not a particularly scalable model because you can only put your in house people into so many companies. So one is just scalability, we can come in from the outside. Two is that perspective that you just talked about. Coming in, understanding the market dynamics and seeing the business, you know, sort of, for what it is and figuring out where the strategic valuation is the other one. And then the rest is basically just implementing, right?

    So pulling the levers. So you can have a wonderful idea for, you know, improving the strategic valuation, but then you got to go get it done. And so for example, the case study that we mentioned in the healthcare company, that was textbook, but it wasn’t just going, Oh, yeah, it’s just the database, stupid. Just do that, right?

    And we had to do all the other things to make sure that that was, in fact, the nugget that the company was identified as and that the company could be discovered around and pumping up the sales pipeline and redoing the website so that it was a discoverable company. And in that case, we also did trot out the co-founders because we found out that they were scientists and they were co-authors of some 100 or so of these peer-reviewed medical journal articles. I mean, the real deal, right? Not just a contributor article to Forbes but, you know, a peer-reviewed medical journal article.

    And they were co-authors. And nobody knew that, right? So we wanted to shine the spotlight that, hey, this company, and therefore the data in this database, is real science from real doctors, and therefore really meaningful information. So a lot of it is, you know,  not just having the idea, not just educating the portfolio companies on what strategic valuation is and then having the perspective to find where the strategic valuation is, but then also turning that into real valuation that an outside buyer can recognize.

    Patrick: Now I’ve failed to mention also, and I apologize for this, but also you just released an article connected to our podcast notes here, but there’s another source of strategic buyers out there. Unicorns. Let’s talk about the growth real quick just in terms of pure number. Our audience here already knows that a unicorn is a privately held company with a valuation of a billion dollars or greater. Mark, you just took a headcount on them. Where are we standing now with that?

    Mark: We are standing at 603 unicorns, which means they are not nearly as special as they used to be, right? You can find a unicorn in any forest now. Not just the magic forests.

    Patrick: There’s another bigger buyer for you out there. Mark, let’s talk about, give us a quick profile, who’s your ideal client?

    X Rocket’s Ideal Client Profile

    Mark: So the ideal client for us, as you might gather is a company that’s maybe one to two years away from considering M&A. And this is important because a lot of companies wait a little too long. And this is what was borne out when we did all those interviews with the M&A brokers and the M&A investors, bankers. They love our model, obviously, because higher valuation means, you know, bigger exits for them. But they also see the frustration.

    By the time you’re talking to that M&A broker, they are preparing the two-sheet, you know, the two-page executive overview and they’re shopping your company to potential buyers, right? And a lot of these valuation increases, it’s too late, right? It’s too late to implement these things. It’s too late to clean up your books if your due diligence isn’t all neat and tidy. It’s too late to rebrand the company, right? It’s too late to make your CEO a thought leader and a sector leader.

    You can’t just do that in, you know, a week, right? So our ideal buyer is one to two years away from thinking about bringing in the M&A broker because that way we can work on all of these, the valuation levers that we uncover in our valuation audit. The other ideal client working revenue model, science experiments, as we call them, are very hard to place. They tend to be one-off, right? A certain strategic buyer needs that specific technology, but there’s usually one buyer for that particular technology.

    And what we’re trying to do is create competition among potential buyers for companies. So a working revenue model and not a science-driven. And then an under-marketed company, right? Per the discussion that we had a lot of times or earlier, a lot of times startups these days are engineering lead companies where they really focus on the product and the product-market fit. And, you know, or on scaling the growth and they really haven’t put a lot of attention to the brand.

    And so those under-marketed companies have a huge potential to increase valuation. And what we try to educate founders on is that, you know, if you’re selling your company for some multiple over EBITDA, you can negotiate that multiple, but it’s going to be within a certain range that is borne out by competitors. So buyers go out there, and whether it’s the ecommerce sector or the healthcare sector or whatever, there is a range of multiples over EBITDA that buyers typically buy at.

    And you can be on the low end of that range of the high end of the range, but it’s a pretty narrow range for negotiation. You’re leaving money on the table if you’re not getting strategic valuation layered on top of your financial evaluation. If you’re looking at selling your company, if you’re looking at increasing your revenue because you think you’re going to get seven times EBITDA as your multiple on sale and you’re going to be focused on that, that is good.

    But if that’s all you’re going to get the company sold far, you’re leaving money on the table. You need to get strategic valuation and that is by being a sector leader. That is by having competition among buyers. They want you and only you. There’s a great quote I have, we work with a lot of security companies and there’s a sales guy, I’ll never forget. He goes, Mark, nobody wants to buy the second-best security technology. There’s no market for that. There’s only a market for the most best.

    Patrick: Excellent, excellent. Well now you’re with the M&A and I’m not sure if you’ve had direct experience with us but have, tell me about any experience you or your clients have had with the M&A transaction insurance rep and warranty, or views with insurance at all.

    Directors and Officers Insurance 

    Mark: Yeah, rep and warranty, especially what you do, Patrick is I think underutilized. I don’t have any direct experience with it because I think it’s underutilized. My experience is with D&O insurance, directors and officers insurance, and that, I’m just in general, a big believer in have good insurance because I think it’s a sign of just a well-run company. But especially to D&O insurance, when you’re trying to recruit board members, you have to have D&O insurance in place because, you know, board members, they tend to be wealthy investors, which means they have assets that they need to protect.

    And they might really love your company and might really want to come onto the board and really want to help you out but it’s just not worth the risk to them if you haven’t bought a D&O insurance policy to protect their assets because now they’re basically signing their assets to your company. And if, and, you know, people who go to court usually look for the deep pockets. And if your potential director is one of those deep pockets, you better have insurance to protect them.

    Patrick: Yeah, I think it’s important to know that a lot of times the facilities that are providing insurance for these companies, they have commercial insurance and the benefits insurance and so forth. They overlook D&O or they don’t have the capacity or the bandwidth to provide D&O. They go elsewhere for that. I think it’s very, very important.

    It gets overlooked that, you know, not only if you want to attract good board members, but if you’re a seller and you’ve got a tight group of shareholders, you’ll still need a D&O policy because your buyer is going to require you to have it because the buyer doesn’t want past lawsuits against the former owners to be brought when they take over the company.

    Mark: Yep, yep. They don’t want a skeleton in the closet to come out and cost them a whole lot of money.

    Patrick: Oh, yeah. Then we were involved in a deal once and I can tell you where we had the widow of a founder that passed away and, you know, we processed the deal, they opted not to get insurance. But within about a week after the deal closed the news about the deal was in the LA Times and how the widow was due to get her half of the money, which is about $60 million. Out of the woodwork, wife number one showed up and widow number one, you know, we were looking around. We had never heard of this. So it does happen.

    Mark: Yeah. And the rep and warranty, from how I understand how you’ve described it to me, I mean, that’s a no brainer because that means that the seller will be able to take more money out of escrow rather than leaving it in escrow to effectively be a bond against, you know, unforeseen stuff that could come up later on.

    Patrick: Exactly. Within the purchase and sale agreement, the seller puts down a number of disclosures about the company, the financials and everything, the buyer performs due diligence on those to ensure they’re accurate and within the agreement, it’s, there’s an indemnification clause that says essentially, if the buyer suffers a financial loss as a result of those seller’s reps being inaccurate, the buyer contractually can claw back a certain amount of funds or all the proceeds from the seller.

    So the seller has the sort of Damocles hanging over them because there could be something out there unknown to the seller, the seller has no control over after closing, and saying the buyer will hold them accountable.

    Well, rep and warranty is an insurance policy that literally steps in between the buyer and the seller, steps in the seller’s shoes and says to the buyer, if you suffer financial loss, we the insurance company will pay you your loss. Show us the loss, we will pay you. And if you’ve got an insurance company stepping in, there’s little or no need for the buyer to withhold funds in an escrow. So seller not only gets more cash at closing because it’s not held up in escrow but they don’t have this huge indemnity obligation that’s going to be stalking them for years after closing.

    And so they get quality of life, free of fear and everything. And the buyer, they’re assured that if something does happen, they can collect. And the beautiful thing is, I will tell you as an insurance person, price is a non-issue with rep and warranty. I know people might not think that. But here’s the thing, if you’re the buyer and the policyholder is the buyer of the company, okay? The seller will gladly eagerly pay the premium so the buyer is protected. Because if the buyer is protected, there’s no escrow. So buyer, you’re getting this great protection and somebody else is paying the bill. I mean inside it.

    Mark: Well, I mentioned earlier that more companies than you think fail due diligence and it’s not because there was something inherently wrong with the company, it’s because the buyer got skittish. And when you’re in due diligence, you’ve got lawyers, right? And the lawyers don’t get all passionate and excited about technology. They’re paid to find, you know, they’re paid to figure out well, could there be a widow number two that could materialize on the seeing? What happens if so and so dies?

    They come up with all kinds, that’s what they’re paid to do. And so buyers tend to be really skittish, and I can imagine that when the policy is in place, they can just relax, those lawyers can sign off and the deal can get done. And, you know, as you know, from deals, time is your enemy, right? So the faster you can close the better off you are because the longer that deal lingers, the more opportunity there is for something to go sideways.

    Patrick: Mark, how can our listeners find you?

    Mark: Two ways. Our website is xrocket.io. And my email address is m.addison with two D’s @xrocket.io.

    Patrick: Well is outstanding. And Mark, really appreciate this because that’s what we’re trying to do is find ways to add value that’s just not on the books. And here’s the nice thing, if you engage an organization like X Rocket, okay, not every firm out there is doing this. So you’re going to have a competitive advantage by engaging Mark. And I’ll tell you, it doesn’t hurt just having a conversation. So Mark, thank you very much for joining us today.

    Mark: Patrick, thank you so much for having me here. I enjoyed this conversation. Always good to talk to you.

  • Mihir Jobalia | Why M&A Is Today’s Clear Exit Strategy
    POSTED 8.29.18 M&A Masters Podcast

    Today, we discuss the details behind the best practices to exiting with M&A.

    Read More >