How a Market Maker Sees Software Firms/Entrepreneurs

The other day, my esteemed colleague and ex-Gartnerite, Tom Ryan and I roamed the exposition hall at ProMat. This is the show to be at if your firm needs to move, store, pick, pull, etc. goods. Every possible kind of pallet, fork truck, conveyor, etc. was on display there. It had to be a good show as my feet hurt for two days.

In our travels around the software corner of the expo hall, we ran into one of Tom's old friends John Sidell. John's a principal with New Course. They look for supply chain vendors who need to (or want to) move to a new level of business success.

I can really relate to their business as I advise, counsel, etc. dozens of software entrepreneurs annually and also consult with large groups of channel partners for software partners. All of them usually want to aggressively grow their businesses. Problem is: some of them aren't ready, some lack the right team, some have the wrong products, etc.  John's firm, from what I understand, helps get the high potential ones back on track.

I fired off a few quick questions to John re: the nature of the business. Here is our dialogue:

1) (Brian) Not every software company is going to be a success. How do you guys pick the winners? What are the critical attributes you look for?

(John) Having been in the supply chain software business since the late 80's, I've had an opportunity to be part of, partner with and compete against many, many software companies.  The common theme all of the big winners shared was an A+ go to market strategy.  Often times start-up software companies lack the proper funding to truly launch the product and capitalize on the market potential.  The long and short of it....the winners can have an average software product but must have deep pockets to fund the go to market strategy and successfully launch the product.  Other critical attributes for a successful software company beyond sufficient capital include strong executive leadership, vision, proper understanding of the channel partnerships opportunities and finally a crisp and well orchestrated go to market strategy to sustain the growth after the initial product launch.

2) I know a couple of serial software entrepreneurs. They seem wired differently from other software company founders. What differences do you see between serial entrepreneurs and other software entrepreneurs?

I would most definitely agree that there is a difference between the traditional software entrepreneur and the serial entrepreneurs.  Often times the traditional entrepreneur end up starting a software company from a need to design / build something that is more robust functionally or better technology than the what's currently available on the market.  Little thought is given to the "end game" or the exit strategy.  The majority of emphasis is on building the product and related service offering in order to build up a clientele and generate profit or in a tight market - break even to keep the company's head above water.

The serial entrepreneur is typically focused on the exit strategy and would have started the company with that end in mind.    Generally speaking, the serial entrepreneur hires the top talent and rallies the organization around top line growth, market penetration and brand recognition while building an organization that is scalable to support rapid growth.  All of these items are key foundational components necessary to drive up the firm market valuation.  Most serial entrepreneurs are positioning the sale of the current company because they already have their sights set on another venture...that's why they are called serial entrepreneurs.  Meanwhile, the traditional entrepreneur is still pushing the current company to be more profitable rather than growth of just revenue.

Both of these types of entrepreneurs are risk takers and each generally have an abundance of passion and energy.

3) What advice would you give for a company whose software vendor has recently got an infusion of new investors or has been bought by a consolidator? Should they be worried?

The one constant in the software industry is change; change in what is considered the "latest" technology and change in the direction and ownership of the companies seems to be a daily occurrence.  For many of the "best of breed" supply chain software vendors, consolidation is part of the growth curve and a rite of passage.   For most software companies it is part of their end game or exit strategy.  They want to grow revenue to the point that they will be attractive to a potential acquiring firm.  The acquiring firm is looking for a software vendor / competitor that is rock solid in a specific vertical or fill a niche they've been missing.  Sometimes the acquiring firm is looking for a software firm acquisition that can launch them into a new market or product offering.

For companies that are evaluating software vendors it's very important to have realistic expectations regarding the potential for acquisitions of their selected vendor.  A couple of key criteria to focus the evaluation on are items such as 1) Does the vendor have mainstream, socially acceptable technology? Or is the platform build on proprietary database and proprietary development tools that will make it difficult in the future to find support resources.  2) Is the software vendor experienced in your vertical market?  Or are they trying to buy their way into your market to enhance their valuation for a pending sale?  If this is the case, the price up front may be attractive, but long term, if the company is sold, the new company may not be interested in supporting the fringe clients and the application won't grow with your business.

For end user companies who have invested with application software vendors that have recently been sold, it is always prudent to open the lines of communication with the management team of the new company.  By doing this you'll have an opportunity to express the importance of the software and support relationship you have and also give you an opening to get some long running issues addressed.  In this scenario the "squeaky wheel" generally does get the oil.  The end user companies that sit idle and don't proactively make an effort to get in touch with the management of the acquiring company often times are forced to deal with undesirable changes because they weren't proactive.

4) What do you tell a software company CEO that is supporting too many versions of the product?

The standard advice is to put together a plan to migrate each of the customers to the latest version and assign an internal team to drive the execution of it. The key components of the plan need to be a future date in which standard support will no longer offered, an offer by the software company to provide resources (internal or external) to assist in the preparation and execution of the version upgrade and an list of tangible reasons why the upgrade is a "good thing" for the customer accompanied by an open line of communications to address questions.  This process can be complicated for software vendors that have accumulated similar functioning software applications (rolled up WMS vendors) and are converting all customers onto a single platform.  For the customers, this isn't an upgrade, it's a re-implementation of software that may be owned by the same company, but it's a completely different application.  To effectively make this happen, the software vendor really needs to be patient yet firm with clients and provide as much support (in terms of resources for planning to project) as necessary to accomplish the project.

5) What do you tell a software company CEO whose firm is chasing services more than new software license sales?

For some software companies, revenue and profitability are more important than market valuation.  So why is this an important distinction?  Software vendors get much higher market valuation multipliers than professional service providers.  In some cases 10+ times the market valuation on the same revenue run rate!  This means the sale price of a software vendor with $50M in revenue could get as much as a $500M or more versus a professional service provider with $50M revenue per year getting $60M to $80M as a sale price.

Software companies that are driven by the importance of market valuation need to maintain a proper ratio between license fee revenue and service revenue - meaning a $1 in license fee revenue and $1 or $1.5 in service revenue is an acceptable ratio in order to still be considered as a software vendor and thus have a market valuation of a software vendor.   For professional service providers it is fair to say that any revenue is a good revenue.

Given the economic conditions of the last few years, I can understand why some software companies would compromise the license fee to service dollar ratio in order to keep revenue flowing in the door.  The rationale is that keeping the doors open and showing either slow growth or no growth during tough times is still better than declining revenue with the proper ratio of license to service ratio.