Trade Sale Exit Strategies – The Contribution of Prior Relationships

Principal Topic
Methodology
Results and Implications
Contact
Abstract
Introduction
Conclusion
References
Principal Topic

As part of the development of the Exit Ready Index by McKaskill, Weaver and Dickson (ICSB Conference 2003), identified informal and formal trading relationships as an attribute in the measurement of the quality of the trade sale exit strategy.

There is a small body of literature that indicates that some prior relationships may lead to acquisitions. Bleeke et al. (1995) state that ‘an alliance can be a good acquisition or divestiture vehicle if its evolution is planned’. Buckland et al., (2003, p30) noted that one of their four primary methods for achieving growth and renewal was corporate venture capital. They defined this method as ‘minority investments in a portfolio of relatively small companies for both financial and strategic gain, sometimes leading to acquisitions’. However this relationship has not been examined from the seller’s viewpoint. Specifically there is no research on whether the proactive development of a relationship by the seller with targeted prospective acquirers can assist in the creation of a trade sale event.

Methodology

Where there is not a comprehensive body of literature that sets out a useful framework for further research, some exploratory work into the field using case studies or other investigative approaches can help to uncover tentative relationships which can be later explored further using more structured research methodologies. In this paper the author uses a qualitative research approach called autoenthnography.

Autoethnography is a qualitative research method which includes within its scope both personal narrative as well as reflective enthnography. This method of investigation allows the researcher to write from their own experience. (Ellis, 2000, p741)

This method was chosen in order to bring forward personal experiences of the author in the area of exit strategies. This paper reviews the specific contribution of prior informal and formal relationships to the trade sale event based on a review of a network of related firms in the applications software sector over a period of 25 years.
Results and Implications

The study shows how informal relationships provided the starting point for many of the subsequent formal relationships. Many of these resulted in acquisitions. Sixteen acquisitions can be traced back to the involvement of several key individuals. The examination of historical events provides some support for the hypothesis that a proactive trade sale strategy can use these relationships to develop a platform for a subsequent trade sale.

Contact: Dr. Tom McKaskill, Australian Graduate School of Entrepreneurship, PO Box 218, Hawthorn, Vic 3122, Australia. Tel: +61 3 9214 8422 Fax: +61 3 9214 8381, tom@tommckaskill.com

Paper Type: Research Paper

Academic Stream: Entrepreneurship

TRADE SALE EXIT STRATEGIES – THE CONTRIBUTION OF PRIOR RELATIONSHIPS

T. McKaskill
Australian Graduate School of Entrepreneurship
Swinburne University of Technology
Cnr. Wakfield and William Streets,
Hawthorn, Melbourne, Victoria
Australia 3122

Ph: +61 (3) 9214 8422
FAX: +61 (3) 9214 8381

e-mail: tom@tommckaskill.com

ABSTRACT

TRADE SALE EXIT STRATEGIES – THE CONTRIBUTION OF PRIOR RELATIONSHIPS

As part of the development of the Exit Ready Index by McKaskill, Weaver and Dickson (ICSB Conference 2003), the authors identified informal and formal trading relationships as an attribute in the measurement of the quality of the trade sale exit strategy.

This paper reviews the specific contribution of prior informal and formal relationships to the trade sale event based on a review of a network of related firms in the applications software sector over a period of 25 years.

The study shows how informal relationships provided the starting point for many of the subsequent formal relationships. Many of these resulted in acquisitions. Sixteen acquisitions can be traced back to the involvement of several key individuals. The paper postulates that a proactive trade sale strategy can use these relationships to develop a platform for a subsequent trade sale.

Keywords: Harvesting, Exit Strategies, Trade Sales

Trade Sale Exit Startegies – The contribution of Prior Relationships

This paper examines relationships between firms that ultimately lead to acquisitions from the viewpoint of the acquired firm. There has been very little research in the area of trade sale exit strategies (McKaskill et al., 2003). In that paper, the research question posed by the authors was; What factors contribute to the seller achieving a premium on sale of their business? In that paper, the authors presented a tool for measuring the quality of an exit strategy; the Exit Ready Index. The Index was composed of a number of attributes of an Exit Strategy that had been validated with a number of venture capital firms. As part of the development of the Exit Ready Index, the authors identified informal and formal trading relationships as an attribute. This paper reviews the specific contribution of prior informal and formal relationships to the trade sale event.

Acquisitions stemming from strategic alliances are relatively common. Bleeke et al. state that ‘an alliance can be a good acquisition or divestiture vehicle if its evolution is planned’. They looked at acquisitions from the acquirer viewpoint stating that ‘an alliance may be used as a low-risk, low-cost option on a future acquisition’. At the same time, they acknowledged that ‘potential sellers should seek partners that would be the best buyers later on’. However, they warn firms looking to sell that entering into a strategic alliance may not ‘capture the full value of their business for their shareholders’ as the alliance may deter other potential buyers thus frustrating the ability of the selling firm to ‘orchestrate a bidding process to drive up the acquisition price’. They also show that this risk may be offset by building into the alliance agreement ‘explicit exit provisions that ensure a fair value in the event of a sale’. (1995)

Minority equity investments can also lead to an acquisition by the minority shareholder. This is often the motivation behind corporate venturing. Buckland et al., noted that one of their four primary methods for achieving growth and renewal was corporate venture capital. They defined this method as ‘minority investments in a portfolio of relatively small companies for both financial and strategic gain, sometimes leading to acquisitions’ (2003, P30).

A good example of a corporate venturing model is found at UPS. They state that, with their Strategic Enterprise Fund, UPS invests where “strategic investing allows UPS to collaborate with and learn from companies actively developing new businesses, market-spaces and technologies’ and “evaluating emerging industries from the inside allows us to observe new, leading edge business models and provides informal market research.” (UPS, 2004). While alliances and minority investments are formal commercial or trading relationships, this research project also set out to identify whether informal relationships were present prior to an acquisition.

THE RESEARCH APPROACH

“Thus, to a greater or lesser extent, researchers incorporate their own personal experiences and standpoints in their research by starting with a story about themselves, explaining their personal connection to the project, or by using personal knowledge to help them in their research process (Ellis, 2000, p741)

This method was chosen in order to bring forward personal experiences of the author in the area of exit strategies where very little research has been undertaken and where this personal experience can be used to stimulate discussion in the area and open up the field for more structured research.

Since narrative is by its nature personal reflections on historical events, reliability of data can be a problem. This can be overcome somewhat through ‘reliability checks’ (Ellis, 2000, p751). This can be achieved by having other people who were present at the historical events review the narrative or by reference to historical documents or other independent descriptions of the same events. In this paper the author has referred to such documents, including web sites and did contact several of the executives involved to verify details.

This project was intended to be exploratory in design. It reviews a network of firms that the author had been associated with. Some relationships were formal, such as through a management role, as a shareholder or through an alliance or partnership. Others involved personal connections through former work colleagues who continued to work within the sector. This personal association with all the firms over the 25 years of the review provides insights into the relationships through successive evolutions. For example, many acquisitions started as loose partnerships, evolved to formal alliances and then ended in an acquisition. The purpose of this activity was to see whether it would support the hypothesis that informal and formal relationships are closely associated with subsequent trade sales.

The research undertaken involved a review of a network of software firms involved in the development and implementation of commercial software applications. Over the period 1979 to 2004, 16 acquisitions are identified. These companies are all linked in some manner through formal trading relationships, informal contacts or intervention by venture capitalists that had a prior relationship with some of the executives.

As the personal examination of this experience unfolded, the author was able to develop a list of identified formal and informal prior relationships. Formal commercial or trading relationships are associated with formal agreements or contracts. There are a variety of ways in which formal relationships can be established. These could include:

Management and/or shareholder roles:

Member of a Board of Advisors
Member of the Board of Directors
Minority shareholder
Venture capital provider

Formal trading relationships:

Distributor
Alliance partner
Joint venture partner
Consortium bidder
Customer
Supplier

Informal relationships are those that link individuals or organisations in ways in which parties have some knowledge of each other as a firm or knowledge of individual executives. Such relationships could include:

Personal relationships:

School alumni
Community activities
Former work colleagues
Sporting or social activities
Introductions by mutual acquaintances
Venture Capital contacts

Informal business relationships:

Common suppliers
Trade associations
Professionals associations
Competitors
Professional service provider introductions
Sales and marketing partners

Formal relationships are generally well documented and in the public domain. Informal relationships are generally not publicised and can often only be identified through interviews with the respective parties. In the network of firms involved in this review, the author knew all the key executives and could recall most of the associations. In some cases, the key executives were contacted to establish prior relationships.
Case Study One: Pioneer Computer Systems, Distinction and Cimdec Systems

Pioneer Computer Systems (PCS) was formed in late 1979 by Dr. Tom McKaskill, his wife, Anne McKaskill and a work colleague of Tom’s, Graham Menzies. The three principles and 6 other minor external investors contributed STG 20,000 to start the company. The new venture was started in the McKaskill’s dining room with a Digital Equipment Corporation (DEC) computer, the PDP 11/03. Shortly after this, Ian Campbell, an inventory controller and New Zealander working in London, was recruited as a programmer and consultant. In 1980 PCS moved to Northampton in England and hired more staff.

In 1983, PCS decided to build an enterprise resource planning system (ERP) for the PDP computers. Anne’s father was actively involved in the computer industry in NZ in a firm called Datacom and introduced them to a 4GL (4 th generation language) supplier, NCCS, in California. The language, USER 11, was then used to build a new software ERP system, COMMAND. COMMAND was subsequently distributed by 16 software firms around the world including NCCS, and Computer Express. Both NCCS (1985) and Computer Express (1987) were later acquired by PCS.

Ian Campbell left England to return to NZ in 1983 where PCS set him up in a business called Pioneer Business Systems. At the same time Datacom were signed up as a distributor of COMMAND. Ian subsequently left PBS to join DEC in NZ. DEC NZ and DEC Australia were at the time distributors of a competing ERP system from NCA. In 1987 when DEC lost its distributorship of the NCA software, Ian Campbell suggested that DEC approach PCS for a new package to distribute.

Lindsay Rewcastle of DEC NZ was sent to San Diego to investigate a new software package that PCS were developing called PROMIX, an ERP for process manufacturing. At about the same time DEC HQ appointed Dan Sweeney to become the account manager for PCS for the process manufacturing sector. Dan Sweeney was also account manager for CSI in Kansas, a control systems integrator. CSI subsequently signed up as a PCS distributor of PROMIX.

Click here to view Figure 1

DEC NZ and DEC Australia agreed to fund part of the development of PROMIX and agreed to distribute the product in Australasia. The ERP team at DEC NZ were however made redundant in 1990 and formed CIMDEC Systems. CIMDEC took over the distributorship from DEC NZ. Lindsay Rewcastle became CEO and Ian Campbell one of the directors. Tom McKaskill became a small shareholder in CIMDEC.

From late 1989 and throughout 1990, PCS were looking for an acquirer. With disappointing valuations in the UK, they sought a potential buyer in the USA. After an extensive search they identified a software firm, ROSS Systems that was using DEC hardware and selling financial applications software. PCS approached ROSS suggesting that their product PROMIX might offer expansion for ROSS into the manufacturing sector. Subsequent to this approach, ROSS Systems ( Asia) signed up as a distributor. Six months later in September 1991, ROSS purchased PCS.

In 1993, McKaskill established a consulting branch of CIMDEC NZ in Kansas, CIMDEC USA, with two managers from CSI in Kansas who joined as founder shareholders together with CIMDEC NZ. Subsequently, in 1994, Motherwell Bridge PLC from Scotland, that already had a minority interest in CSI, acquired the CIMDEC businesses and, with other firms it owned, created Motherwell Information Systems. On leaving ROSS in early 1995, Tom McKaskill signed an agreement with a research institute in London to distribute their production scheduling software through a new venture he started called Process Logistix. McKaskill had seen this software at an APICS exhibition and encouraged ROSS to distribute it. In late 1995 McKaskill and two managers from the research institute bought out the business unit and named it Proasis Pty Ltd. Process Logistix was rolled into Distinction Software in 1997 along with Lark Software and Scope Software, two other firms started in Atlanta by the McKaskills. Distinction Software developed supply chain optimization software. The Poasis software was then distributed by Distinction Software.

One of the developers at Distinction, Russell Strachan, subsequently left to join Peoplesoft. In 1998 when SAP introduced their supply chain optimization solution, Russell Strachan approached Distinction to enquire if it would be possible for Peoplesoft to distribute their software in order to complete with SAP. This discussion quickly moved to an acquisition which was agreed in October 1998. The acquisition formally concluded in mid 1999.

The Proasis software was not required by Peoplesoft and thus the connection with Distinction was severed. However Proasis needed to replace the Distinction software components that they had been integrated to as part of their wider software solution. McKaskill introduced them to Prescient Systems, a competitor of Distinction. This subsequently resulted in an acquisition of Proasis by Prescient in August 2000 (Prescient, 2004).

Case Study Two: ROSS Systems and Datalogix

ROSS systems continued with the development of the PROMIX product, making it their flagship product and becoming a leader in the process manufacturing ERP sector. More recently they signed Chinadotcom as a distributor. Chinadotcom has subsequently made an offer to acquire ROSS. That acquisition should be completed in mid 2004.

In 1993 the President of ROSS, Richard Giordanella and the EVP of Sales, Peter Sobiloff resigned from ROSS to take up the senior positions of a competitor, Datalogix (Insight, 2004). The offer had come via a venture capital firm. Datalogix at the time was in trouble and the VC intervened to put new management in charge. Datalogix in 1994 signed a distribution agreement with Oracle. The introduction to Oracle was made through a fromer DEC executive then working at Oracle. From this initial introduction, Oracle and Datalogix started working on joint proposals. Oracle subsequently invested in Datalogix and in October 1996 acquired the firm. (Datalogix, 2004)

Peter Sobiloff left Datalogix in late 1996 and was recruited by another VC to become the President of Think Systems, a high end sales forecasting software developer. (Sobiloff, 2004). Think Systems had been working with I2 Technologies on some partnering deals prior to Peter joining Think Systems (Sobiloff, 2004). Peter had an existing personal relationship with the newly appointed CEO of I2 Technologies through his association with that individual at Oracle. Within weeks of joining Think Systems, Peter proposed that I2 Technologies acquire Think Systems. Within a few months the acquisition was completed (Think, 2004).

Click here to view Figure 2

RESEARCH RESULTS

Very few key individuals are required to link all these firms. Dr. McKaskill as Managing Director of Pioneer Computer Systems was responsible for the development of trading relationships with Computer Express, NCCS and Ross Systems ( Asia). PCS subsequently acquired NNCS and Computer Express. Ross Systems ( Asia) was acquired by ROSS Systems Inc. at the time they undertook an IPO in May 1991.

Ian Campbell, an employee of PCS from 1979 to 1993, provided the link to DEC NZ and DEC Australia which resulted in a distributor agreement being entered into between PCS and DEC NZ. This subsequently resulted in the formation of CIMDEC (NZ), CIMDEC (USA) and the ultimate sale of the CIMDEC firms to Motherwell Information Systems.

While working at ROSS Systems between 1991 and 1994, Dr. McKaskill worked closely with both Richard Giondanella and Peter Sobiloff before they left to take leading roles in Datalogix. On leaving Ross Systems in late 1994, he undertook consulting assignments with Datalogix for several years. Also while at ROSS Systems, Dr. McKaskill met Dr. Chris Taunton at an APICS conference. This relationship resulted in the buy out of Proasis from the research institute and subsequently to the sale of Proasis to a competitor, Prescient Systems.

It is clear from the case studies shown above that both informal and formal relationships contribute to an explanation of how and why the 16 firms in this study were acquired. While the reasons for the acquisitions are not a matter of public record, the author was associated with many of these and can recall the main objective.

PCS acquired NCCS to take control over the direction of the development products that NCCS owned and were used by PCS to develop their application products. PCS acquired Computer Express in order to increase the size of the business subsequent to seeking an acquirer. ROSS systems acquired ROSS Systems (Asia) as part of a prior agreement relating to the valuation of ROSS Systems ( Asia) at the time it was setup. That agreement provided for the Asian firm to be acquired when the ROSS Systems Inc. went public. ROSS Systems Inc. acquired Cardinal Data Systems and Argonaught in order to build revenue and critical mass from which to launch an IPO.

Motherwell Information Systems acquired the CIMDEC firms in a consolidation transaction designed to build sufficient critical mass to spin out the systems part of the business from Motherwell Bridge. Motherwell Information Systems subsequently went public. Proasis was sold to Prescient Systems as it could not survive as a stand alone company. Oracle acquired Datalogix to take control over a critical supplier. I2 technologies acquired Think Systems for a similar reason.

PROACTIVE TRADE SALE STRATEGIES

This examination of the author’s personal experience in the software industry provides reasonable support for the hypothesis that prior relationship can contribute to trade sale exits. It would seem apparent from this brief review that it should be much easier to set up a trade sale deal where existing relationships exist, especially if the firm has taken the trouble to meet the key representatives of the potential buyer. Within most sectors, the number of key executives is quite small and they can often be met at seminars or conferences. This applies even to competitor’s executives. Also in most industries there are people who have worked for several companies, thus the network is often well connected across companies. When they need to sell, or when they get an attractive offer, or when they wish to sell, these prior connections will help ensure the right potential buyers are brought into the sales process.

A firm can often position itself well in advance of making an approach or being approached. Executives can use their time at conferences positioning the firm in the market where competitors and other industry providers will be in the audience. They are simply letting people know about the firm and what it does well. For a presentation on the company an executive could, for example, describe their core strengths and produce an interesting case study around it. This can be presented to industry participants in the trade press or at a conference.

CONCLUSION

This study of prior informal and formal relationships in trade sales contributes to a better understanding of both trade sales strategies and acquisitions strategies. While this is a limited study, the number of acquisitions that resulted from this network is quite impressive and does show clear linkages over time. Additional networks could be studied to provide a more through understanding of the contribution of prior relationships to acquisitions.

In terms of the longer term objective of developing an understanding of proactive trade sale strategies, this study provides some useful insights into how relationships could be used to position a firm for a subsequent sale.

Future studies might examine whether formal relationships have a high conversion rate to acquisitions if the firm proactively seeks out potential buyers to develop trading relationships with. It is a ‘try before you buy’ transaction. It would seem logical that, where the buyer has more of an inside view of products and management and has a better understanding of the fit of the two firms and of the potential benefit of the acquisition, that this would improve the chance of an acquisition.

This examination also suggests that, where the seller has taken the trouble to develop multiple informal and formal relationships, that they can create’ competitive tension’ in the trade sale process. Future research might look at situations where such competitive tension was created and determine to what extent this impacted on the final sales price.

REFERENCES

Bleeke, Joel., & Ernst, David.,1995. Is your strategic alliance really a sale? Harvard Business Review, Jan./Feb 1995, Vol. 73, Issue 1.

Buckland, William., Hatcher, Andrew., & Birkinshaw, Julian., 2003. Inventuring: Why big companies must think small, McGraw Hill: London.

Datalogix, 2004. http://www.lionhrtpub.com/IM/IMsubs/IM-10-96/news.html (accessed 1/3/04)

Ellis, Carolyn and Bochner, Arthur P. “ Autoethnography, Personal Narrative, Reflexivity – Researcher as Subject” in Denzin, Norman. K., and Lincoln, Yvonna. S (Eds) , (2000) Handbook of Qualitative Research 2 nd Edition, Sage Publications Inc. Thousand Oaks CA, USA (pp 733 – 768)

Insight, 2004. http://69.20.19.254/cgi-bin/insight/team/teammembers/peter_sobiloff (accessed 1/3/04)

McKaskill, T., Weaver, K. M., & Dickson, P., 2003. Development of an exit readiness index, ICSB Conference, Belfast.

Prescient, 2004. http://www.prescientsystems.com/news/release.asp?pr_ID=19 (accessed 1/3/04)

Ross, 2003. http://www.rosssystems.com/ accessed 6 th September 2003

Sobiloff, 2004. e-mail 29/2/2004

Think, 2004. http://www.row2technologies.com/guest/aboutus/investors.jsp (accessed 1/3/04)

UPS, 2004. (http://www.ups.com/sef/sef.html) accessed 3/3/04