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Built to flip

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Some companies are built to be sold. The intellectual property and business processes are bedded down and bundled into a transferable package. Find a market gap, identify potential buyers, build it, drive home the value and make the trade sale. And then, if you enjoyed the ride, do it again.

Standing at least 6′ 3″, with burly shoulders, Trevor Presser is a hulk of a man. His placid demeanour belies his excitement about corporate cogs and suitcases. Tucked away at the noisy back end of a Japanese noodle house in the inner-Melbourne suburb of Richmond, he lays out his roadmap for how ambitious entrepreneurs can ‘monetise’ their companies.

“Flipping is what police informants do,” he says with a contained smirk. “This is about realising value.”

COGS AND SUITCASES

“A large, established company is made up of lots of cogs – business processes – which all work together. Little cogs run around big cogs, and so on. As things change, those cogs wear; and sometimes a cog becomes inoperable. It’s generally tolerated until it starts to impede the way the whole machine works.” Presser cranes over his bowl of laksa, conspiracy in his eye. “This is the opportunity for the entrepreneur to create a brand spanking new cog and convince the company to substitute it for the inoperable cog.”

Presser specialises in advising start-up entrepreneurs on how to identify and target faulty metaphorical cogs in cashed-up corporations. Now on the cusp of middle age, he graduated university as a nuclear physicist, but cut his teeth from the mid-eighties to the mid nineties at Mouldflow, a computer software start-up for the simulation of plastics injection moulding. He rode out the rocky times, including several missed payrolls, to head up Mouldflow’s Asian operations and help attract US venture capital, leaving just as the company was listing on the NASDAQ to form his own business, PPA Consulting.

“I wanted to help other companies take the ten-year journey that I took in a much shorter time period; to help shape them into investable businesses,” says Presser.

For entrepreneurs seeking a quick exit – say, inside two to three years – a trade sale is the most promising option. At the pre-seed and seed stages in Australia, venture capital is usually but a mirage on the horizon.

“Too many entrepreneurs clutch onto the illusion that they will attract venture capital,” says Presser. “Most VCs come from an M&A/ banking background, and haven’t actually wrapped their arms around their toilet bowl and vomited blood because they don’t know where the payroll is coming from. They’re generally not interested in playing in this space. It’s high risk and bloody hard work.”

For Presser, 2007 will be the year that big media is on the prowl for new media replacement cogs to sure up revenues. He believes the corporate cog metaphor represents a loophole for entrepreneurs seeking to monetise their ideas in a short time period. But it requires a focus on preparing a company for investability from the outset. Something he believes most entrepreneurs are inherently bad at.

“You know in the James Bond movies where they open a suitcase and inside is a disassembled gun with a spot for every component? That process of putting all the assets in a defined, describable order, and a structure that is very logical for a buyer, was in the forefront of one of my client’s minds. He felt that a silver suitcase placed in the middle of a room would actually be a reminder to him every morning that his work was not complete.”

WATER TIGHT

You might have an idea that clearly offers significant commercial benefit for an established company, but that’s a long way from clutching a cheque.

For a big company to even entertain the notion of a trade sale, the company for sale needs to do everything it can to remove execution risk from the proposition. Corporate executives don’t want to buy a good idea. They want to acquire a complete package, with an innovative business model, a water-tight intellectual property portfolio, a meticulously planned execution strategy and preferably a capable and stable management team. “One of the risk management strategies for dealing with a trade sale – which can be difficult to secure – is making sure if it doesn’t come off, you still have a fallback position of raising more capital to allow the business to continue operating,” says Jack Redfern, a Partner at intellectual property firm, Shelston IP.

According to Redfern, only a very small proportion of the business population can move from lodging a patent to selling the business and moving on within 12 to 18 months.

“There are lots of good ideas and good technologies around. But there is a shortage of people who are actually able to crystallise some of the value and make clear that the value is attainable.”

Indeed, value is in the eye of the beholder. What an inventor/ entrepreneur sees as a peerless technology, an investor or potential buyer might very well see as a risk worth neither the time nor the capital.

Another issue at play here is the question of the entrepreneur’s motives. If they are pushing the sale at all cost, the potential buyer should rightly question their commitment to the business and haggle the price down. If the entrepreneur is clearly attached to the business without possessing the skill set to successfully commercialise it, the potential buyer will most likely walk away rather than inherit a meddling know-it-all.

“The key is to be able to demonstrate the nexus between the IP that’s been secured and the commercial value that it represents in the market,” says Shelston IP Managing Partner, Stuart Smith. “The most successful pitches are the ones that show in a compelling, well researched way a) what the market opportunity is, and b) that it is backed up with a rigorous IP portfolio as part of a broader commercialisation strategy.”

BIG MEDIA RIPE FOR REINVENTION

Ben Barren, web whiz kid insider turned independent entrepreneur, knows a thing or two about the deficiencies currently afflicting big media. His decade spent programming from within the high walls of media titans such as ninemsn and Sensis taught him how they worked – and how they didn’t. Now he has gone out on his own, launching Gnoos, Australia’s first local blog search engine (see Tunnel Talk).

“Unlike Google, which spent $332 million last quarter on R&D, the major Australian online companies aren’t spending much on R&D or launching new products,” says Barren. “It pushes people like me to go and start the kind of business that Australia needs but can’t be created within these organisations. I’ll go and build my own set of products over two to five years, and then in three years I’ll get a call and they’ll say, ‘Ben, what you’ve developed is interesting. How can we work together?’ I’m already getting the calls now! I’ve already licensed some of my technology to media companies looking to extend this online social media – that’s how I make money.”

Barren is just one of scores of new media entrepreneurs seeking to exploit the torpor displayed by Australia’s (and the world’s) old media behemoths. Some of them no doubt have ambitions to be the next Google. But that’s a long shot. The real money is in leveraging big media’s desperation to claw back advertising revenues through introducing (and acquiring) innovative new offerings.

Nick McNaughton and Yorke Hinds of Quivalent (also profiled in Tunnel Talk) are in the final stages of selling their two-year-old email marketing application, Zookoda.

“Yorke and I believe that there is a two to four year technology cycle, which ends when the technology is either superseded or a new technology creates a paradigm shift,” says Nick McNaughton. “That’s been proved many, many times in the technology adoption cycle. When we created Quivalent, we were looking at a two to four year time frame to have some kind of exit.” McNaughton and Hinds had a pretty good idea when they started which of the larger entities would be potentially interested in a trade sale. They deliberately avoided angel capital so as to retain 100 percent of the equity, and supplemented application development by running a premium email marketing solution for high-end clients.

Now they are in a position to sell to a larger media player and launch another appealing start-up once the transition is complete. It’s the kind of guerrilla strategy that hones eager entrepreneurs into seasoned (and wealthy) business builders.

REGIONAL OPPORTUNITIES

For a prospective “flipper”, a dash of daring and taste for adventure are prerequisites. In this day and age, the world is your playground.

John Hummelstad has seen enough entrepreneurs who are capable of flipping companies in a short space of time to know that they are extremely rare assets.

As Microsoft’s Asia Pacific Director of Partners, Venture Capital and Emerging Business, based in Singapore, it’s his job to keep abreast of emerging technology companies, venture capital dealflow and partnership opportunities for Microsoft in the region.

According to Hummelstad, “In the US, these ‘flippers’ are commonly viewed by the VC industry as great ‘backable’ management – therefore, they will commonly be brought into an invested portfolio company that can benefit from their past experience and present network.”

Hummelstad says he has yet to meet many “flippers” (also known as “serial entrepreneurs”) in Australia. “But these folks are rare and most are on the Rolodex of the Sand Hill Road club.” For those gung-ho Aussie entrepreneurs who are already plotting their rapid-fire trade sale to the likes of Microsoft, Hummelstad has some sobering words.

“Last year we purchased just 24 companies… and we were one of the ‘most aggressive’ acquirers in the software market.” In contrast, Hummelstad says Microsoft partners with over 70,000 smaller ventures in the Asia Pacific region, and 500,000 globally. “For the vast majority of your readers, the value of the ‘early stage riddle’ lies in building a sustainable business on a good idea that is growing based on its merits.”

But a silver lining exists. The Australian market for technology and innovation is minuscule compared to the surging economies of Asia (China, India, Vietnam, etc.). The opportunities to partner with North Asian companies are many and potentially lucrative. “Japan still accounts for over 50 percent of the region’s GDP, M&A and IPO activity,” says Hummelstad. “I raise this point because when we consider innovation and exploitation of large markets, infrastructure like broadband, cell phone, PC penetration and the smart people who put this all together _ these are the true enablers of the valuations we see on exit these days.”

‘Build and flip’ might sound like a flamboyant art practiced only by swashbuckling entrepreneurs. In reality, only those with strategic thinking, meticulous planning, attention to detail and impeccable timing are able to create the kind of genuine and demonstrable business value that satisfies corporate buyers. Trevor Presser recommends keeping a suitcase handy, if only as a daily reminder of what is required.

“It’s all about planning and preparing that box; reshuffling and repacking it, working towards its completeness, and then taking it to the market at precisely the right time. Build and flip. Build it well and flip it at just the right moment.”

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GET YOUR HOUSE IN ORDER

Often, the process of due diligence flushes out IP issues that should have been dealt with beforehand. For example:

  • Ownership issues that haven’t been resolved. There could have been an initial collaboration with some other party who is or potentially could make some claim on the ownership of the IP.
  • There can be breaks in the devolution of title where there isn’t an effective assignment or chain of assignments from the original inventor to the commercialising company.
  • Sometimes, a patent may have inadvertently been allowed to lapse because, for example, renewal fees have not been paid.
  • Prior art may exist that compromises the scope or validity of the patent.
  • Sometimes, product development takes on such a different direction that the original patent no longer covers the product that is being commercialised.
  • The commercialisation of a new technology, even if validly patented, can potentially be impeded by earlier conflicting third-party IP rights.It is therefore often worthwhile to conduct a rigorous internal due diligence process and address any substantive issues that may be revealed, before even approaching potential investors or purchasers of the business.

Stuart Smith – Managing Partner, Shelston IP

A CHECKLIST FOR GROOMING YOUR BUSINESS FOR SALE

Being able to demonstrate the following will maximise your business’ sale value:

  • You as the owner are not crucial to the business’ continued success.
  • Specific industry experience is not essential for potential buyers.
  • Clients and suppliers are not inextricably tied to the current owner.
  • The business has appropriate management, operational and information systems.
  • Key staff are in place and are stable.
  • Intellectual property can be preserved and transferred.
  • Market position is stable.
  • Legal and contractual arrangements are tidy.
  • Past performance is credible
  • The platform is right for growth and a profitable future. Source: PricewaterhouseCoopers, “CleverCompanies”, Oct 2006, p32.
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