strategies in the new economy:
roll-up or not, is it right for you?
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Mr. Starzynski: One of
the reasons why roll-ups, and acquisitions in general, have been so popular in recent
years is because of the lack of technical talent. Nelson, have you ever been concerned
that you might need to go out and acquire a business or take part in a roll-up in order to
get the technical talent you need?
Mr. Carbonell: That's a great
question. Everybody's worried because finding talent and getting the right people is
difficult. I'm not going to tell you that it's easy for us. We have a very aggressive
recruiting program. In a company of a little over 100 people, 5% of our staff are
recruitersfive people who basically spend their full time out looking for employees.
I'm sure that a lot of you have had to hire software engineers. Software engineers
think a little bit differently than other people do. Ultimately, the value proposition
that our people get is that they get to work on challenging projects, which are really
going to be used, with other very talented people using the latest technology. That gives
them reason to come to work for us, but also to stay. My biggest fear is not whether we
can recruit people, it's can we continue to do things to make sure people don't
leave. People are our capital in our business, so we do everything we can to make sure
that the value proposition for our employees remains the same. I think that's pretty
Mr. Roshfeld: I'm Larry
Roshfeld with E-Certify (http://www.e-certify.com).
I've been involved in a lot of acquisitions on both sides. I find that it's easier for the
senior management of companies to get aligned than it is for the folks who are being
bought, who often find themselves in an "us" and "them" mentality.
I've been involved in situations where people who joined the company after the roll-up
were still talking about the good old days in which they'd never participated. How do you
keep the folks who are actually driving the business?
Mr. Clark: The key success
factor we experienced as part of Verio is the communication process. You've got to go
overboard with communications, to over-communicate. You must continue to have the
lines of communication open to ensure that those folks feel like they have some ownership
in the process. At the end of the day, they're the intellectual capital that makes or
breaks a business. Our challenge was to make sure that the people in the customer care
group and the billing department understood why we were making this transaction. What did
it mean to them, and what did it mean to the customer base? We have a lot of loyal,
long-established ClarkNet customers who enjoyed the old days of being able to use UNIX
shell and talk to an engineer about the deployment of a latest router or modem technology.
You lose some of that, but you have to continue to communicate to bring your customers
As Nelson refers to it, what's the value proposition for them? It's a bumpy road,
because the value proposition isn't immediate. It's not like you turn on the
"Verio" light outside and everything is wonderful for your employees and
customers. You continue to drive the vision and the culture and communicate it to the
employees so that they understand. Finally, they start to see some tangible results,
whether it's an improved benefits programs or the ability to interface with talented
people all across the country. You have a technical issue you don't understand? All right,
let's talk to Dick or Jane in Seattle.
That's one of the attractive features of being part of Veriopeople can be tasked
with things that they never would have been tasked with before. They are challenged
intellectually, which makes them feel rewarded and fulfilled and more marketable in the
long run, should they want to go out and do something different. They've got a collective
experience that we couldn't have provided them at the local level. The key is
communication, but, you know, that's a challenge that goes all over, whether you're a
person in a consulting practice or a systems engineers. How does General Motors
communicate with 50,000 folks across the globe? To me, that's a daunting task.
Mr. Owens: My name is
Charles Owens, chairman of AbleMedia (http://ablemedia.com).
As an investment banker for the last 25 years, I have been involved in and encouraged
numerous roll-ups in the neighborhood of millions of dollars. The majority of the roll-ups
that we encouraged were limited partnership roll-upslimited partnerships in oil and
gas and real estate, for example. Those roll-ups were investor strategies; they weren't
entrepreneurial strategies. We rolled up entities which, as far as management was
concerned, were passive management entities. The roll-ups worked because we didn't have
all of the problems that you're talking about with active managers.
I would call what you have
described an acquisition, which is a bloody difficult exercise. The idea of rolling up 50
companies is strictly an investor play. I can't imagine it being primarily in the interest
of the entrepreneur. Verio sounds like it was started by a group of investors who raised
venture capital. It is not an entrepreneurial play from the perspective of the individual
companies, but a financial play aimed at an IPO by well-capitalized, large investors. It
seems to me that there's some conflict between what most people in this room are trying to
do, and what is being attempted in a roll-up. In my view, you're talking about a process
that is fundamentally not in the best interest of most people here. Would you address
Mr. Clark: To a great extent I
agree with that. As I alluded to at the start, there are gradations of what I'll call
roll-ups versus acquisitions. I happen to know one of the key members of onemain.com (http://onemain.com). He pulled together a number of ISPs and
signed them all up saying, "Okay, if we're successful with the IPO, we'll become one
family." To me, that's the classic definition of a roll-up transactionit's
encouraged for financial purposes only. As Mark Twain said, "If they tell you it's
not about money, it's about money."
If you look at the Verio proposition, clearly there was some element of that. There was
a vision to take a fragmented industry and create a company that would, hopefully, have a
high value proposition for the investors from the early stages, as well as those investors
throughout the life of the company. Where roll-ups succeed or fail for the entrepreneur,
the employees, the customers and, ultimately, the investors who buy into the concept, is
in their ability to create a culture and have a vision to take the company to the next
levelto become a change agent or transformer. Most people are entrepreneurial
because they want to be change agents. There are a host of factors why people become
entrepreneurs, but I think that, when push comes to shove, it's the change factor. Time is
the true test. If Verio is a successful company five years from now, then that will be the
true measure of success, whether the stock is at $10 or $150. That's a secondary issue in
my perspective as an entrepreneur.
If it's all done and driven purely for a financial engineering motive, it's probably
not a good thing for the entrepreneur. There's also the issue of how an entrepreneur gains
a return on his or her sweat equity, besides the recognition and the intangibles that go
along with being an entrepreneur. That sweat equitythe 20 hours a day trying to
recruit and retain people, creating the vision and growing the companyyou want some
sort of financial return for it. At some point, will it just sort of fade off into the
night, and you retire saying, "Okay, we created a great culture and a great vision
and I feel really good about that, but did I actually earn something from that in terms of
an economic return?"
I think the entrepreneur is served by an acquisition strategy, although it depends on
what the motivation is. Certain people get to a certain point in their life and say,
"I'm tired of banging my head against the wall." Maybe you want to be more
involved in the community, and this is a way to get some financial security and accomplish
that dream. There are different motivations for the entrepreneur, but I agree with your
initial comment that's it's not always right to head in that direction. It depends upon
the point in your professional and personal life cycle, but I think it's a good vehicle if
Mr Starzynski: Assuming that everyone here is an entrepreneur who has or will
be faced with the question of whether to sell into a roll-up or not, what is your advice
in 20 words or less?
Mr. Carbonell: If you think you're done, then sell. If you think you're not
done, then don't. If you think that you can sell without being done, well, most people end
up disappointed in that. I always imagine that it's a challenge to roll up a company where
40 guys used to be presidents of their own companies.
Mr. Clark: I think that's a great formula. What feels right? At the end of the
day, you have to feel comfortable with your decision. Hopefully, you evaluated all the
factors; now you have to make the decision that feels best for you as the entrepreneur.
Mr. Halligan: I'm Rob
Halligan with Evolve, Inc. (http://www.evolveweb.com).
We are what could be called an IT services roll-up, building solutions integration
services. It isn't for everybody and you have to find the right people who want to do it.
It's not always whether you're done or not, because we personally don't want companies
where the owner is ready to jump. We want him or her to work with us, so it's not all
black and white.
Mr. Carbonell: I don't have the
psychological profile of entrepreneurs down pat, but I know that they are people who like
to build things. If the value proposition from the roll-upp-er is, "We can get
you away from all of this stuff that you don't want to do," then why did you become
an entrepreneur to begin with? You probably are miscast in your role. You should either
look to go to work for somebody, and probably a roll-up is one strategy, or do something
else. Entrepreneurs, at least the ones I know who are successful, are the ones who live to
Audience Member: A public company is worth a lot more than a private company.
That's the attraction.
Ms. Young: I'm April
Young from Imperial Bank (http://www.imperialbank.net).
Do you see any segments, not necessarily in IT, that are particularly right for roll-up?
How do you suggest somebody go at them?
Mr. Clark: I think you have to
ask some of the roll-upp-ers in the audience.
Mr. Carbonell: I think you can say that there are two characteristics that have
to exist in order for a roll-up to even be attempted. One is that you have to have
favorable market conditions in the industry. Going out and saying, "I'm doing a
wallboard company roll-up," is probably not going to get you a big splash in the IPO
market, even though it may be a fragmented industry. You also have to have enough players
in the market that you can find enough companies to acquire.
And I think there's also a third elementyou have to be convinced that the
strategy ultimately builds a real business. Maybe the investment bankers have to convince
themselves of that, but you have to be sure that this thing is going to be around and that
it's going to grow and deliver on its promise.
Mr. Starzynski: To elaborate on Nelson's points, the industries that I see
rolling up more successfully are those that are very disparate, the ones that have a
couple of large leaders, but also a bunch of undervalued mom-and-pops. Of course, that's
assuming it's people with financial intentions putting the roll-up together. They're
really going to go after the markets that they see as undervalued.
Mr. Khera: I'm Raj
Khera of Khera Communications (http://www.kcilink.com)
and GovCon (http://www.govcon.com).
We've been approached by many companies to do a roll-up, but have resisted, although maybe
the day will come when we decide it is right. If so, what can I expect in terms of the
nuts-and-bolts after the roll-up happens?
Mr. Clark: There's a universe
of potentials out there, depending on how the transactions are structured. In some cases,
the due diligence and the agreements are executed, but nothing happens until,
"poof," the IPO happens. Things really will run the gamut, depending upon how
the companies want to structure the transaction. There's give and take between the
acquirer and the selling company. You can dictate that in terms of the negotiation
process, as well as contractually.
I will tell you that, at the end of the day, it doesn't really matter what's on paper,
if there isn't good faith in the process. If there isn't the sense of moving forward
together, then why have a consulting agreement or an employment contract without any real
intention for either of the parties to adhere to it? Get the baloney off the table and
dictate what you want to accomplish. If you're set on being involved with the company on a
prospective basis, you need to make sure you have a level of trust with the existing
management teamthat you buy into the culture and you feel good about moving forward.
It comes down to a lot of gut feelings.
The process and conditions can run the whole course. It can be very, very legalese, or
it can be more laissez faire. The transition period can run from 30 days to three years.
It depends on the circumstances. If you're a key component of the acquisition because of
your intellectual talent, or your leadership or your ability to keep the sales force
motivated, then you're going to have a lot more value than if you're writing code that
somebody else can maintain. Unfortunately, there's no pat answer. You can't go to the
Harvard MBA program and find out what happens after an acquisition. There are themes and
trends that are similar, but they are all unique.
Mr. Dejardan: My name
is John Dejardan and I'm a software engineer. I recently joined a company called
and I made that decision because I want many of the things you mentioned, Nelson, such as
the ability to work on interesting projects. Are you against any kind of acquisition
strategy at all, or are you just not interested in being acquired?
Mr. Carbonell: That's a great
question. Let me just say this: roll-ups and acquisitions are different. A roll-up is an
acquisition on steroids, okay? It's a different model. Acquisitions are a difficult
business strategy to execute, but they can be done. Cisco Systems (http://cisco.com) is one of our customers. They're an
acquisition master. They can do an acquisition and you will be assimilated. It's very
effective and it managed to create a market-dominant position for them. I can't say that
acquisitions are not in our future, although we will more likely be the acquirer than the
acquiree when we feel that we can deliver consistent numbers in the marketplace.
At the stage we are now, we are putting together foundations for our company. It's very
difficult to do an acquisition at a foundation level because you get overwhelmed with
people and problems. A Cisco Systems acquiring someone like LightSpeed
Internationala huge company acquiring a very small companythat's been done
more than once. It's a very different transaction than a roll-up where you have 40 small
companies and you show up one day to meet your 39 best friends who are going to be working
with you in this company. We are not anti-acquisition; we just think that the roll-up is a
strategy that doesn't work for us in our industry.
Mr. Starzynski: I was looking through Verio's annual report and noticed that it
has $200+ million of goodwill on its balance sheet. For those of you who are not familiar
with "goodwill," it's the price over the assets that you pay for a business.
Drew, what kind of burden does that put on a company that is still trying to grow
Mr. Clark: It's not cash, so it doesn't really hit your operations other than
from a financial accounting perspective. There's a big debate over what type of accounting
standards should be in play, the delta between the asset value that you're acquiring and
the purchase price. To me, if you're trying to build value and attain a certain synergy
level with the acquisition process, whether through a roll-up or the more traditional,
slower-paced acquisition, you're most likely going to pay a premium. Hopefully, the
premium you pay for companies is less than the premiums you would garner in the
marketplace. The key element is not what goodwill does, but does the market capitalization
you achieve through public financing methodologies justify that goodwill.
I don't get hung up on goodwill. Being an ex-CPA, they call me an accountant with an
attitude. What I'm really concerned about is whether a business generates cash, because
you can't spend goodwill. One of our measurements is to get to a positive EBITDA (Earnings
Before Interest, Taxes, Depreciation And Amortization). If you can get to that point,
you've done something that not many others have done in software development or the
Internet space. We think we're going to get that. Cash flow, for me, is a much more
important measurement than the non-cash items of the balance sheet which amortize over the
period of time they have to be amortized.
My name is Anil
Hemrajani, president and CEO of Divya, Inc (http://divya.com). We've been around for about two and a half
years and have added some very large customers, mostly Fortune 500 companies. We're sort
of a hybrid company which implements custom applications employing mainly subcontractors.
We have a very good reputation with a specialized department that focuses on Java Web
solutions. Like you, on the bad days I think about exit strategy, not because the business
isn't growing, but there are just days when you really get tired of putting in 14 hours
and to maybe get some cash out for all the hard work that I put into it. Is there value in
a company like ours?
Mr. Carbonell: First, I can
tell you that I feel your pain. Deciding what you want out of it is important, and what
your objective is. I really don't have an answer to that question, but as a service
business companies are going to acquire you for two reasons, both pretty important. One
reason is to get your customers, so the first question you have to ask yourself is, when
you're acquired, will your customers stay with you? Do you have that kind of relationship
with them? Will the new company do right by them?
The second reason that they'll acquire you is to get your employees. The concern I have
is that if your employees are subcontractors and you sell, what is the chance they're
going to stay around? What kind of retention rates can that company expect among those
people? Those two things drive the acquirer's mind-set. If it were me, those are the two
things I'd be most concerned about, but there are acquirers out there who want companies
like yours, so you probably have something pretty valuable.
Mr. Jordan: My name is William Jordan, with MelaNet (http://melanet.com), an
Internet consulting firm. With both the roll-up and acquisition process, I'm trying to
follow the equity and what's happening to it. Can you clarify the difference between the
two processes and what's really happening to my equity stake in my company?
Mr. Clark: It'll probably get diluted. Again, it depends on the structure of the
transaction and a lot of other circumstances, but what you need to understand is a simple
equation. You have something over here that you're going to exchange for something over
hereit's either going to be cash or equity in the new company. You've got to make
sure that you're getting fair value for what you're exchanging and for the risk it
carries. If it's nonpublic equity, there's the chance that the paper could be worth
nothing more than a napkin. You have to figure out the true value of what you're receiving
for what you're giving up, and you have to be comfortable with that exchange.
I sat down and had a heart-to-heart meeting with the CEO when we completed the sale of
ClarkNet about how the transaction was structured. We sold 51% of the company originally.
We had to come up with an appreciation and a confidence level that the valuation Verio was
using was something we felt good about. Was it equitable to us? Fortunately, yes. If you
don't have that expertise, I'm sure there are folks here that would love to help you
figure out valuations and how to structure a transaction.
Mr. Carbonell: I think the easiest way to look at the game is that it's
arbitrage. It's got to be worth more to them; otherwise, it doesn't make sense to buy it.
The question you have to put to yourself is how much? Ultimately, that's the game the
acquirer is playing, especially in a roll-up. "I can acquire you for 10X revenues,
but I know I can sell you for 20X as a package with everybody else." That's what you
have to keep in mind.
Mr. Howe: Could you comment on the role of strategic alliances as an
alternative way to rapidly accelerate your company's growthbottom line and top line?
For example, Verio has a new deal with Network Solutions to give out domain names, so
rather than roll up, why not hitch your wagon to a large company's star and shoot along
Mr. Carbonell: Part of our strategy has been to build alliances with
companies like Sun and Cisco Systems which are at a different end of the business from us.
Alliances can be a kind of fair weather friend situation, because they have to work for
both partners in the alliance. The thing you have to keep in mind is that things change.
What was in Sun's best interest a year ago when they were selling hardware is different
from today when they are the ".com in E-commerce." Now, they are our competitor
as opposed to being our partner. We have to be constantly vigilant in these strategic
relationships as to what the objectives of the other partner are. You also have to be
ready to change partners, so it's a much more fluid set of relationships than if you're
somebody like Drew who's part of Verio. Now, they're a team and their mutual objectives
remain the same. Alliances require a lot of work and you have to be nimble.
Mr. Clark: I think the analogy is, do you want to date or do you want to get
married? Dating is not a permanent relationship. As Nelson said, in the strategic alliance
it's tough to keep the partners aligned. There are so many examples of those alliances
gone awry. Also, bottom line, if you're small, let's say a small shop of Java programming
experts, it's not likely that Sun's going to come knock on the door saying, "I want
you to be my strategic partner today." You don't have the mass. You don't have the
presence in the marketplace or the resources that makes it interesting enough to get on
Sun's radar screen.
Verio was able to bring those things to the table, or at least had the potential.
ClarkNet was never going to do a Web hosting alliance with America Online, but we just did
one as Verio. I hate to say it, but if you want to play with the big boys, you have to be
big. You have to bring something of value to the table to enter into those strategic
relationships. Verio will not do as much acquisition activity in the future. We'll
continue to do it when it's strategic, but we will do more relationships and more
Mr. Kling: My name is Arnold Kling from homefair.com (http://homefair.com). Having been through a recent merger that took us from three presidents to
four, I agree with Nelson's comment about software shops having strong cultures. To me, it
would be like trying to roll up three rock-and-roll bands into one orchestra. Do you think
that if you took away the stock market and its ability to price earnings, or have a
"price to fantasy ratio" as one economist called it, we would even be talking
about these kind of roll-ups?
Mr. Carbonell: No. It's an essential element of the formula. If the executor of
the roll-up can't get arbitrage for their dollars, meaning they have a market that's going
to price what you're giving them at a higher value than what you're selling to them, it
End, page two of two
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1999, Morino Institute. All rights reserved. Edited for length and