Buy vs Build: Why Large Companies Acquire Instead with Ed Roberto

[00:00:00] Ed, hi. Thank you again for making the time. if you can an overview about your background and what you've done, I know you for years now, so I'd rather leave the introduction, uh, to be done by you.

[00:00:14] you.

[00:00:15] you for having me. As a quick background to our listeners, I started my first software company in 1982. I was 22 years old and it just so happened to be in what we now call the cybersecurity space. That name did not exist way back when we just called it, operating System Security, but it was a security company.

[00:00:43] And so what is that? 40, 42, 43 years. Since 1982, I've been, a serial entrepreneur. I've also been an angel investor in technology companies. I have sold a number of software firms to larger organizations like Oracle. I've also taken two companies public. And I've had, numerous financings through both venture capital and private equity.

[00:01:16] So I think that there's a long history of experience in this very topic of how do we deal with exits? How do we deal with mergers and acquisitions? How do we deal with, the various and tribulations of being founders in a company, taking on investors, taking on, operating executives, et. So hopefully I can answer questions you

[00:01:43] Thank you. Thank you, ed. so we'll jump right into it. Now, many startups, when you talk to them, the founders, so I'm talking from the perspective of a startup leader. When I want to join a company, almost every founder wants to be in a unicorn. every founder believes that they are so special, and this is what, keeps them going. So your point of view, at it from a pragmatic approach, for me as someone who's joining a scale up, what are the things that I need to ask myself? What are the things I need to look at Because if, I feel like I need to think like an investor, if I'm joining this startup or scale up, I need to think like an investor, does this startup or scale up have what it takes for it to become a unicorn?

[00:02:36] That's one. thing is I'll be investing so much time with them. What are the questions to be asking them to be able to qualify them, especially if I'm leaving a corporate job, a secure job to get in that level of uncertainty.

[00:02:52] Yeah, it's a very good question. As I collect my thoughts to think of a great way to answer this, let me start by saying if If you're looking at starting a company, I actually don't know if I would ask the question, how do I become a unicorn? I think what I would ask myself and ask of my co-founders is how do we build a sustainable and enduring business model for whatever that service or product is that we're building that makes it a must have to our.

[00:03:38] total addressable market. Becoming a unicorn, I actually think takes care of itself. If you build something that people want, if you provide something that people want. So that would be my first, starting point is becoming unicorn status will take care of itself if you actually build something that's meaningful.

[00:04:06] I think whether you're a founder, co-founder, early executive, an employee that comes on from, let's say, the corporate world into the startup world or the later stage scale up company, one of the first questions I'd ask is, how do you make money? I want to understand the fundamental business model of the company I'm joining.

[00:04:31] tell me how you make money. And that has to be a very, tight storyline from whomever you are interviewing with. Because if we don't know how we make money, then we're destined to waste a lot of investor cash trying to figure that out. I think I'd also ask questions like, how can I meaningfully affect

[00:05:00] the success of the business. So if I'm interviewing as a developer, I'd like to hear about my product development cycle, my product roadmap, and I, a SaaS company and my a monolithic software company. Those kinds of characteristics would be very important to me. If I was a sales executive or a sales rep, I'd ask questions along the lines of, how do we develop a target revenue number for the business?

[00:05:34] What's our growth rate each year that we desire to have? Am I being paid on the gross or am I being paid on the net? These are all very practical questions that anyone should have, if they're interviewing for a job that's got some degree of, serious contribution, right? Otherwise you're just, you're interviewing just to get the job.

[00:06:00] You don't really care about the fundamental underpinnings of the business. So, in the context of our conversation, I'm gonna answer all of these questions as if I was a founder, a co-founder For a key executive coming into the business.

[00:06:18] Thank you, ed. I think this also is interlinked with our main topic, which is if someone is acquiring a company, if you wanna assess the health of a startup is, they genuinely building the right team? Have they been attracting the right people or over promising the people that join them too much power at the beginning, until they mess up and then they leave, or they fire them. I would go now to the perspective of an acquiring company. Let's say, have sold a few companies, you facilitated the acquisition of smaller companies and the companies that you took to the New York Stock Exchange or took them public. when you are looking at these companies, what kind of questions you ask when you're assessing them?

[00:07:08] So at a very high level, if I am the company doing the acquiring, that presumes a few things. Number one, I have capital in my treasury to actually acquire a target company. So I'm actively out in the market looking for companies that provide a very direct, adjacent capability that I've made the decision it's going to be cheaper to purchase the business than it is to build the product from scratch.

[00:07:41] So that's my initial, thesis. As I'm out shopping for a target company, I am looking at product functionality. Is it complimentary to my own technology stack? I look at product market fit. Is it helping me expand my existing market or is it helping me to get into a very close adjacent market that I want to be in as well?

[00:08:08] And assuming there's a good, product market fit, I absolutely look at the team. Is this a team of people that I want to keep for the long term, can they build on the expertise of the team that's currently in my existing company. And very early on in the discovery conversations, both of these topics, the product efficacy and the quality of the team, they're gonna come up almost immediately.

[00:08:40] I would like to know who gets to stay, who's going to leave? I find that when you buy small companies especially, the founding entrepreneur, generally speaking, it's a 50 50 chance whether they wanna stick around or leave and go start their own business. And depending on how they answer that question would actually determine do I move forward with the acquisition?

[00:09:09] Do I create lock up mechanisms to keep that entrepreneur on staff for at least two years. These are the kind of things that will come up. Again, I can't be very specific 'cause each acquisition is very individual and unique. Sometimes you don't want to keep every team, you can't actually create a unified culture.

[00:09:34] and I think that as a business grows, culture is very key. You can't have two cultures. You can't have co-CEOs. I know that's been tried quite a few times. I'm very biased. It doesn't work. At the end of the day when a hard decision gets to be made, it falls to one person not to. So figuring out, how that team is integrated into the acquiring companies, staff who stays, who leaves.

[00:10:07] Those are all conversations that happen very early on in the discovery process. And in parallel, you're looking not only at the tech stack, you're looking at the financials, you're looking at the, go to market sales process. You're looking at the market messaging process of the target company.

[00:10:25] You're looking at how do they develop software as a software business and you make sure that those operational processes, can in fact be complimentary to your own.

[00:10:37] The other thing as well, I know that it might sound repetitive. you've been mentoring me for years about these topics, and one of them that we keep discussing is the internal dysfunctional behavior that comes in post the deal, before closing the deal, all you can do is just do an assessment, interview people, and that's it.

[00:10:59] But the actual discovery happens once you sign the deal and you start integrating the teams, the product. And also you mentioned previously in other discussions, that, If we're acquiring a company because we want market access that would be a different approach. But if you're acquiring a company because of the technology, then this will require a different way of thinking. Can you please give us, manner, what kind of integrations? I'm sure there are many, but the top two or three types of integrations and how to deal with them. What kind of approach

[00:11:38] Yeah.

[00:11:38] an executive take to overcome that challenge?

[00:11:43] So if we continue to expand on this question around acquisition, it's my belief, it's been my experience that when you acquire a business, rarely do you acquire just the technology, just the customer base.

[00:12:02] you're always acquiring people. Now let's give an example. One that comes to mind for me.

[00:12:09] You're looking to acquire a early stage business. It's got 20 employees, half the employees are engineers. The rest are sales, marketing, product management, and general administrative staff, the CEO, the office manager, et cetera.

[00:12:32] One of the things I would do in parallel with the due diligence of technology business operations is, I'd actually get the founder in a room with myself, and I would ask that founder, of your 20 people, who would you keep and who would you let go? They're gonna give me a set of names, and I would not accept, keep them all for an answer.

[00:13:01] only because every business has, its A players, B players, C players, D players. And let's face it, as a human being, it's actually very difficult to fire people. That's not the easiest thing. Most executives wait far too long before terminating a poor performing employee. So somewhere there's fat in the system.

[00:13:25] By the way, the fat could also be on my side. So it's possible that I keep people from the acquired company, but I let people go from my side of the, equation.

[00:13:40] In talking to the CEO of the target company, about who stays, who goes, I'm not only looking for, business skills and technical skills, I'm also looking for personality fit. So if somebody has a, difficult time taking direction, if somebody has, this grievance attitude where they're just never happy, it almost doesn't matter how good that person is, they become a problematic individual to the smooth running of the business.

[00:14:14] And you have to think really hard about whether or not you take on that kind of, challenge. 'cause it could really, slow you down. So that's the personnel side of the house. While that process is, occurring, while that conversation is unfolding, the other thing I would be asking the target company management team is tell me about your plans for growth.

[00:14:38] Tell me about your plans for operating efficiency. Tell me about your plans for profitability. what I'm looking for in the conversation is a set of numbers, what I call KPIs, key performance indicators. So if you tell me you plan on growing 20% this year in top line revenue, I want to take that into account and see how does that mesh with my own top line revenue target, and I'm going to start measuring that team day one after the transaction's completed.

[00:15:17] On a set of key performance indicators, maybe it's a 20% growth in revenue, maybe it's 15 that's gonna get decided between the combined teams. On the technology front, I might use a KPI delivering a software release in the next two weeks or being on a two week release cadence. So there are ways that you can

[00:15:44] create numerically driven results driven key performance indicators to track the quality and the performance of not just the acquired team, but the entire combined team of bringing two companies together. When you bring two companies together.

[00:16:09] Thank you What about just building on that same, answers that you've been talking about. What about if we have, let's say, Two CTOs of, a similar product that are clashing with each other do you deal with that? We mentioned also previously, we were discussing scenarios where just makes sense not to integrate the company, it as it is, as a subsidiary, just align the products and the experiences. would that kind of strategy be applicable and useful? when you are working on an integration process, and will you realize that before the actual acquisition, or you need to be flexible and decide after closing the deal.

[00:16:57] Yeah, you raise a very good question, and I'm gonna answer it from certainly my own personal perspective. I think that if the acquiring company is less than 500 million in US revenue, whoever you buy, you are going to integrate. You're not gonna leave them alone. Going back to my original example, buying a 20 person company and leaving it alone as a independent subsidiary, I just don't see that happening on a regular basis that seems to be a very outlying condition because by default, as you're building your business, the acquiring company.

[00:17:41] Again, you're back to building a team of people. You're back to building, scale, growth and efficiencies in that operation. So having a subsidiary that's operating independently is actually a really good way to waste money. So you wanna be able to make the integration happen, almost as fast as you possibly can inside of 90 days if you don't have a 90 day plan to do a full integration.

[00:18:08] You're doing something wrong, in the question you've posed directly. Having two CTOs, that's gonna get rationalized. If the company that I'm acquiring is much smaller, that CTO might have a new title, could be the VP of engineering, but I'm not going to have two CTOs, right? One of them will be CTO and the other one will either leave.

[00:18:34] Because they can't stomach the demotion, or they'll look at the opportunity to say, okay, I'm actually a VP of engineering for a bigger combined opportunity and I want that job. So when you acquire a business, when it comes to people, I don't want people that are gonna be dissatisfied. If you want to be here, please stay.

[00:18:58] Let's find a role for you. If your ego is too bruised by the acquisition, let's decide what the soft landing is for you and get you on your way to your next career.

[00:19:11] now this brings another question as well, which you have sold these companies, you've experienced it from the entrepreneur's point of view, from the investor's point of view. what also you've done is that you invested these two companies that you've taken, or facilitated taking public, from very early, stage of their life cycle. witnessed the whole growth period or, throughout the stages. What's one thing that, you feel is very common many of these startups that go through that journey, that reaches that level of being able to go public? I understand there is no clear formula, but, there are things that you sense, that you see within a company that you know what this is the right team and if they don't have these elements, it's very difficult for them to go public. Are you able to pick these traits or these skills or some kind of a formula,

[00:20:12] I can. Yeah, I certainly can. I would say that when I think about the companies that I have invested in when it was just three co-founders and an idea, or I think about companies I've invested in that had, $5 million of top line revenue and growing. And when I think about companies where I've been, an integral part of the IPO journey, or even a large company that was acquired by an even larger magnificent seven size business, they do have common points in each and every one of 'em. I would say the first is, they have a good product or a good service, something that the market wants. And it's a large market. It's a multi-billion dollar market. And if you can become, an important provider of services or products to a very large market, and you're now approaching, 10 million, 50 million, a hundred million.

[00:21:23] Some interesting things begin to happen for the business. usually at a hundred million, at least in the United States, that represents a level of revenue that could be interesting for an IPO. Anything less than that, it's too early. So if you're a sub hundred million dollar business. The next likely exit strategy is you're either acquired by a larger organization or you continue to raise money and you continue to grow the business and do all the right things to make a better and better company.

[00:22:01] And that leads us to the second, common trait, and that's the team. So I could be a founder of a company. I could maybe do 2, 3, 4 acquisitions. We get to 50 million in revenue, and it might actually be possible that I am not the CEO, even though I've founded the business, made some acquisitions, not everybody scales past a certain level of size.

[00:22:33] So great teams are comfortable with change. And I'll tell you, there's a very recent, situation that I've been involved in where the company is in the cybersecurity space. It's a, secure cloud offering, business. The company does about $120 million a year in top line revenue, and with the exception of the founder, CEO, the entire management team has changed four times.

[00:23:07] So new CTO new CFO. New general counsel, new VP of sales, all of them changed. because as you're building a business, as the business grows, not everybody can scale with you. They can't keep up, and that doesn't mean they're bad people. It just means that their skillset has been outpaced by the growth of the company.

[00:23:35] And then the third commonality is you have investors that comprise your board of directors, that give you good advice. And, just because somebody's a venture capitalist or a private equity, director doesn't always mean they're infallible. Some investors like to wait. They wanna get greedy. That's, and I mean that in a complimentary way.

[00:24:02] So a company's at a hundred million and the question comes up, should we go public? And the investors say, no. Let's wait until we're 200 million before we go public. We'd be leaving too much money on the table. they're not wrong, they're not right. That's just their opinion. And the timing certainly has a lot to do with it.

[00:24:21] So in today's current climate, you want investors that are savvy, that have gone through several cycles of economic, up and down. And in today's market, I think I would say to a company, if you're not ready to operate as a public entity, don't go public. Go raise more money from private equity, continue to build a business, continue to make it more efficient.

[00:24:51] when you can get very good at predicting month on month sales numbers, month on month EBITDA margins, then let's have a conversation about going public. That's the strongest, in my opinion, that's the strongest condition on which to go public. If you can't raise private equity money. Then going public is in fact a way of raising money.

[00:25:22] And I'm also reminded, there's a small company that I'm affiliated with that, at its zenith, it was doing well over 200 million in revenue, as certain, products that they had exclusive rights to became genericized. That 200 million dropped to below 100, they could not raise any more money from private equity, so they went public.

[00:25:50] But their stock price today, they opened at, about $5 a share. They're trading today at under three $53 and 50 cents a share. Going public does not guarantee you're going to be successful. It's just another form of raising capital. So that third point is really important, is whoever your investors are, they need to have the ability to stay with you over the long haul.

[00:26:23] And if not, they need to help you find the appropriate way to raise money to keep the business going. And position it for its best outcome. If in fact an IPO is the route that makes sense.

[00:26:39] You mentioned previously as well there are scenarios where, the investors decide, you know what? We're taking our shares back off the market. We're buying all the shares and taking it private again. What kind of, scenarios do trigger that? Let's say if someone, if a company does that, first question is, can they do that? let's say for example, there is a company in the US coming into the Middle East or getting into Africa, potential targets to acquire to enter a specific market, and that company is either public in their local stock exchange or if they're not, they would go ahead and negotiate and acquire them. are the complexities that are added when either the acquiring company is public or the local company is public? I don't have an answer and I don't honestly expect you to have an answer on the Middle East or Africa, just wanted to ask, maybe you could, raise our awareness as well from your experience on what to look for.

[00:27:42] So I've been very directly involved with one of those transactions that's known as a take private transaction. Whenever a company is on a public stock exchange, let's use the NASDAQ or the New York Stock Exchange as an example. Anyone can come in and buy shares of that business. It's not unusual in the specific example that I'm thinking about that I was directly involved in.

[00:28:09] We were a public company. We had been a public company for almost four years. We were actually doing okay, not bad. We were above our IPO price. And one of the challenges for a business when you go public is there's a significant amount of financial overhead that is brought about by the, mandatory reporting requirements of the Securities and Exchange Commission.

[00:28:42] So your accounting process is much, much more rigorous. It takes a lot more people, it takes a lot more sophisticated systems. It's a cost. And, if you miss your sales numbers, it impacts your stock price. If you miss your profitability numbers, it impacts your stock price. If you make an acquisition and do a terrible job of integration,

[00:29:05] it could affect your stock price. So there's a lot of, operational excellence that's demanded of being a public company, and sometimes that presents an opportunity to large private equity players. Examples of large private equity players could be, Toma Bravo that manages several billions of dollars of assets.

[00:29:32] Vista Capital, Marlin Capital, platinum Venture. There's a huge number of private equity firms that love to look at public companies and say, I think it would be better if we could buy that business and take it private, take it off the exchange. Now it no longer has mandatory reporting requirements.

[00:29:57] We can actually start to fine tune the business, maybe tuck in some acquired companies in our portfolio that are complimentary, and instead of having a $400 million business, which we bought private, we buy it private, we're gonna pay a premium. Maybe we pay 600 million for the business, but by the time we're done with it, 2, 3, 4 years later, we now have a company that's now worth a billion dollars in top line revenue.

[00:30:32] we can take that company public for an even bigger return. So taking private for the right reasons could be another useful tool for financial investors.

[00:30:46] Thank you, Ed for the clarification. we'll end it with one question and then, one general question that we ask all of our guests. So last question I've got you spoke earlier about the metrics and KPIs, and you've been advising private equity firms as well and even VC backed companies, all of that experience, what are the top three or four you look at, especially post-acquisition?

[00:31:18] so we're talking about, post, closing the deal, during the integration process. What are those KPIs, that you're looking at? And with the C levels, I'm assuming, you've got the CEO, you've got the CFO, you've got, whoever's in charge of engineering and the product, and then you've got whoever is in charge of building the system operations. We're assuming it's the COO. So out of those four, how would you hold them responsible or what kind of KPIs you'll apply to them?

[00:31:48] So post acquisition, I'm going to assume for the purpose of this interview that we've rationalized the combined teams. So I don't have two CFOs. I don't have two general counsels. I don't have two CTOs. I've got one of each. Wherever they come from. Whether it's the acquired company or the acquiring company.

[00:32:12] So in my mind, the minimum team that I think about is the chief operating officer, if you have one, the chief revenue Officer. So the head salesperson. The CTO, if you have one. Or it could also be just a VP of engineering. There's the head of marketing, usually a vice president if the business is big enough, could also be called a CMO, chief Marketing Officer.

[00:32:45] If we're talking about a software business or a product business, you probably have, a head of customer success could even be a head of professional services. So you're gonna have somewhere between five and eight key people. And what I would do is, this is usually going to be around the budgeting process.

[00:33:08] I would get all of those people in a room and I would say, let's take a look at our results for last year. Last year, we ended the year at, I'm gonna make up these numbers to make my point. Last year we ended the year with a top line revenue of 100000010% profitability to the bottom line. So 10 million to the bottom line.

[00:33:35] We need to present a plan to the board for this new year where we see 30% growth. At the top line and maintain at least 10% EBITDA. I'd like you all to go back to your respective departments and figure out how we're going to make that happen. Now there's a lot more conversation obviously than what I've just said.

[00:34:05] and we do that planning process together. But let me tell you why it is a 30% top line number and a 10% EBITDA number. There's a rule of performance here in the United States. It's actually across the globe if you're a SaaS company. So software as a service, a healthy, growing, meaningful company in that, category,

[00:34:35] is operating to what they call rule of 40 or rule of 50. So let's use rule of 40. That's actually pretty common. Rule of 40 says some combination of your top line growth and your EBITDA growth adds to 40. So 30% top line, 10% EBITDA. There's your rule of 40 right there. Could it be 20 and 20?

[00:35:03] Yes. Could it be 10 and 30? Yes. why would you have a 10% top line growth and a 30% EBITDA? You're probably a very large company. Your growth curve is slowing down. you're probably 500 million in revenue. So when you take 30% of 500 million. That's $150 million. Hard to grow that fast in one year organically, right?

[00:35:35] But you could be more profitable, right? So in this very simple example, when you see a slower growing business, it means it's a larger company, and you expect it to throw off more profit. If you see a company that's growing at, let's say. 40% top line and break even EBITDA. That's a fast growing company,

[00:36:04] in a fast moving space. I expect a lot of the AI companies, the AI startups are going to be of that nature, right? The growth curve at the top line, the revenue is substantial and we don't really care about profitability at the moment because it's a land grab, to see how much market share I can get.

[00:36:26] So I would tell those executives, here are the reasons why we are setting these KPIs for, revenue growth, ebitda. And I'd also say to every executive, every year, stack rank your employees and cut out the bottom 20%. Because every year there's always room the quality of your team. And whenever an executive says to me, I don't have a bottom 20%, I would call bullshit on that state.

[00:37:02] That's an executive that should not be an executive. You always have fat. That's just people.

[00:37:12] And I would hold those executives to those top two KPIs, revenue and ebitda, and I would ask them to create sub KPIs specific to their departments. So if you're the salesperson, you say, yes, I'm signing up for a 30% revenue growth and I'm going to hold my salespeople accountable to, gross margin of 80%.

[00:37:43] Why would I do that if I was head of sales? Salespeople love to give discounts to close the deal and sometimes those discounts are not necessary or they're very generous. So I've seen salespeople say, it's the end of the quarter and actually this is a good time for this question, ot. 'cause it's April 30th. if I can get you to sign this contract today. I'll give you 20%. Why 20% discount? Why not five? Why not 10? Salespeople, they love to get to the easy Yes. Which is a terrible attribute. So if I'm the sales executive, I will say to salespeople, you can give a discount up to 10%.

[00:38:33] Anything beyond 10% has to come through me. I need to maintain that profit margin. So with every executive, whatever that subset of KPIs are, I want them to own the development and own the management of those KPIs 'cause their bonuses are gonna be tied to that. And when I go to the board to get the budget approve, I'm declaring the 30% growth number, the 10% EBITDA number.

[00:39:05] probably a dozen KPIs that will drive whether or not bonuses get awarded to the top executives in the company. And I would make sure that those executives also say your departmental KPIs affect the bonuses of your employees. So if the engineering department can't deliver

[00:39:27] software updates every two weeks. Let's say they do it every three weeks, instead of getting a hundred percent bonus, maybe they only get a 50% bonus. So I wanna use those KPIs as incentives to get people to work smarter, not just harder, smarter, harder, and making the difficult choices to keep the business healthy and growing.

[00:39:58] Thank you, Ed. This helped us, in the discussion to cover two main of failure when it comes to m and as one of them is dealing with people and culture, which you touched on, which is a very critical aspect to look at acquiring a company post-acquisition. And then, okay, you align the people.

[00:40:18] Now how do you align their interest and values that they can deliver and you increase the chances of success to this acquisition that you've done and the money that you spent. Which gives us, an excellent overview. Thank you so much, Ed, for taking us through these experiences.

[00:40:35] Amazing. Thank you, Ed. Thank you.