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Business Development

But screw your courage to the sticking-place, and we’ll not fail.
—William Shakespeare, Macbeth

In my last post, I described how, at Opsware, we would step back from the fray about once a year to go through a strategic review of our situation with the board. In November 2005, our conclusion was to keep on building an independent company, but in early 2007 another review led us to a different conclusion. Our business was strong, but meeting quarterly expectations was difficult and the market wasn’t rewarding us for the growth and leading market position we had achieved. We were at a decision point: Plow even more money into R&D and sales expansion or explore a sale. We decided to explore a sale, but only if we could achieve a top-dollar price for our shareholders.

The dance begins: May 2007

Our February update meetings with the major enterprise IT players had piqued their interest and led to several follow-ups.  The key was to get someone to set an initial price. On May 22, we went back to the Opsware board with an update. A company we’ll call Company 1 had just offered to buy the company for $11/share. That was a 38% premium—good, but not exceptional. Once again, we discussed the opportunities, risks and shareholder value implications of continuing in the business. We debated long and hard: What was our number?

We decided to send a strong message to anyone considering us as a target: We told Company 1 that the Board had rejected its $11/share offer and would not give serious consideration to any new offer below $14/share. For good measure, we took the opportunity to notify the other companies who’d followed up with us (HP and several others) that we’d received an offer but were not interested in discussing any deal below $14. Since that was a 75% premium over our current price, Company 1, HP and everyone else told us they were out. We sent all of them letters requesting the return or destruction of any information we had shared. Those brief dreams of exit seemed to be just that—dreams. We went back to the slog of making yet another quarter.

Then, almost a month later, the CEO of Company 1 came back offering $13.25/share. Yes! We were getting close to our magic number! We reconvened the board for a serious, fact-based discussion of staying the course versus selling in this price range. Our analysis suggested we would have to grow revenues at least 75% annually to exceed $15/share. That seemed impossible—Wall Street consensus was 28%.

In addition to upside opportunities, we discussed the risks of staying standalone. (Note #6, macroeconomic slowdown: We had no idea how real a risk that would turn out to be just months later.)

It was clear: We should exit. We decided to stick to our guns and drive for a deal at $14/share, leveraging competition and urgency to get there. The first step was to get Company 1 to $14, which we did two days later. Then we notified the others, notably HP, that we had an offer at $14. A whirlwind of meetings and calls followed with the various contenders.

While we had discussions with 10 companies, by July 18 it became a two-horse race between Company 1 at $14.05/share and HP at $14.25/share, each acutely aware of the other’s interest. To keep up the pressure, we negotiated detailed agreements with both in parallel right up to the end, with a real prospect of getting to $15 or more. Although exhausted, we were on a massive emotional high—this was going to be a fittingly impressive end to an eight-year odyssey!

Crisis strikes: July 18

Then, with 24 hours to go, we had an inconceivably ugly crisis. In diligence, Company 1’s auditors, Ernst and Young (EY), challenged the way we had accounted for three customer contracts, despite the fact that EY was also our auditor and had ordered this accounting. Unbelievably, two regional offices of EY were disagreeing with each other. Called to arbitrate, the national office sided with Company 1’s regional office and informed us we would have to restate our publicly-filed financials for the past several years! While the issue was entirely technical and the amounts immaterial, the prospect of a restatement was horrifying. Not only had our glorious deal suddenly vaporized, but by chasing it we’d triggered something that might panic investors and cut our stock price in half. In the blink of an eye, our likely outcome had plummeted from $15/share to maybe $4/share. We were devastated.

Company 1 was seriously spooked and asked for a couple of days delay. We knew we’d have to tell HP. We put the best face we could on it—“technical issue, immaterial amounts, no impact on value, etc.”. Hearts in our mouths, we waited for their reaction. To our intense relief, they reacted with concern but didn’t walk. However, our leverage was gone and our deal seemed on the brink of collapse.

Our only hope was to get the three customers to agree to a minor change in their contract language that would enable the original accounting treatment. Theoretically possible, but we were almost out of time, and these were huge corporations. Working through the night in a hot stuffy conference room, we started emailing and calling our executive contacts. Unbelievably, in a testament to the strength of our customer relationships, all three mustered their attorneys and got it done in 24 hours. Restatement avoided! We were back on track—but with only one bidder currently left at the table. Could we still get it done?

Psych test: July 19

Perhaps sensing advantage, HP execs suddenly dropped their offer to $13.75 in a tense 3 pm meeting the next day with Ben and me in their executive offices. We were furious, but we had come this far and we had no other live bidder. Maybe we should just suck it up and accept that EY’s ineptitude had cost us a few hundred million dollars?

Then, thinking on the fly, we realized it wasn’t that simple. How we reacted would be critical, not just to the deal price but to the very survival of the deal itself. Anything less than an unequivocal rejection would signal to them that they were in the driver’s seat. If we were now willing to accept $0.50 less per share, then why not $1 or $2 or $3 less? If there was really no one else at the table, why not drag out the process and wear us down? After all, this was a very expensive deal—why not terminate and restart at a much lower valuation?

We knew HP was the only one currently at the table, but they couldn’t be sure of that. We knew it was time to “screw our courage to the sticking-place”. We informed them that we had scheduled a final board meeting for 6:30 pm and we would not be recommending the deal with HP for anything less than the original price.

With Company 1 still AWOL and no word from HP, we started the board meeting. What the hell were we going to tell the board? Had we killed our deal over 50 cents a share?

We needn’t have worried. By 6:35 pm, my cellphone was lighting up with calls from HP’s M&A guy, worried they were about to lose the deal. We made him wait. When I finally called him back about 7 pm, he told me they were willing to offer $14.05. Ha! Although some board members and fellow execs strongly urged us to take it, we resolved to go back for the final 20 cents as a matter of principle and to preserve the crucial psychology of a hard-won deal. Fifteen minutes later, we had an agreement to sell Opsware to HP for $14.25/share in cash. We were drained, but elated. Our eight-year journey was at an end.

In summary

Although we never built Opsware with the intent of selling it, acquisition ultimately turned out to be the best outcome for our shareholders and our employees. While the company was clearly an attractive target, the significant premium we achieved in the sale was also the result of the company’s ongoing investment in strategic business development and a tightly executed deal process. And in knowing where the exits were.

So you got to let me know
Should I stay or should I go?
—The Clash

To lead you to an overwhelming question….
Oh, do not ask, “What is it?”
Let us go and make our visit.
—T.S. Eliot, The Love Song of J. Alfred Prufrock

Taking the exit

On July 23, 2007, HP announced it was buying Opsware for $1.6 billion in cash. By any measure, it was a very attractive deal for Opsware shareholders. The acquisition price of $14.25 a share represented a 74% premium over the prior six-month average, and a forty-fold return for anyone who had bet on us at our low point in October 2002, when only an intensive investor relations effort had saved us from NASDAQ delisting. Almost five years later, the acquisition multiple of almost 16 times trailing revenue still far exceeds that of any other billion dollar-plus enterprise software acquisition—ever.

The hard work of hundreds of employees contributed to making us the clear high-growth market leader in what was finally an important enterprise software category, but the significant premium we achieved was also the result of a multi-year, strategic business development effort designed to turn a merely good outcome into a truly exceptional one. That business development effort was built around five key principles that you, too, should consider as you build your company:

  1. Always know where the exits are: Take the time to build relationships with potential acquirers. You never know when you may need them.
  2. Step back from the fray occasionally: Review the company’s strategic situation with the board every 12-18 months and evaluate the alternatives with quantitative and qualitative rigor.
  3. In evaluating your alternatives, ask yourself how you would feel if the environment were to change radically: Days before we signed the HP deal, the Dow hit 14,087—its highest level ever. Within months, hedge funds and mortgage companies started imploding and we entered the worst recession since the great depression. Just three months later, a sale at even $8/share would not likely have been achievable.
  4. If you do decide to sell, a meticulously executed competitive process is key to a successful M&A outcome: This SEC proxy statement description of Opsware’s process details discussions with 10 companies, stretching over nine pages. Every one of those contacts was tightly scripted and carefully orchestrated to drive to the ultimate successful outcome.
  5. Creating and managing the acquirer’s psychology is critical: The key is subtly to convince the acquirer that they have no option but to acquire you, but that you have multiple attractive alternatives—and to reinforce that impression in every interaction, no matter how small, until the deal is definitively done.

“Your best exit may be behind you”

As I’ve discussed in previous posts, the best CEOs leverage strategic BD to cover critical flanks not well covered by other functions—helping to navigate crises, driving acquisitions and strategic partnerships, leading international expansion. No great entrepreneur sets out to build a company to be acquired, but as the company grows, it’s important to have options and to understand them well. Perhaps the most important role of a strategic BD exec is proactively to make sure the company always has options and that the CEO and board always know where the exits are. They tell you on an airplane that “your best exit may be behind you”, but that’s not something you ever want to hear in business.

Stepping back from the fray: November 2005

At Opsware, 90% of our board discussions were naturally about the day-by-day work of building a great company: quarterly bookings, wins and losses, product plans and challenges, financials and so on. However, about once a year we would make a point of stepping back from the daily battle for a more strategic review of our situation. As part of this review, we would address more fundamental questions.  For example:

  • How do we feel about our market?
  • How is our competitive position?
  • Who are potential acquirers of the company, and what’s their current state of mind?
  • What are the major opportunities and risks facing us?
  • Bottom line: What’s the likely value of staying the course versus exiting?

Prior to these board discussions, we would make a round of senior visits to HP, BMC, Oracle, EMC and other behemoths to give them an update on the business.  While our ostensible purpose was to explore the potential for a partnership, our real objective was to understand (and pique) their interest in our space and to make sure we’d have an open door if we should ever decide to explore selling.

I’ve linked our board presentation from November 2005 here. As you can see, it’s a pretty thorough analysis. Here’s the executive summary:

In other words, let’s keep marching!

Stepping back from the fray: February 2007

In early 2007, Marc Andreessen, Ben Horowitz and I made another set of visits to the usual suspects in preparation for a new strategic review with the board. We had made major progress since we had seen them last: exceeded $100M in annual revenue, fired up a productive distribution deal with Cisco, added storage automation, expanded internationally. As before, we went through a pretty slide deck that showed a winning company in a strategic category, with a final slide that mused vaguely about partnership. Left hanging in the air at the end of some of the meetings, we could sense the “overwhelming question” in the mind of the big company CEO: “Should we buy these guys before someone else does?” Several of them requested follow-up meetings.

For us, too, the possibility of actually selling the company was of more than theoretical interest this time around. Meeting Wall Street’s expectations was still a challenge every quarter. Our one serious competitor, BladeLogic, was about to go public. Despite five years of strong execution, our own stock price seemed stuck in a narrow band around $8/share due to continued heavy investment in R&D and sales expansion. Strategically, we were now at a critical juncture: Invest even more heavily in new capabilities like monitoring and enhanced support for virtualization—or capitalize on our current position and the strong interest from acquirers. That exit looked pretty tempting.

That said, selling for a typical enterprise M&A premium of 25-30% didn’t feel compelling to us or the board. We hadn’t escaped the jaws of death and worked this hard, for this long, to build a great company, only to sell it for 10 bucks a share. We were resolved: The only way we’d consider selling was for a price much higher than what we felt we could achieve in the standalone case.

Here’s the recommendation from our February 2007 board update:

That led us into a dramatic three-month dance with a series of suitors that would test our negotiating and business skills, as well as our resolve.

Next up: The dance begins

SUNNYVALE, Calif., June 2, 2003
HP and Opsware Inc. Join Forces to Deliver Enhanced Automation for HP’s Utility Data Center

SUNNYVALE, Calif., Feb. 13, 2006
Opsware Announces Worldwide Distribution Agreement with Cisco

These two headlines sound pretty similar—“Small company partners with giant company to reach a bigger market”—but they led to two very different outcomes.  Our 2003 deal with HP didn’t generate a single dollar in revenue, whereas our 2006 agreement with Cisco drove tens of millions of dollars in sales and helped to make Opsware the uncatchable leader in data center software.  Why did one succeed spectacularly while the other never took off?

As a startup with the best product, your challenge is often getting it in front of enough customers and getting them to buy.  In theory, striking a deal to have an HP or an EMC or a Vodafone sell your product to their customers is the way to cover the market and exponentially increase sales velocity.  In practice, however, most “David-Goliath” distribution deals turn out like our 2003 HP deal: great PR, but not much else.  Here’s the way it typically plays out:

  • The deal is announced with great fanfare and high internal and external expectations.
  • Goliath needs product changes, training and lots of help to even attempt to sell your product.
  • Goliath deluges your already overloaded people with feature and support requests.
  • You can’t justify assigning dedicated people to support Goliath because you can’t bank on any new revenue.
  • Goliath sells nothing, or even worse, ends up competing against your sales team for customers you would have won directly at a higher margin.
  • The “partnership” quietly withers away, leaving a damaged relationship with Goliath and a bad taste inside the company.

The temptation for some startups is try to “make it up in volume”—sign as many distribution partners as possible on the basis that none of them is likely to deliver much on their own.  While that degree of over-coverage might feel temporarily reassuring, it only multiplies the challenges exponentially in practice.  The only thing worse than having no partners is trying to manage multiple ineffective partners competing with each other in the market and drowning the company with their demands.

In my experience, one well-constructed, high-impact partnership is better than a hundred run-of-the-mill arrangements.  Distribution partnerships take an enormous effort to make work.  It’s just not realistic to have many of them, which is why picking the right one and constructing it intelligently is fundamental.  At Opsware, we only had one significant distribution relationship over eight years, but it had a massively positive impact on the company.

Time to find a partner

It was early 2005, and things were starting to go pretty well for three-year-old Opsware.  We had just closed our $33 million acquisition of Rendition Networks, giving us a lightweight but powerful network automation software product that we christened Opsware NAS (Network Automation System). NAS would allow us to penetrate and rapidly deliver value to new accounts, then upsell them to our considerably heavier and more expensive Server Automation System.  (Our average NAS deal size was $115k, took a month to sell and a couple of weeks to deploy, whereas SAS deals averaged $765k and could take a year to sell and six to twelve months to deploy.)

It made sense to market and sell NAS as aggressively as possible—but we faced a challenge:  Our direct sales force was small, only covered US and UK, and had few relationships with network buyers.  We needed a big partner with the buyer relationships and global coverage we lacked.

The right partner

The right partner was obvious:  Cisco.  So was the product: NAS.

Thanks to our investment in strategic BD (see Part I and Part II of this series), we’d been calling on Cisco since the founding of Opsware, from the C-suite to mid-level data center managers.  Now we finally had something to talk about.  For all its pre-eminence in router and switch hardware, we knew from customers that Cisco’s management software capability was weak for its own devices and non-existent for, say, Juniper devices in the customer’s network.  We had the market-leading, cross-platform product.  Within days of closing the acquisition, we visited the Cisco SVP responsible for management software and offered him the solution his customers were demanding.

Mission clarity

Before you can construct a high-impact deal, you have to be crystal-clear on what you want to achieve.  We spent a substantial amount of time up front to achieve internal clarity and consensus across the company on what we wanted from a partnership.  These were our main objectives:

  • A real commitment by Cisco to market and sell a lot of NAS product, at an attractive margin to us.
  • Opsware’s right to target every Cisco NAS customer for an Opsware SAS sale.
  • Opsware branding on the Cisco NAS product.
  • Minimal product changes and a single code base.
  • Enough assurance of financial potential to allow us to invest in the support Cisco would need to succeed.

In a seemingly endless series of meetings in Cisco’s blue-gray conference rooms over the spring and summer, we gained a good understanding of Cisco’s main objectives.  They wanted:

  • The ability to sell NAS to any Cisco account, with active support, not competition, from Opsware.
  • Cisco-branded product.
  • Freedom to sell at any price they chose, including throwing in the NAS software free as part of a big equipment sale.
  • “Insurance” against a surprise acquisition of Opsware by a competitor.
  • Access to Opsware NAS source code, and even the ability to make derivative works.   (As you might imagine, this one caused us a lot of heartburn.)

All through the fall and early winter, we shuttled back and forth between Tasman Drive and Opsware’s office on Mathilda Avenue, alternately negotiating a deal structure with the Cisco software team and updating and strategizing with our sales and product organizations to make sure we were staying true to our objectives.  Some issues, like source code, were extremely complex.  Nonetheless, like a figure emerging from the fog, a compelling deal gradually took shape.

On February 13, 2006, a year after closing the Rendition acquisition, we announced a worldwide distribution agreement with Cisco.  Cisco’s enterprise sales force would sell our NAS product, rechristened Cisco Network Compliance Manager, to their worldwide customer base.  Opsware’s sales force would follow their Cisco counterparts, supporting their efforts to sell the network product and in the process building the relationships and laying the groundwork for a subsequent million-dollar-plus server software sale.

Behind the headlines – a deal with teeth

While the press and public endorsement by Cisco were valuable, what made this partnership work unusually well in practice was a smart deal structure designed to achieve both sides’ objectives:

Minimum revenue commitment:  It took us almost nine months, but we persuaded Cisco to make a binding three-year quarterly revenue guarantee that totaled almost as much as we had paid to acquire Rendition.  We helped our Cisco counterparts to understand that this would be a win-win:  Guaranteeing several million dollars a quarter to Opsware would give Cisco huge motivation to drive sales.  In turn, it would give us the assurance we needed to back off our own NAS sales efforts and do everything—including assigning some dedicated sales and product headcount—to make our partner successful.

Substantial revenue share: We secured a revenue share and pricing floors that made a Cisco NAS sale almost as financially attractive to us as if we had sold it directly—because Cisco could actually charge more for the software than we could.

Co-branding:  The product was marketed as Cisco Network Compliance Manager, “built on Opsware automation technology”.

Channel-neutral compensation:  To motivate Opsware’s sales people to support their Cisco sales counterparts instead of competing with them, we compensated them for every Cisco sale in their territory.  While this cost us real money, it made sense because every Cisco sale opened the door for us to sell a much bigger, higher-margin product.

Acquisition insurance:  We committed to give Cisco advance notification of any agreement to sell the company, and the opportunity to enter the bidding if they wanted to.  (Note this is very different from a Right of First Refusal.)

Source code license:  We gave Cisco a three-year license to view our source code and build on it, but came up with an innovative licensing approach that protected us fully and even generated millions in additional revenue.  In any case, we bet they would never actually do anything with the code, and we were right.

Goliath delivers…

Within nine months, Cisco was selling large network software deals into accounts like DHL, Costco, Sprint, USPS and Telstra, and a short time later, they were selling enough to exceed the quarterly minimum revenue guarantee to Opsware.  The Cisco deal would go on to generate over 25% of our bookings.  Cisco’s massive distribution power vaporized our NAS competitors.  Just as important, every NAS sale opened the door for our SAS product in accounts we had never penetrated before, providing a major thrust to our high-margin server business.

Seen in a Cisco corridor

with a little help from his friend.

Of course, there were many challenges along the way.  Cisco people needed lots of training and support to sell the product.  There were occasional conflicts over accounts that had to be arbitrated.  We ran a separate weekly pipeline call with Cisco to track and drive their sales and direct our follow-on server sales calls.  Product change and bug fix requests from Cisco had to be triaged and folded into our roadmap.

However, we were able to handle these demands with equanimity, because we had a couple of dedicated heads in sales and product management to handle them, and a large guaranteed revenue stream that helped the whole company to realize this was a deal worth supporting.

In summary

Like Opsware’s 2003 HP deal, the vast majority of David-Goliath type distribution deals don’t deliver beyond PR[1].

On the other hand, like Opsware’s Cisco deal, the right distribution deal with the right partner can be truly transformative.  In formulating your partner strategy, consider four golden rules:

  1. Quality trumps quantity:  One well-constructed partnership will have far more impact, and be far more supportable, than lots of toothless arrangements.
  2. Mission clarity:  Invest the time up front to get crystal-clear on your objectives and those of your partner.
  3. Demand hard commitments:  Big companies are easily distracted.  Binding commitments focus the mind and create incentive to deliver long after the deal is signed.  (Note this means finding a senior executive sponsor with the authority to commit.)
  4. Make hard commitments in return:  You will need to invest substantially in making your partner successful.  Commitments like sales and product support and channel-neutral compensation are worth making in return for the right commitment from your partner.

Only a few startups invest in the ongoing BD effort to systematically cover the landscape of potential partners and create that game-changing partnership when the opportunity presents itself.  For Opsware, that investment paid off three years after our start as a software company.  Like the Loudcloud-EDS deal and the M&A campaign that followed, the Cisco partnership provides another example of the power of strategic business development. 

 

 

 


[1] Note that our objective (and HP’s) for the HP deal was in fact PR, so it met its objective.  It may well make sense to announce lots of lightweight “partnerships” to demonstrate integration and gain market credibility—just don’t expect them to generate revenue, and make sure the company understands that too.

In part I, I talked about how up-front investment in a high-caliber strategic business development function helped to save Loudcloud when an existential crisis hit in 2002.  But the value of strategic business development didn’t end there.  In fact, it was only beginning.

Opsware V1: Single product, single customer

The EDS transaction closed in mid-August, and we started into the fourth quarter of 2002 in much better shape than we’d entered the first quarter.  That said, we still had plenty of challenges.  We were a single-customer, single-product company.  Moreover, the product—software that automated the administration of servers—was powerful but far from ready for broad commercial adoption.  It had been developed solely for internal use by skilled (and somewhat forgiving) Loudcloud system administrators in a controlled environment.  It was difficult to sell and hard to implement, requiring significant process change on the part of the customer’s IT staff.  It wasn’t easily consumable in small chunks, leading to protracted sales cycles and long implementation periods.

Of course, we had 60 great engineers and plenty of cash, and they lost no time starting the work needed to make the software easier for our small but talented sales team to sell.  While they did that, the BD team led the development of what would become a selective but highly productive M&A strategy to turn Opsware into a broad data center automation platform.

Kicking off the M&A strategy

Working closely with the product and sales teams to understand needs and build consensus, we started identifying and prioritizing categories adjacent to our core server automation category and tracking the key players in each.  Together, we developed a set of criteria for acquisitions, including technical factors such as architectural compatibility and APIs as well as non-technical factors like location, team size, culture and financial profile.  As a general theme, we wanted products that fit with our core proposition of data center automation and were compatible with our server product, but were easier to sell and implement, opening the customer’s door for a subsequent server automation sale.  We briefed the board repeatedly to prepare them for specific acquisition proposals to come.  Thus armed for battle, we set forth.

Going into battle

Any good strategy allows for opportunism and, as it turned out, our first acquisition was highly opportunistic and somewhat unusual.  Tangram was a 20-year-old company, publicly-traded on the OTC “pink sheets” exchange, with a market cap of about $10 million.  Their product was IT asset management software, and while their revenues were growing slowly, their 200 enterprise customers were very satisfied with the product.  We seized the moment and picked up $10 million in annual revenue for stock valued at less than $10 million—a bargain.  The deal brought us a complementary, consumable product, 200 new prospects for server automation software and a low-cost base in Cary, North Carolina, that soon became our “offshore” location for support and sustaining engineering.  In short, a good start to our M&A plans, just four months into our new life as a software company.

Our next acquisition, a year later, was much more strategic.  Our customers were beginning to like our server automation product and wanted to know if we could solve their next pain-point: automating the configuration of network devices such as routers and switches.  We identified the four leading players in network configuration management, visited and screened them all, and ran a competitive process to get them competing to sell to us.  (It’s always better to have them trying to convince you to buy than for you to be trying to convince them to sell.)  We got the one we wanted, Rendition Networks, for a combination of cash and stock valued at around $33 million.  In addition to 30 new enterprise customers and a strong engineering team in Redmond, Washington, we would now have an attractive starter product and a combined server-network automation offering that put us further ahead of our only credible single-product competitor, Bladelogic.  Within a year, Opsware Network Automation was generating over 20% of our bookings.  Even better, the Rendition purchase positioned us for a major OEM deal that would further accelerate Opsware’s breakout lead.  I’ll talk about that in the next post.

With servers, network devices and asset management in the bag, storage was the missing piece of the puzzle.  That proved to be harder—there were few storage automation startups to begin with and none that looked like a great fit.  We ultimately did acquire a small startup named Creekpath Systems in 2006 for $10 million in cash, closing their small Colorado HQ and moving a few team members to Redmond.  Unlike our other acquisitions, storage automation proved just as hard to integrate and commercialize as it was to find an acquisition target, and this was the least successful of our purchases.  Notwithstanding that, we now had a unique full data center automation story: servers, network and storage.

Our fourth and final acquisition was in an emerging category called Runbook Automation.  Having automated individual functions such as server provisioning or router configuration, our customers now wanted to automate entire IT workflows across servers, networking and storage, integrating with other systems such as monitoring or ticketing.  Here there were just two viable targets: RealOps in Herndon, Virginia, and iConclude in Bellevue, Washington.  We knew we wanted iConclude, but again a competitive process of negotiating with both companies helped to drive a speedy transaction at a fair price of $54 million in cash and stock in March 2007.  (iConclude’s founder and CEO, Sunny Gupta, now runs Apptio, an Andreessen Horowitz portfolio company).

Although we only made four acquisitions in five years, spending less than $100 million in cash and stock, the M&A strategy played a vital role in transforming Opsware from a single-product player, solely dependent on one giant customer, to a full-suite data center automation market leader with hundreds of enterprise customers.  The acquisitions positioned the company for a major strategic partnership with a technology giant in 2006 and a billion-and-a-half dollar sale to another a year later.

Who you gonna call?

Just like the Loudcloud sale to EDS, Opsware’s M&A strategy relied on many essential ingredients and actors: an aggressive but disciplined management team, outstanding engineering, marketing, sales, legal and finance functions, an acquisition currency and a supportive board.  Again, however, a small effective business development team was there to leverage these assets and drive the process to achieve results while the rest of the company continued to fire on all cylinders.  While we acquired four companies, we evaluated hundreds and gained massive industry insights in the process.

What’s your M&A strategy?  Who’s driving it?

Next up: Strategic Distribution

This series of posts starts off with a short quiz for the startup CEO:

Q: Who’s responsible for developing your product?
A: That’s easy—Engineering!

Q: Who in your company is responsible for selling your product?
A: That’s easy, too—Sales!

Q: Who in your company has primary responsibility for:

  • Mapping and networking your ecosystem?
  • Building long-term relationships and driving deals with strategic partners?
  • Identifying, evaluating and executing acquisitions?
  • Developing and executing your strategy to go global?
  • Working with you to tackle major strategic opportunities, including existential crises?

A: In many startups, the answer to this one is, “That’s no one’s job yet.”  What’s your answer?

Seizing the transformational opportunity

Given the all-consuming nature of a startup, it’s natural to be focused on your own company first, then on customers and competitors.  What’s often under-appreciated is the importance of expanding that focus to cover the other large and small companies around you.

Over the lifetime of any company, there is a handful of potential deals that could dramatically transform the outcome:

  • It could be a high-impact distribution relationship, like Zynga’s company-making relationship with Facebook.
  • It could be a transformational acquisition, like BEA’s home-run 1998 purchase of Weblogic.
  • It could be a deal that saves you in an existential crisis, like the Loudcloud-EDS deal I’ll describe below.
  • Ultimately, it could be a billion-and-a-half dollar exit, like the Opsware sale to HP that I’ll describe in a later post.

Although every company theoretically has access to transformational opportunities, few actually manage to identify them, let alone seize them.  What distinguishes the winners from everyone else is that they are systematically networked into all of the surrounding companies that matter, so they can identify and seize the transformational opportunity when the time comes.

It’s not Sales

Strategic business development is an investment in systematically mapping and networking your ecosystem to drive transformational opportunities.  Although the CEO will be heavily involved at times, it’s not primarily the CEO’s role.  Nor should strategic BD be confused with Sales.  Although very complementary to Sales, it’s also very different in that it doesn’t follow a quarterly cadence.  It’s focused on a very few high-impact events a year rather than a large volume of quarterly transactions, so it should have separate goals and incentives from those of Sales.  Strategic BD should be low headcount and high impact, led by a senior professional operating at a peer level to Sales, Engineering and other company functions.

Strategic BD in action – Loudcloud/Opsware

At Opsware and its predecessor Loudcloud, strategic business development played a critical role in virtually every phase of the company, generating over $140M in direct revenue and contributing fundamentally to the survival and ultimate success of the company.  In this series, I’ll use four examples from 2002 to 2007 to illustrate the unique high-impact role a small professional business development function can play.  In closing, I’ll talk about the characteristics of the function and selecting a person to lead it.

Example 1: Tackling the existential crisis[1]

It was the spring of 2002, a miserable time to be a startup cloud computing company, or managed service provider as we were known back then.  The Nasdaq had peaked at 5,048 in March 2000, collapsed to 2,200 by the time of Loudcloud’s nail-biting IPO a year later, and slid even further following the 9/11 attacks, floundering around 1,800 by March 2002.  In the year since the IPO, the dotcoms who represented half of our customer base had been dropping like flies as the bust took hold.  Our blue-chip enterprise customers and prospects, although highly satisfied with our service, were becoming increasingly skittish about relying on a small Silicon Valley startup for their mission-critical web operations.  After all, much larger, supposedly safe companies like Worldcom and Exodus were turning out to be highly vulnerable to the downturn.  For Loudcloud, “winning” the technical sale only to have the contract vetoed as too risky by the prospect’s CFO was becoming an ever more frequent occurrence.  With revenues and bookings slowing and ongoing heavy costs for data centers, bandwidth, hardware and staff, we were hemorrhaging cash.  After a year of layoffs and draconian renegotiations of our obligations, things were looking grim, but we kept our heads down and soldiered on.

Then came a killer blow.  Our largest customer, a transatlantic foreign exchange trading venture paying us over $1 million a month, suddenly informed us they were shutting down, blowing a gaping 20+% hole in our 2002 revenue.  Marc, our chairman, and Ben, our CEO, interrupted my St. Patrick’s Day family dinner with an urgent summons to meet at Marc’s house.  We had a crisis on our hands and we were going to go bankrupt within months if we didn’t pull a rabbit out of the hat.

We quickly eliminated all of the obvious options:

  1. Replace the revenue?  Impossible in that economic climate.
  2. Cut costs further to reduce our burn?  We had nothing left to cut.
  3. Raise more money?  The capital markets were slammed shut.
  4. Sell the company?  Maybe we could find an acquirer to cover our liabilities, but we wouldn’t return anything to shareholders—and what a tragic waste of talent, time and money!
  5. Shut down?  Perhaps we’d have no choice in the end, but it would be even worse than #4.

As we discussed the sale option, I brought up the business development conversations we’d been having with a number of major IT outsourcers over the past year.  We knew IBM, EDS, Cable & Wireless/Exodus and others were keen to offer advanced managed services to their customers.  They kept losing deals to Loudcloud’s massively superior offering, which was powered by an advanced software automation platform and a super-talented team.  I had been exploring deals with these companies to resell our service, but several thorny issues made the conversations slow going.  Would we end up competing with each other for the same customers with the same product?  How should their offering be branded?  How could we apportion the service level agreement obligations between us?  Could we find enough margin to go around? And so on…

Perhaps inspired by Jameson and Guinness, we asked ourselves an out-of-the-box question: What if there were a way to sell the company without selling the company?  We knew we’d built something important, and we didn’t want to give up, but it was clear this business model wasn’t sustainable.  And so a germ of a deal crystallized in our minds:  Could we convince one of the big outsourcers to buy the managed services business while we kept the software and restarted as a software company?  It was a crazy idea—the managed services business was our entire revenue stream and customer base and was massively unprofitable; the entire IT industry was in massive retrenchment; our software had never been intended for commercial licensing.  But desperate times call for desperate measures, and so the three of us parted that evening with an agreement to give it a try.

In the days and weeks that followed, we crafted and executed a process designed to rouse three conservative, slow-moving corporate giants to action in time to rescue our heroic but beleaguered enterprise.  In a story to be told at another time, we employed the key ingredients of competition, scarcity and unrealistic deadlines to galvanize senior executives at IBM, EDS and Cable & Wireless to drop what they were doing and engage.

Exactly three months later, on June 17, 2002, we announced a deal for EDS to acquire the Loudcloud business—with 50 customers, 140 employees and 100% of our revenues—for $63.5 million in cash.  In addition, EDS agreed to license our automation software, Opsware, to automate their tens of thousands of servers in hundreds of data centers, for a series of quarterly payments totaling $52 million over three years.  We kept 100 employees, changed our ticker symbol from LDCL to OPSW, and started anew as an enterprise software company with no debt, $65 million in cash, a guaranteed $20 million a year in revenue, and one hugely credible customer.  We had sold the business without selling the business.  Within a year, almost all of Loudcloud’s competitors went bankrupt or sold for a few cents on the dollar.

How did we achieve this improbable outcome?  Certainly, we couldn’t have done it without some exceptional advantages, including:

  • Brilliant and committed founders.
  • An industry-leading product, stellar team, reference-able customers, strong brand.
  • A significant dose of luck, including a visionary EDS executive, Jeff Kelly, who was willing to bet on us.

What enabled us to leverage these advantages to save the company in three months was a decision Marc and Ben had made years earlier: to invest in a strategic business development capability.  By the time we needed to engage IBM, EDS and C&W in an urgent dialogue, the Loudcloud BD team had already been engaged in exploratory discussions with them for over a year.  As a result, we knew the executives to target, what their hot-buttons were, the sales deals they’d lost to Loudcloud and what their competitive position was.  Just as important, they knew Loudcloud because we had educated them and their staffs.  If they hadn’t been primed for the discussion, it could have taken six months just to find the right executive and start the conversation—time we didn’t have.

Getting a deal done in three months required a meticulously crafted and executed process, running 24 hours a day at times and involving a few key Loudcloud managers operating in an absolute cone of silence.  We had to turn zero negotiating leverage and big company inertia into high leverage and real urgency.  Each of us had our role.  Every conversation anyone had with the potential acquirers had to be scripted to send the right messages and add to the picture we were creating.  We needed to keep up the competitive pressure.  We needed to share new developments between us rapidly and strategize the next steps in the process at every turn.  We needed to model potential scenarios, craft proposals and counter-proposals, support clandestine diligence and keep the board updated.  All of this while the company continued to try to win sales, serve demanding customers, meet SLAs and manage increasingly unhappy investors.

The process was driven by the business development function.  While the sales guys stayed focused on selling and the engineers on engineering, the BD guys worked on orchestrating and executing the deal.  Ben, Marc and co-founder/CTO Tim Howes (now co-founder and CTO of RockMelt, an Andreessen Horowitz portfolio company) played absolutely critical roles, which they were able to do effectively because they had people running the process who knew the company intimately and whom they trusted implicitly.

Who you gonna call?

When they started the company in late 1999, Loudcloud’s founders could not have imagined the existential crisis they would face less than three years later.  Their decision to invest up-front in strategic business development enabled them to leverage the firm’s unique assets and execute a company-saving transaction when the crisis hit.

Who will you turn to when you face your existential crisis?

Next up: Strategic M&A


[1] My partner, Opsware co-founder and CEO Ben Horowitz, has eloquently chronicled the Loudcloud story in “The Case for The Fat Startup” – appropriately dated March 17, 2010 (St. Patrick’s Day).