First Convo to LOI in M&A Session 1

First conversations

First conversations are extremely important, and people take for granted the amount of work it takes to build up to that point where you can submit a letter of intent. It starts with building relationships and trust and getting to know the company. 

The last thing I want to do is get on an initial call with a target company and immediately say we're interested in buying them. It's more about having conversations about Progress and hearing about their company.

From there, see if we can explore something interesting, such as partnerships or something more strategic like M&A. To avoid scaring target companies away, do not approach them with the intent of an acquisition. 

There has to be a lot of relationship-building and a lot of dialogue. There are times when relationship building can take 3 to 9 months before you even have a conversation that circles around an actual acquisition. 

As these target companies learn more about Progress and get excited about what Progress could mean for the future of their business, they get more and more interested in having that strategic conversation.

When I have an initial call with them, most don't even know who Progress is. As much as I educate them on who Progress is, they educate me on who they are. I take pride in spending quality time with CEOs and companies and getting to know them personally. That kind of effort pays dividends down the road. 

Building relationships

Building relationships is key because you want the target company to trust you and have enthusiasm for engaging with you. 

We had a situation recently where we had been talking to a company for a couple of years. Over the course of that time, they got to know more and more of our team and met the CEO and GMs of our different business units. 

At one point, a light bulb went off, and they gave us the idea of doing something more strategic. It's a better scenario if they bring it up as opposed to me bringing it up.

Giving them exposure to more people within your company gives them better visibility into who you are as a potential acquirer. It gets them more comfortable to have that conversation and introduce you to a broader set of their people. That's how we get to know the company and its team better. 

The importance of people is huge. Having those relationships in place gives you greater conviction and confidence that a deal can be successful.

Milestones

There aren't specific milestones in a relationship. It has to be fluid and depends on the target company and its willingness to engage in those conversations, but it's a learning process. We're learning different aspects of that company, but it varies with each opportunity.

Some might be more formal: they'd give you a demo after an initial call because many companies and CEOs are so excited about their technology. And then you get some of your technical people on a call to see what this technology is all about. 

If my technical team comes back and says they want to learn more about the technology, we can come back to them interested and tell them we should explore it further. So there could be a partnership opportunity for us. 

One of the great things that Progress has is that we have a hundred thousand enterprise customers, and three and a half million developers use our tools daily. And some of these early-stage companies would kill for that kind of distribution. So there are ways to leverage our platform to get these companies excited.

I do not have a formal playbook per se as to how I engage with these companies. But it starts with the CEO of the target company itself or sometimes their lead investor. We can take multiple avenues to get to know about a company, and each situation varies. 

Discovery phase

Discovery is a good way of describing it when we're learning about that company and assessing whether or not this could be interesting. The nice thing about Progress is that we cast such a wide net regarding what we look for across infrastructure software. 

We can look at many things, but it's still important for us to understand what those businesses do and how they could fit within a respective business unit or product progress, and that takes time.

I'm not a super technical person by background, so I depend on the technical experts within Progress to help me evaluate these companies and discover and learn more about them. It's also a great way to weed out what isn't working for us because we tend to have a very broad top-of-the-funnel. 

Through discovery and learning more about these companies, we can narrow it down to a much smaller subset of companies that we want to engage with at a more detailed level and potentially get to discussions around a letter of intent or an indication of interest.

Hypothesis

The hypothesis is usually high-level out of the gate. We do a good job at Progress identifying the adjacencies and the interesting areas across all the different products we have at Progress. 

We have a general idea that if we're talking to a company in the observability space, that will have some interesting relevance to what we're doing with a couple of different products that we have at Progress, but we don't know a lot.

• We don't know if the go-to-markets are aligned. 
• We don't know if they're built in a similar technology that will make it easy to integrate into Progress. 

It's a high-level hypothesis. It's not much more than that unless it's a company that is going through a process and we have more details and financial data, where we can run an analysis and assess if we can afford this company and if it fits within our financial criteria. 

But those are more formal process-type situations. When we're more proactively reaching out to companies, it's a very high-level hypothesis when we initially talk to them. We have a very basic template for that initial conversation. There are certain things that we're looking for. 

• We want to understand the company's history.
• We want to get a better feel for what kind of products they have.
• How big of a team do they have?
• Are they a distributed workforce?  
• Are they in the office-type workforce?
• How much technology is built on open source?

We can ask a bunch of things that can help us determine if a company will be interesting and relevant to us quickly. 

For instance, we don't do technology tuck-ins at Progress, so if we have a conversation with a company and they hope to start generating revenue next year, that's probably not going to be a good fit for us. We can end those discussions quickly.

Suppose we learn that the company has a meaningful revenue and hits some other criteria. In that case, we can continue to have meaningful and productive dialogue for both our side and the potential target company side. 

Getting targets to like you

It's building that trust and having a good dialogue. Before I get on a first call, I look at LinkedIn to see if I have connections or similarities to the person. Whatever it is, those icebreakers make those conversations go more smoothly. 

Target companies tend to enjoy talking to me more when I do that rather than coming out and telling them we want to buy them. So that would create a different tone. 

One of the nice things here at Progress is that our CEO is more than happy to get on the phone with any of the target companies we're looking at. That helps me a lot because:

• It shows that we're serious
• It gives those target companies visibility at the highest level within Progress, making them feel good and important.

Doing those different things, for the most part, gets most CEOs or whomever I'm talking to at target companies interested, willing, and happy to have a good dialogue with me.

The hit rate is not a hundred percent. There are certainly some companies that just have no interest. Because I'm a corp dev person, they know where this will ultimately go, and they just have no interest in engaging, and that's fine. 

But for the most part, they're open to that conversation. Given today's market environment, it's harder to raise money. There's no IPO window open right now. We, as an acquirer, are great liquidity alternatives for many of these companies they're engaging in.

Deal proposal

For VC-backed or PE-backed companies, their partners on those deals will be very protective of those companies and their teams focusing on executing. But at some point, the rubber hits the road, and you have to say to the private equity person or the VC person that after these conversations with this company, there could be something more strategic here.

We can determine a view or perspective on value with little information. If we can get a basic financial package and an anonymized census, we can run an evaluation model where we can support a deal in such a range. 

I talk directly with the company's CEO if it's a bootstrap company. If conversations go well, they might be interested in doing something more strategic.

With the VCs and the PEs, if conversations go well, you can ask if you could do a deal somewhere in this range and if that's something they would be interested in. We typically know what the post-money valuation on the last round is, so we have a feel for whether or not we can put in something compelling to a VC or private equity firm.

Because before we get to that LOI stage, we haven't gotten a chance to do a lot of diligence. We've done a few management calls, but we haven't dug in on anything in the back office side and the technology. So there's a lot that we need to do that we can only do once we get to that LOI point. 

But we need to make it interesting enough to the VC PE person that they're willing to open up at this point because this is an interesting price, and a deal at this price is worth it. We'll have that dialogue with the respective person on the other side, and if it resonates, we can jump right into an LOI. 

Dealing with the management team to get to the VC PE or talking to them directly depends on a deal-by-deal basis. What I like to do is find a soft landing. I don't like cold calling or reaching out to someone out of the blue. Instead, I like to see where I have connections and who I can leverage to give me a nice introduction. 

Often, that's with the VC or the private equity person. And I ask my contact to give me a warm introduction. Instead of going directly to the company's CEO, I might go to the VC or the PE if I have a relationship there. 

If I have a good connection to the company and I can get a nice warm intro to the CEO of that company, I'll do that too. I try to have that initial contact be warmer than just a cold call outreach that tends to have a much lower hit rate of success. 

After that initial conversation, we'll sign an NDA if there's an interest in continuing the dialogue so we can talk more freely and openly and share more about each other. 

Approaching LOI

When we're at that LOI stage, we've typically already gotten the financial pack that will have details around the following:

• P&L
• balance sheet
• recurring revenue streams
• operating expenses
• the cost of goods sold. 

Typically, the seller should provide basic information so the buyer can put together an offer.

Sometimes we'll have a much more high-level financial detail, but we can build a valuation perspective on high-level information. We will need to validate that with diligence in more detail, but at a high level, we can do something in this range.

Once we learn things in diligence that prove your revenue is significantly less or your expense profile is significantly higher than what you told us, we should be able to evaluate such a range. 

We get that information varies from company to company. We can access so much more if it's a banker-led process. They have established a more robust data room so we can do some preliminary due diligence. 

If it's a more proactive approach where we've reached out to the company, and they're not necessarily in an M&A process, it takes more courting time and building that trust. 

If we get to that point where we think there could be something more strategic here, we can ask for details that allow us to submit a more meaningful letter of intent. But a letter of intent is a non-binding document, it doesn't have to be that detailed.

Unless you're negotiating indemnities and escrows, at an LOI, you're just saying

• I think I can do something in this price range
• This is the diligence that I still need to do 
• I'd like to have some time for exclusivity so I can hire all the third-party resources that I need to do this work 
• Hopefully, at the end we can negotiate a deal 

People involved in getting to LOI

We typically have a limited set of folks involved until we sign a letter of intent.

• Legal team - helps draft and negotiate the letter of intent.
• Finance team - helps build out the financial model.
• Executive champion - involved in evaluating the company from a technology and a go-to-market standpoint.

Similarly, with the target companies, they're not bringing a bunch of people over because they don't want people to get all nervous that they are about to be sold. It's typically the CEO, the CFO, a Chief Revenue Officer, or a Chief Product Officer. It's also very limited on the target side.

But once we execute that LOI, we bring in a much more robust diligence team across all the different functions.

HR is not typically too involved pre-LOI. I have a good relationship with my Chief People Officer and a couple of people on her team. They're aware of the deals, but they're not necessarily doing a lot of work pre-LOI.

Negotiating price

We'll walk away from a deal rather than retrade on price. We don't want to back off once we set a price or a range. We have good conviction because, having done this for as long as we have, we know we can get good operational efficiencies. 

We know at Progress, as a percentage of revenue, how much G&A, sales, and marketing we need to operate a business successfully. We know where there will be synergy opportunities when we have a high-level PnL, so we'll make general assumptions.

If we get into diligence and conclude that we need a lot more of that team or we're not going to be able to get to the operating margin profile that we expect and need to have to get a deal done, we'll walk away from a deal. But we've done this enough that we know what we can do.

We have a high conviction that we'll get a deal across the finish line if we've gotten some of that basic information before we get to an LOI stage. Then, the diligence process is confirmatory and validates what we've assumed or what they've told us.

Engaging people

We have a core diligence team across all the different functions. So we've spent a lot of time building up the bench across each of the different functional areas that evaluate a company.

Once we get to that LOI stage, we bring in a much broader set of folks to help us dig in under the covers to truly understand the business and do it from the standpoint of confirmatory diligence. But also to map out a detailed and thoughtful integration plan so that we can integrate seamlessly once we do get to the finish line.

We've done enough deals to know what we need to make a deal work. Suppose a company is bleeding $10 million and doing $30 million in revenue. In that case, it's probably not a company that we'll be able to get to the operating margin we needed to get to.

We look at companies we know are spending 50% of their revenue on sales and marketing and are growing 5-10%. We know that's inefficient, and we can do that much better. Same thing on the G&A side. If they have seven different facilities and no one's going to the office, we know we can operate that better. 

We can understand many things at a high level when looking at a deal that can give us conviction around certain assumptions. But then we go in, and the functions who have to live with it need to go in and validate it and see if they can do this or not. 

If they say they can't do this, there are harder discussions where we look for puts and takes across other parts of the business, or we ultimately say we can't make the deal model work, and we have to walk away.

We rarely have to do that because we know well what we're doing and where we can extract operational efficiency. So there's a high degree of conviction, even with a limited set of folks evaluating the business before we get into an LOI stage.

That initial evaluation comes from the corp dev team, the executive champion, and the finance team. It doesn't just come from finance because that would be ineffective. Everyone, including the CEO and CFO, has to be comfortable with the number before we can submit a bid.

And then that deal model involves and gets more refined. One of the reasons why finance owns the deal model is because it will eventually transition into an operating model. We want to have a good understanding of all the different inputs and assumptions going into that model because, at the end of the day, the business unit and its finance partner are going to live with those numbers, so they need to be comfortable with that.  

Bidding accuracy

We have enough dialogue before submitting an LOI, ensuring we have a good enough understanding of different aspects of the business.

• If it's a CapEx-heavy business
• If it's a customer-support-heavy business
• If it's heavily dependent on cloud hosting costs
• If they're spending a lot of money on demand gen
• If they have a crazy sales model with multi-levels of folks involved in deals like a VP, director, or an actual salesperson.

We have a lot of things that we know and a lot of questions that we can ask to get enough insight to build out a preliminary model.

On the cost of goods sold side, if they use a third-party provider like AWS, Azure, or Google Cloud, we want to understand the following:

• What are those relationships?
• What are the dependencies?
• Are they just using it for computing and storage?
• Are they using it for other support? 

That can influence our ability to get synergies. 

Regarding facilities and having a whole bunch of office locations: 

• Is it more of a virtual environment?
• Is it a work-in-the-office environment?

We can get potential synergies there.

We ask many questions to dig in and understand the key marketing initiatives that drive the top line and where we can get synergies. 

Same thing on the sales side. Sometimes the sales ratios to sales expense and sales to account managers are just out of whack. So we can look for many things that allow us to show a clear area where we can get synergy. 

It sounds weird that you can have that level of insight early before you let all the different functional folks go off and hit the ground running. But at the same time, we need to have some perspective because we need to be able to assess whether or not we can:

1. Get to the kind of operating margin profile we need
2. Get to the price that will resonate with the seller and the seller's investors.

Negotiations

When I'm working on a deal, I'm never going to necessarily give them the highest bid out of the gate because then there's no room for negotiation. I need to have room to move for more negotiation between both sides.

I usually have a good perspective of my range that I can do a deal in. If we can get some alignment, then we can have a conversation. If we can't, we move on. 

There are situations where we want to come in with as strong a bid as we can because it's a competitive situation. There are situations where we're feeling each other out, so we're going to throw out a number, but we know we can move on it. It varies based on the situation with the company that you're having a conversation with. 

It varies from deal to deal on what we're trying to accomplish. In a situation where a company's in trouble, there could be opportunities where we can get assets for cheaper prices than we may have been able to get last year. That's just the result of the market environment and dynamics.

In private companies, there isn't an equilibrium between what sellers want and what buyers are willing to pay. There's more correction happening in public than the private markets. There will be many more companies that will at least be willing to engage and explore that. 

Frequently negotiated aspects

There are certainly LOIs where the seller wants to negotiate more upfront. They want to understand what are the things that would affect the purchase price. 

In certain situations, the seller or the banker wants the buyer to commit to procuring rep and warranty insurance as your recourse for indemnity. That can get negotiated during the LOI stage. 

We're trying to negotiate exclusivity. It's hard to expend hundreds of thousands of dollars on diligence resources and not know if you'll even win the deal. Sometimes, you need to do that in super competitive situations, but when they're not as competitive, you try to get that exclusivity period.

We talk high-level about structure. But a lot of the structure is dependent on the tax work and digging more deeply into some of the legal aspects of the target company, so it's hard to really have a lot of visibility there.

We try to make it clear that we will take good care of the people we retain in the deal. We usually put together some sort of package of retention for them.

It's rare that you can get someone to sign up for an LOI or an indication of interest where you're just setting the price and expecting exclusivity. They want a bit more detail, so you have to negotiate. If it is proprietary, we will get exclusivity. Typically, we want exclusivity on a deal we source and find ourselves. We're not going through all that work without exclusivity.

Benefits of having a banker

They can have a much more robust data room in place when you start doing diligence in a proactive process, where the company isn't teed up to sell. The information trickles in a little bit more. 

In a more formal process, there's a much more robust data room with much more detail that we'll be looking for in a diligence process. 

They also bring a level of experience that entrepreneurs or sellers who are newer to that process sometimes don't know what they're doing. Bankers can keep them more balanced and focused on what we're trying to accomplish on a deal.

There's value to bankers. If it's a CEO who's been through it before, knows what they're doing, has processes in place, and has all the materials easily accessible, then they don't need it. If they've never done it before and don't know the first thing to do in a diligence process, it might not hurt.

Pulling other leverage

Other than price, I am definitely focusing on some other pieces.

• Speed–being able to get to a deal quickly
• Certainty to close
• A willingness to do rep warranty insurance
• Having a lot more flexibility on deal trends that are much more aligned with the market today versus the market 3-4 years ago.

I'm highlighting those pieces, which are the things that differentiate us. Price is one piece; I can do diligence in 20-30 days. At the same time, I can negotiate a deal, and I have the cash on hand because I have a balance sheet with over half a billion dollars in cash, so you're not going to have to worry about financing contingencies and other things like that.

Reps and warranties insurance hesitation

There is no hesitation from sellers. We once did a presentation to our legal team, and we talked about how rep warranty insurance is table stakes today. In most deals, it's expected. So we've gotten comfortable with it as a vehicle for giving us the protections we need. 

Convincing an acquisition

Some bootstrap situations I was alluding to had a very long courtship period. It's interesting; sometimes, there are two or three founders. Maybe one or two or all on board was selling, and the third one is not necessarily as sure, so you need to work extra hard at convincing that party why selling makes sense.