Validating the Acquisition Plan

Approaching M&A

So we are religious about our M&A practice, which we've perfected over time. It's been a fun journey. Early on, we were more cavalier, but now we have a system with six steps to validate our approach.

In these steps, we focus on writing a thesis, keeping the other party in mind. We want them to participate in the process and provide insight on how they see the two businesses working together. We explore the potential value add of combining our efforts.

Our process is straightforward. First, we constantly survey our customers. As a tech company, it's crucial to ask questions in various formats, ranging from full surveys to quick queries during interactions. We even conduct polls in webinars and gather data at conferences. This helps understand current needs and start with a need analysis.

Secondly, we examine industry trends, considering both external and internal influences. This helps us identify potential targets or decide if we should build solutions ourselves. We've already originated themes throughout our M&A practice, so our surveys are broad, looking for emerging topics.

For example, if we noticed a trend in car transfer software inquiries, we'd survey our customers and industry experts to understand its relevance and potential. This helps us determine whether to build or buy the solution.

In deciding between building or partnering, stress test the strategy with a proof of concept. This involves selecting a sample of customers to try the new product or service to gauge its viability. The success criteria are set based on previous research and analysis.

Next, we explore potential targets or partners. This involves analyzing the company's talent, culture, and capability. We pay close attention to how they present themselves and interact during product demos, looking for cultural fits and passion.

After thorough steps, we write a memo or prepare a document, involving the potential partner. This document transparently shares our vision, risks, and concerns, and we expect the same level of transparency from them. This leads to efficient due diligence and prevents surprises.

For instance, in a deal last year, we discovered a discrepancy in a company's reported revenue during our quality of earnings analysis. This led us to reevaluate and eventually acquire the company as an asset, without the team.

Our process is about building a framework that fosters clear communication and understanding between both parties. This often involves in-person meetings to discuss details more casually, which can reveal crucial information. This approach has refined our M&A practice, making it more robust and effective.

Surveying customers

I'll give you a perfect example. Last year, we conducted a survey around AI during one of our product release webinars. We asked hoteliers questions like, 'What does AI mean to you?' and 'Which AI practices do you find useful?' We provided options like operations, data, and revenue pricing. Our goal was understanding their perspective on AI, even though we have a clear idea of its practical applications in the hotel technology sector.

We conducted this survey not only in the webinar but also as a follow-up and at trade shows, focusing on the same theme. We wanted to gauge how much the buzz around AI, including generative AI and open AI, was penetrating an industry not known for its high digital adoption.

To validate our assumption that it was still early days for AI in this sector, we repeated this survey each quarter, employing different methods. At every industry trade show I've attended, AI has been a major topic. We're observing how our customers' responses evolve, whether through in-app notifications or quick surveys.

Our aim is to track whether interest in AI is growing and how this might influence our future product lineup for 2024. We're exploring questions like the real value of AI, the investment required, and whether it's something we need to prioritize now or can wait on.

We've been using machine learning in our application for seven years, so the concept isn't new to us. AI has gained more attention lately due to media coverage. Getting real-time feedback is crucial, so when we have a thousand hotels on a webinar, we seize the opportunity to learn from them. We conduct polls, ask a couple of questions, and have a team interact in live chat to gather more insights.

This process is about having continuous conversations to identify clear trends. If responses are the same, it indicates a strong trend. If answers vary, then there is a clear need to delve deeper to understand the real picture.

Industry trend analysis

Yeah, our Corp Dev team is responsible for mapping the industries bi-annually. This effort is separate from specific deals. We aim to create the largest database of competitors, peer groups, and point solutions, to understand everyone's standing in the industry. Twice a year, we update this information in our CRM, focusing on employee numbers and revenue scales.

During industry surveys, identify the key sources where customers gather information.  These include conferences, niche media outlets, reputation or review sites, and partners. Additionally, I am part of a group of CEOs in our industry where we exchange information openly. Some of us are competitors, but I find this transparency incredibly helpful. We're not just seeking competitive intelligence, but a broader understanding of the industry.

Our surveying aims to revalidate the customer insights with third-party perspectives. The goal is to ensure that the customer feedback isn't biased and represents a broader view.  With over 300 responses, we achieve statistical relevance. But it's also important to gather insights from outside the customer base, so engage third party consultants to conduct broader surveys.

This is the essence of our industry research. It's more about surveying than just gathering data. While we're familiar with big consulting firms like Bain, McKinsey, and Deloitte, we haven't engaged them extensively as their services might be more than we need. However, we do subscribe to and purchase data from niche consulting practices to confirm the findings.

As for working with consultants, we use them for specific tasks. For example, we conduct mock RFPs through third-party consultants to evaluate our messaging and understand the value proposition and sales cycle. We hire them for 'outside-in' work, especially in markets where there are only a few providers, to avoid signaling our interest. They also handle tasks that our team doesn't have the capacity to manage.

Partner vs build analysis

That would be an interesting dilemma for us – deciding whether to build or partner for an AI application in our housekeeping module. We have our own basic housekeeping app, which we offer for free, but it competes with paid services from our partners in the housekeeping and maintenance sector. The question is whether it's better to enhance our own app with AI or to integrate AI into an existing, more sophisticated partner app.

In this situation, we would run a dual-track analysis. We'd evaluate the product cycle and capabilities of existing partners, particularly their integration of AI. Simultaneously, we'd assess our in-house product team's capabilities and the feasibility of developing such technology ourselves.

This situation is fascinating and somewhat amusing, as it perfectly illustrates the internal debates we have. The role of AI in our operations varies – for some, housekeeping is mission-critical, while for others, it's a matter of efficiency. We'd start by surveying all our users, both those using our app and those using our partners', to understand their needs and preferences.

Our goal would be to identify patterns and validate our hypothesis about the importance of AI in this context. We'd conduct surveys, one-on-one interviews, and create Figma mockups to explore different scenarios. This is a unique case that might not yield clear answers initially. We might experience analysis paralysis or deal fatigue, leading us to abandon the project if it becomes too complex.

If the analysis suggests that building the solution isn't viable, it’s time to consider buying. We would calculate the costs, including engineering, project management, UI design, and timeline, and factor these into the deal price. We'd then compare the economics of building versus buying. If buying gives us a more advanced app with revenue and EBITDA advantages, we might lean towards acquisition, despite the higher upfront cost.

However, if the price analysis reveals only a small gap between building and buying, it could lead to further indecision. There must be a clear winner to move forward, as unanimous alignment within our team is crucial.

Regarding internal biases, our developers often prefer to build everything in-house. They are ambitious, but sometimes it's beneficial to bring in external expertise. We believe in mixing perspectives to spur innovation. Sometimes, it's necessary to bring the outside in, which can be both helpful and healthy for our growth.

Formulating the strategic rationale

At some point, the internal sponsor comes into play, potentially adding bias to the strategic rationale. They might be a product manager, product owner, my co-founder, our head of strategy, or a sales or product leader. They could assert the necessity of a project based on their conviction. Product managers, who are effective in their roles, also conduct field surveys and interact with competitors and partners, understanding the market as thoroughly as CorpDev does.

Our PMs and CorpDev team often have similar levels of knowledge about a space, but from different perspectives. The debates between them about building versus buying are always interesting. For example, a PM might initially say a project will take two years, then propose a quicker, iterative approach. It's like an architect showing you beautiful home designs, only to learn the actual construction will take much longer.

Integrating products in a tech company is rarely straightforward. What's planned as a six-month integration often ends up taking two years, mirroring the building scenario. Consequently, I've stopped using speed to market as a measure for strategic rationale; it never pans out as expected.

In-depth company analysis and product demos

Cultural fit is crucial in M&A. During product demos and discussions, we pay close attention to team dynamics and leadership styles. For example, we had a deal last year that failed. It involved just the two founders, and they never involved any other team members. 

Something felt off, and we realized early on that we were just a stalking horse for another deal they were pursuing. Their behavior was inconsistent, alternating between commitment and detachment. They couldn't sell their product convincingly or explain their sales challenges, which made no sense to us. In hindsight, I'm thankful that deal didn't go through.

There was a lot of back-and-forth, and we almost brought in our bankers because we were tired of dealing with theirs. It was a storm of issues, and our tolerance for problems in a deal has its limits. When too many things went wrong, we started backing out and even retraded the deal, but they kept coming back. We ended up permanently stepping away from that deal due to these issues. 

Another experience involved a technology we were very interested in. The entire team agreed we needed this asset. We flew to meet with the team, spending a week to align our visions and start the due diligence. However, during the negotiations, one founder suggested cutting out their co-founder, revealing internal conflicts. 

This was a red flag for us, similar to the 'beer test' where you gauge if you can endure a long conversation with someone. Their infighting and bizarre behavior led us to decide against moving forward with the deal. Interestingly, that team is still together and doing well, so perhaps we caught them on a bad day. But in M&A, it's crucial not to reveal internal conflicts too early in the process.

Drafting a detailed memo

The goal is to be completely transparent to both parties. This approach, which I learned from someone much more experienced in M&A, is particularly effective when there's a board or venture backers involved. 

When a founding team openly discusses their fears, risks, and how these relate to the synergy between the two companies, it shapes the conversation. Similarly, we share our concerns about the deal, including any threats or risks now known to us. This openness allows us to reevaluate the deal's value creation and our offer.

If the other party is venture-backed or has a board, they're obligated to share this formal offer, like our binder or MBIO, with their directors. This often leads to eye-opening moments in the boardroom, revealing concerns they might not have been aware of. It's about fostering an honest conversation, not trapping anyone.

Venture capitalists or private equity firms often have high expectations for returns, but we know the reality can be different. The cap table is just a legal document; it's not the sole basis for a deal. We focus on the value from our perspective and set the deal parameters accordingly. If we want to shift the value to the team going forward and pay less for the asset, we can propose that. They don't have to accept it, but it's within our rights.

The memo aims to align both parties going forward, focusing on the teams that will work together after the deal. If we're allowing shareholders to roll over, we want them to feel confident about the future and understand the strategic rationale. We are transparent in our management and board presentations, explaining our thesis, historical performance, and how we've created value for our shareholders.

This process is a two-way street, very collaborative, and we believe it works well. It covers everything – price, terms, all outlined in the memo. Typically, we restrict the memo to ten pages, including some financial analysis. We try to keep it concise, ideally two pages, but it usually extends to six to ten pages.

Pitching M&A to the board

The memos we write are full of conviction. If someone doesn't believe in the deal after reading one of our memos, they probably don't understand it. These memos include everything from our return on invested capital to the attachment rates and reasons for the deal, as well as how we're structuring the stock. Our analysis is thorough and straightforward. In our company's history, we've never had a memo rejected.

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