Knowing Where the Exits Are

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

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