The Hidden Chasm

In our latest episode, Allen Born dives deep into the current state of the M&A market, shedding light on the challenges and opportunities for tech companies. 💡

Key takeaways include:

» The impact of SaaS multiples on valuations 📊
» The importance of understanding the rule of 40 for growth companies 🚀
» Strategies for navigating market fluctuations and maximizing value 💼

Tune in to learn how to avoid the hidden chasm and make informed decisions in your M&A journey.

Creators & Guests

Host
Bo Motlagh
Founder & CEO @ United Effects
Host
Josh Smith
Co-founder, Head of Product @ United Effects
Guest
Allen Born
Director of Technology Investment Banking, Fairmount Partners

What is The Hidden Chasm?

An ongoing discussion of how tech debt and legacy solutions become barriers to growth and innovation for established SaaS companies.

Josh Smith:

You're listening to the hidden chasm, a podcast where we speak with leaders of software enterprise companies to investigate the impact that legacy technology has on growth and innovation. The hidden chasm is sponsored by United Effects where we help companies break free from legacy tech, improve retention, and empower m and a growth. Learn more at unitedeffects.com.

Bo Motlagh:

We're back at it. Josh, how's it going, man?

Josh Smith:

I'm always chill. How are you doing?

Bo Motlagh:

I'm doing alright. I'm pretty excited about our guest today. We've got Allen Born from Fairmount Partners. How's it going, Allen?

Allen Bo:

Hey, guys. Good to see you. Yeah. You as well.

Bo Motlagh:

Thank you so much for joining us. I'm gonna do the quick read so everybody here knows exactly what you do and who you are. K. Allen is a senior technology investment banker with over 25 years of experience advising CEOs, boards, and investors on strategic alternatives and capital structures. He is currently a senior member of the technology investment banking team at Fairmount Partners, specializing in mergers and acquisitions and capital raising.

Bo Motlagh:

That's a lot, and that's awesome. Yeah. We're super excited to have you around because we've been chatting with a few folks about this whole hidden chasm concept, which is just a fancy way of saying things that you maybe didn't think about for years in terms of your technology and your strategy and your strategic alignments that then come and hit you in the face when it matters most.

Allen Bo:

Mhmm.

Bo Motlagh:

And one of those moments that I think matters most is when a company is looking to raise or sell. And, obviously, you know, I think you're gonna have a lot of interesting perspectives on that piece of it. And so far, we've had conversations with process experts and product experts. We'll probably having more conversations with revenue and technology experts. But I think this is the one I'm super excited about right now.

Bo Motlagh:

Tell us a little bit about yourself and what you guys are doing at Fairmount.

Allen Bo:

Yeah. I'll give you a little bit of background. I got into tech in the mid nineties. I was working at the American Red Cross. This is like 93, 94 time frame.

Allen Bo:

I was doing marketing for the Red Cross. And one of the things that I had identified was we would create these publications that we would have printed and sent to the chapters, and they would use them as part of their educational program. And every time we'd have to update the language, we'd throw out 1,000 of dollars worth of inventory because the brochures were now wrong. And so I thought, is there a way that we can digitize these brochures and put them on the Internet? We didn't even have a website at the time, but make them available so that they can print them out and distribute them that way.

Allen Bo:

So I started talking with folks about that. I got invited into the task force at the Red Cross to get the Red Cross online. Well, part of the task force was an ISP that was based out in Irvine, California. They were called Epic Internet and they hired me away pretty quickly to join their team based in Irvine. They were an ISP typical ISP.

Allen Bo:

We were selling fractional t ones. We were selling dial up. We were selling hosting. We were selling web development. And I joined I walked into an old Bell Atlantic switch building in Falls Church, Virginia, and there's boxes everywhere and stains on the floor.

Allen Bo:

I'm in an office with a hole in the ceiling and the data center air is coming down. So I've got a winner going on, I'm like, what in the hell did I do? So that was my first exposure to tech. And I did that for a number of years. Our firm, the company, we were doing really cool things.

Allen Bo:

I mean, we were trying to become I used to say we were trying to become Exodus before Exodus became Exodus, but no one knows who Exodus anymore. So we were trying to become Rackspace before Exodus became Exodus and Rackspace became Rackspace. But we ran into funding challenges, and so I left to go back and get my MBA. And I went to Duke and got my MBA and came back and joined the technology practice at Legg Mason in Baltimore. So Legg Mason, Woodwalker, I started there as an associate, and I was doing all the tech deals because I knew tech.

Allen Bo:

We did a number of really interesting public offerings. We helped take Orbitz public twice. We helped take OpenTable public. I got great stories about OpenTable. We can save that for another time.

Allen Bo:

And then ultimately had a child in 2,008. My daughter was born and moved up to the Philadelphia area to be closer to home where I was introduced to Fairmount Partners and joined Fairmount Partners as an emerging growth technology banker.

Bo Motlagh:

Very cool. And and you and I met through PACT.

Allen Bo:

Yes. That's right. Yeah. I was, you know, the funny thing is when I first joined Fairmount, I think it was my first week, Charles Robbins, who runs the technology practice there, said to me, hey. I'm gonna bring you to this meeting and you it's gonna be great.

Allen Bo:

You're gonna meet a lot of people. And it was the steering committee for the 1st packed forum conference. The very first forum, and he introduces me to everybody, and then he leaves. And now I'm on the steering committee. That's cool.

Allen Bo:

That's and that was my introduction to PACT as well.

Bo Motlagh:

For our listeners, PACT is the Philadelphia Alliance of Capital and Technology in the Philadelphia area. It is a really great community of both enterprises and startups that do a lot of interesting events, and Alan has been at the helm of a a few of them over the years.

Allen Bo:

I have. Yeah. I ended up chairing in, I think, 4 or 5 of the forum conferences, and I'm on the board of PACT.

Bo Motlagh:

Very cool. And I think this is the first time you're meeting Josh.

Allen Bo:

Yes. It

Josh Smith:

is. Pleasure to meet you, Alan. Good to meet you too. I've heard a lot about you.

Allen Bo:

Terrific. I will.

Bo Motlagh:

So thanks for the background. Could you tell us a little bit more about Fairmount specifically?

Allen Bo:

Yeah. Happy to. We are a boutique investment bank. We cover 4 industry sectors. We cover healthcare services, which is really pharma services.

Allen Bo:

We cover business and consulting services, which is a lot of IT services and staffing. We have a practice that does industrial and consumer, and then we have a practice that focuses on emerging growth technology, and I'm part of the technology practice. As a firm, we probably do 20 to 25 deals a year, mostly sell side, about 70, 80% of what we do is sell side. We do some buy side m and a for areas that we know really well. That's probably 10 to 15% of what we do.

Allen Bo:

And the rest is later stage growth equity and general financial advisory. From a deal size perspective, we operate in the, call it, 30 to 300,000,000 in enterprise value range. And I think over the last couple of years, our average enterprise value on a sell side was around a $100,000,000.

Josh Smith:

K. So you deal more with organizations that seek to be acquired than to acquire?

Allen Bo:

We do. Yeah. We do we do quite I mean, interestingly, so when I was at Legg and Stifel, we were doing mostly sell side and public offerings. We avoided buy side like the plague. But at Fairmount, we view buy side as a way to really get deeper into the industries that we serve.

Allen Bo:

And so if it's a strategic type of a deal, so we're instant, HR Tech is an area that we focus on and we're engaged with a $35,000,000 ARR company that's looking to accelerate their roadmap through acquisition and do a number of other things. So what you do is you come up with a list of 500 names and you call them. Right? It's a much easier call and people are much more willing to pick up the phone when you call them up and say, hey, I've got somebody that is really interested in acquiring you, then, hey. I'm Allen.

Allen Bo:

I'm an investment banker. Can I sell your business? Yeah. It's a different message in it. But what that allows us to do, you know, not only is it good from a marketing perspective, but it's also really good because we're out talking to our emerging growth companies who are doing really cool things, and and we're learning about their business, and we're learning about their go to market, and we're learning about how the economy is impacting their business.

Allen Bo:

Are software buyers buying your software? You know, are you up 10% this year? Are you down this year? And by having these conversations on the buy side, you can get a really good flavor of what's going on in the broader market out there. And then consequently, you can use that to advise your clients.

Bo Motlagh:

I've been hearing that in M&A, it's a seller's market at the moment. Would you agree with that or not?

Allen Bo:

I would disagree that it's a seller's market at the moment. There's still there's still we're not in a headwinds environment anymore, but we're not in a tailwinds environment either. So, what the the bigger so one there's there's a number of things that are impacting tech just in the frame that I deal on, which is tech. There's a number of things that are impacting tech m and a. So multiples are impacting tech m and a.

Allen Bo:

At the height of the, you know, in 2021, SaaS multiples, right, we we have a SaaS index. We track, like, a 100 SaaS companies, and SaaS multiples, median multiples were 20 times revs in 2021. By the end of 2022, median multiples were 5 times revs. So the dislocation there was huge from a valuation perspective. Right?

Allen Bo:

And so consequently, when the multiples pull back, you have a lot of folks who are sitting on the fence and saying, well, I'm not going out to market where multiples are today. Now interestingly, if you do a straight line back to like 2018, multiples are sort of in the range, Okay. You just had this, you know, 2000 to 2001 blip, and if you missed it, unfortunately, you missed it. So we don't we don't know that that's we don't know that that's gonna come back anytime soon.

Allen Bo:

But so median multiples since 2000 and since 22. Right? Because we kinda if you're looking at median multiples, you can't really go back into 2000 and 2001 because they're just so outsized. And so but if you look at median multiples since 2022, call it 3a half times revenue for median, but a good company can trade for 5 to 10, but the median's way down. So now back in terms of is it a seller's market?

Allen Bo:

If you're a really hot SaaS company that's sort of on its way or past $10,000,000 in ARR, that's rule of 40, and what rule of 40 means for those that don't know is rule of 40 is if you add your growth rate, so I grew at 20% last year, to your EBITDA margin, my EBITDA margin was 20% last year, That combination is rule of 40. So in that scenario, rule of 40. But typically, for emerging growth, it's their growth rates like 50%, 60%, and they're burning a little bit of money. Right? But if you're so for a rule of 40 company, so growing rapidly, has some size, and is close or can be profitable, those are the ones that are still trading at big multiples because there aren't that many of them out there.

Allen Bo:

So there's a scarcity effect that is for really good companies driving up valuation multiples. But if you're a median company or a below median company, it's tough to be a seller today.

Bo Motlagh:

I'd imagine there's also, especially in this economy, like a fire sale thing going on with a bunch of companies as well.

Allen Bo:

Well, yeah, we haven't seen a lot of it yet, but I think we will see it. And there are companies out there. So there's a lot of founders who have raised money who've never lived through a recession. They came out in 08, 09 when it was easy to raise money and everything went up into the right. So there's a whole host of folks who raise money and who raise money in 2021 where we think everything's gonna continue to go up and have spent a lot of it and are now in a position where VCs have pulled back and PEs have pulled back because, one, they need to support the companies that are gonna be their winner.

Allen Bo:

If they don't have you tagged as a winner and you're running out of cash, they're not gonna re up. So there are groups out there who have raised a bunch of money, spent a bunch of money, and are now in a position where VCs have pulled back. They're much more discriminating in terms of new deals, and so you're gonna have, there will be companies that come up that need to find a home, And, you know, so so does that look like a fire sale? Yeah. A lot of times it does.

Bo Motlagh:

How involved are you in Fairmount post acquisition, post transaction?

Allen Bo:

That's a great question. So it it really it it really depends. So one of the nice things about being an investment banker is you develop a really deep relationship with your client. Right? You go through a 9 month process, you are their adviser, you are their counselor, and you develop friendships.

Allen Bo:

And that's I mean, that's one of the things that I love about doing these deals is that you get to know a really interesting business and a really interesting founder, and you're able to add to create wealth, meaningful wealth for them, and that's just like a really good feeling. And so, you know, if some if a company sells to a strategic right? So there's there's 2 flavors of m and a that we typically see at Fairmount. So one flavor is you sell to a strategic, your company gets absorbed, and they integrate you, and that's kind of the end of it. And maybe maybe you've got a product name or something like that, but you basically get absorbed by the bigger entity.

Allen Bo:

We'll stay in touch with those founders, and we may stay in touch with people who are a key part of that process. For companies that get sold to private equity, which is the other flavor, we will continue to try and add value because those companies, you know, private equity has a holding period of call it traditionally 3 to 5 years where buy a company, grow it up, sell it. Mhmm. We typically get involved with companies early before they ever sell. So our our what we're trying to do is meet a company a year to 2 years before they ever think about an exit so that we can help guide them and provide support.

Allen Bo:

Similarly, for a company that's been acquired by PE, you know, our you know, we don't stop returning their calls once the deal happens. Sometimes they'll say, hey. I've got an issue with my board. Can you help me think about how to deal with it? Yes.

Allen Bo:

We can. Can you help us with our financial modeling? Yeah. Sure. Happy to do that.

Allen Bo:

We wanna continue to support companies. We think about the life cycle of a company. We wanna add value when they're early, help them when they're ready to raise money, Help them when they're ready to exit. If it's an exit to PE, help them where when they're ready to do the next exit.

Bo Motlagh:

That makes sense. And what you were talking about with the strategic acquisitions, what I was hearing is sort of these bolt on or tuck in deals.

Allen Bo:

Yeah. That's right. So a PE would call that a bolt on or a tuck in. A big strategic would just say, yeah, we're just gonna buy it and absorb it. But that's exactly right.

Allen Bo:

So what you're doing in this type of a transaction is and we've done a bunch of them. So, you know, big PE backed company has a product gap. Mhmm. And and they are looking to good example is the the buy side that I mentioned earlier. They've got a product gap.

Allen Bo:

So you find a company that you think can fill the product gap, and that that becomes the rationale for your acquisition. So you're bringing in a new organization to help fill many times a technical gap within the acquiring company.

Bo Motlagh:

And this has been a really interesting piece of this for us as well because I think bringing this back to the whole hidden chasm concept, that's where you can really run into a lot of trouble. Have you seen a stat actually I read about, the last week or so? I think it was the Harvard Business Review put out that between 70 90% of M and A is considered a failure, which kind of blows my mind. I'm also very curious. Yeah.

Bo Motlagh:

Our stats

Allen Bo:

are much higher.

Bo Motlagh:

Oh, really? Well, I mean, that's a good question. Like, what does failure mean in your mind post acquisition?

Allen Bo:

That's a good question.

Josh Smith:

I mean, I so you could also flip it and say, what are the key conditions of success?

Bo Motlagh:

There you go. Yeah. Get positive about it.

Allen Bo:

That's a good question. So when we think about an acquisition, there's part of the rationale that you you lead with is synergies. Right? So there's there may be cost synergies related to duplicate personnel, duplicate systems, and we can come back to duplicate systems, are they really duplicate? So there's cost synergies related to personnel and then there may be sales synergies, revenue synergies related to the ability to cross sell a product.

Allen Bo:

So when it works, that synergy story holds and you have a situation where 1 +1 equals 5. Right? We're now selling a lot more. The Target's selling a lot more. The acquiring company is selling a lot more.

Allen Bo:

The product sets go together really well. They fit nicely with each other. You're able to achieve some cost synergies on the back end. And so what's happening is is that the acquisition is paying for itself. So is the acquisition paying for itself?

Allen Bo:

If it is, then that's a success. What can go wrong is you acquire a company that you have a theory that your buyers are gonna wanna buy that product, but they don't. And maybe it's because, you know, you're you're an enterprise buyer and you acquire SMB focused business, and your salespeople can't sell that Yeah. To SMB. And the SMB guys, the SMB salespeople don't know how to sell enterprise.

Allen Bo:

SMB is very high velocity, a lot of churn, enterprise is very long sales cycles, hopefully stickier. So even that, if you have a product that at face value might make a lot of sense together, if it's built for a particular company or if the focus of the target and the acquirer is at odds in terms of who their ICP is, their ideal customer profile, that can create a lot of problems.

Josh Smith:

That resonates with me just someone who has stood up and run, user research practices so that you run against companies with mindsets where the people in positions to make decisions about what's in a product and what can sell believe that it's something their their value in the organization is based on their ability to make it up, to just think it. They're smart enough. And Yeah. Having to figure out how to train them to be more curious and to say, let's put in processes to evaluate, perhaps validate assumptions. You mentioned the word theory.

Josh Smith:

Evaluate these theories, reduce the risk of being wrong or be wrong as quickly as possible so we know not to go down that route so that we can learn what our market, what our customers, what our users really value and really want before we make a critical and expensive decision to implement. I assume there's some sort of similar process

Allen Bo:

for you all as well in

Josh Smith:

your investigation discovery of the opportunities for sellers.

Allen Bo:

Well, there is for sure. What we want to do when we're representing a seller is we're trying to describe the unique characteristics of a company. If you think about it as an asset, what's unique about it? What's unique about the tech? Do they have a moat?

Allen Bo:

Do they have a technological moat? Do they have a 2 year lead ahead of somebody else? Right? So we we try and really understand that, and we try and communicate that along with, hey. Here's the tech stack that we're using and, you know, trying to describe the data flows and things like that so that people will not only And we think that's important because it needs to work on the acquirer's platform.

Allen Bo:

Right? So unless they wanna keep it as a stand alone. Right? And and keeping it as a stand alone can be really, really expensive. So, you know, here's an example of one that didn't work.

Allen Bo:

We helped a company acquire another business, and it's part of the deal. We didn't we just bought the assets. The acquiring company who I was representing didn't bring on any of the people. So when they started to spin up the product, so and it came with a bunch of customers and what they found was that, first of all, there were a bunch of customers who are already pissed off about how the thing was functioning and they had not disclosed that to us. But also, our guys were on Azure.

Allen Bo:

They were on AWS. And so now you're running 2 different environments, and that's incredibly expensive. And then when stuff started breaking, didn't have access to the people to come and fix it. So that was a really tough situation. You try and raise these issues, you try and identify them early, you try and identify them during due diligence.

Allen Bo:

There were other reasons why they decided to ignore red flags and pursue it anyways, but you try and do this early and it's and it's really helpful. So that's one of the reasons why you gotta bring in really good advisors, not just financial adviser. It's important to bring in somebody who can come in and evaluate, what am I acquiring? Or if you're, you know, if you're a sell if you're on the sell side, what am I acquiring? But also if you're a seller, you want them to be evaluating your tech and making sure that all fits and that there's a path to integrate it because if it doesn't work, you may have an earn out tied to that.

Bo Motlagh:

Right.

Allen Bo:

Right? And if it doesn't work, you're not getting your earn out. So before you sign that deal, you wanna understand, okay. What's our in it? We've not yet signed the deal.

Allen Bo:

Maybe we're under a letter of intent, but you're gonna have an integration plan related to headcount. What's our integration plan related to the tech? That's equally as important because if it doesn't work, that's worse than having somebody, you know, a headcount person slide in the wrong spot. It's significantly worse.

Bo Motlagh:

I love that because I'm a tech head. So I think you're speaking to the thing I love about these problems and solving them. But I think, I mean, what I'm hearing you describe is really the importance of a strategy and a clear understanding of how these things are going to fit together and not just once. Right? Especially if you're the buyer on, like, a bolt on strategy, after it.

Bo Motlagh:

So what is this gonna look like?

Allen Bo:

Well, it's not yeah. It doesn't scale. And then the other thing that we look at is, you know, is tech debt.

Bo Motlagh:

Right.

Allen Bo:

Right? The acquiring company. Alright. So we're representing somebody somebody that's a that that's we're represent a company that's either trying to raise money or trying to sell themselves. And it's 2024, and they built their platform in 2012.

Allen Bo:

So you've got systems that are old, that are held together by duct tape, and they just haven't invested in modernizing the tech stack. Right? And you see that all the time Yeah. Because it's expensive to modernize a tech stack. And so what are the implications of that?

Allen Bo:

Well, the implications of that are when a buyer starts to do the work on, okay, how are we gonna integrate these companies? What becomes relatively apparent pretty quickly is it's gonna cost a lot of money to update that text stack such that it can integrate within hours. So that becomes very expensive. If that company is looking to raise money, a savvy investor out there is looking to understand your tech stack and what sort of Ted debt may be there, and that goes into their valuation calculation. If it's gonna cost $10,000,000 to upgrade the tech stack, they're gonna be responsible for that.

Bo Motlagh:

Right.

Allen Bo:

Right? They stroke that check. But guess who's gonna pay for it? You are mister seller or the guy who's taking an investment. So people look at it and they quantify what is needed to bring this up to date.

Allen Bo:

And if you haven't done a good job and, again, you're the company that's thinking about raising money or selling, if you haven't done a good job of maintaining your tech stack, it will be it will be very expensive, And the longer you wait, the more expensive it'll be.

Bo Motlagh:

How how often well, I mean, we called we call this whole thing the hidden chasm because a lot of times it's a surprise.

Allen Bo:

So It is very much a surprise.

Josh Smith:

It shouldn't be a surprise.

Allen Bo:

It shouldn't be a surprise, but it is often it's often a surprise, you know, when I mean, this is why it's important to have good advisors who who can who can think about this stuff. But people need to be people need to be focused in on the blocking and tackling of putting companies together. Very often, you've got a deal advocate on one side and a seller on the other side who thinks about 1 +1equals5, and the strategic rationale is really great. And there's a tremendous market TAM that we can go after together, and it's gonna be awesome. There's no reason why we shouldn't be doing this deal.

Allen Bo:

We have every reason to do this deal. But they think up here. Yeah. And you need and and and many deals happen where they don't consider, okay, how are we gonna when when Lend got bought by Stifel, which I think I missed in part of my bio, was I was at LAG for 5 years. Stifel acquired it in 2,005, and I left in 2,010.

Allen Bo:

But anyway, when Stifel acquired LAG, like Mason Woodwalker, the Capital Markets Group, and they didn't announce it until it was done. So we had no idea. And then I got an org chart. So deals close without actually people actually thinking about, okay, where do people go? Where does tech go?

Allen Bo:

And it happens all the time. It's not often. It's probably 5050 where do you have somebody actually really leaning in on the integration piece during the LOI period? And if you don't, it becomes really, really challenging. And deals happen all the time where they don't.

Bo Motlagh:

I always joke on paper, it sounds great to buy 15 houses and make an apartment building. In reality, that could be kinda hard.

Allen Bo:

Yeah. Exactly. That's exactly right.

Josh Smith:

Yeah. It feels like what is it? An ounce of preventions worth a pound of cure? And I've I've heard several things. Several you you you heard the word you you said the word synergies.

Josh Smith:

And I'm thinking, you know, you talked about the synergy of value early on. Understand, like, what's the actual value to the user base on the buyer side or the customer base on the buyer side of this product gap. And then the technical integration side. Alright. Mhmm.

Josh Smith:

If even after that's validated, if there's no way to integrate it in from a technical side, then it's

Allen Bo:

Yeah. So right. So so if if your if your thesis is that we're going to we've got a product and we can add a new product into our bundle and everything's gonna work together seamlessly. If that's your thesis and it turns out that this piece doesn't talk to this piece, then it's hard to execute on that. And so you end up running things in parallel so that this great theory that you had that we'd have we, you know, we can sell you one platform and you'll have one throat to choke.

Allen Bo:

Well, if the stuff doesn't talk or work together or integrate, even at the product level, never never mind the back end level, your whole thesis is out the window because I still need to have have this and I still need to have this.

Josh Smith:

Then you talked about the 3rd component. So, like, even if you got those 2 correct, the I'll say the word. The agility or the velocity with which you can pivot and adjust and shift is dependent upon the size of the legacy or the tech debt. So you can get those 2 taken care of, but then if you've got a huge burden in the technical debt or the legacy tech, whatever you learn needs to adjust based on the integration and the value in order to achieve that value is going to depend upon that 3rd piece. Is that accurate to say?

Allen Bo:

Yes.

Bo Motlagh:

What I really like is the point you made that I mean, it's it's a little easier to talk about this problem from a buyer perspective because you have to build the machine. But you made the point that it's also very, very important from a seller perspective because, not so much because you're trying to build all these integrations, but because you need to be easy to integrate with because it's not like you can't just assume as founder that you're going to build this thing, get a check and walk away and everything's fine. There's gonna be real financial repercussions if it doesn't work.

Allen Bo:

And that's exactly right. And part of it is being really thoughtful about how you put the components of the tech stack together. Part of it is being thoughtful about, are you using, open source? And if you're using open source, are you building with the right licensing? How are, you know, are you are you doing a really good job of documenting and maintaining your tech specs, tech stack and your code base?

Allen Bo:

We did a deal where we sold a company called Petrus. It was an oil and gas data management business and we sold them to Halliburton. And they ran a code scan, a black duck scan, on Petrus, the seller, and that tech was cobbled together over 20 years. Mhmm. And so they found, like, you know, all these licensing issues.

Allen Bo:

And what it did is it delayed the process, because now they've identified a page full of things that we need to mitigate. So we've got to go through and mitigate all this stuff. And some of it was pushing out new codes to all your companies. But the problem was a lot of them were not on the cloud. So it was on prem.

Allen Bo:

Now you've gotta push out new versions on to to on prem customers. And how do you do that? You know, so that that process cost us 2 months because we didn't know it was in the code. When you're first getting involved with a new potential buyer or seller Mhmm.

Bo Motlagh:

Before you potential buyer or seller Mhmm.

Allen Bo:

Before you've really been able to do the due diligence or

Bo Motlagh:

anything like

Allen Bo:

that, are there

Bo Motlagh:

KPIs you look for and other indicators that basically set off your spidey sense like, hey. I I should probably have somebody look at this.

Allen Bo:

Yeah. So I'll tell you that most of them are on the financial side.

Bo Motlagh:

Yeah.

Allen Bo:

Right? So we think about what does revenue retention look like? Are we able to track gross margin by customer? What's the LTV to customer acquisition cost, stuff like that. Right?

Allen Bo:

Those those metrics, we will benchmark companies against. What's your gross margin? If you're a SaaS company and your gross margin is 55%, well, why is that?

Bo Motlagh:

Right.

Allen Bo:

Right? Because that's really bad if you're a SaaS company. We'll track a lot of those, and a lot of times those can help identify operational issues within the organization. Right? So it could be that your margins are down because your development guys are busy helping customers make their product work.

Allen Bo:

That could be a reason. Okay. So that identifies a problem. If you're sort of out of the bounds of normalcy on any of these metrics that people track for SaaS companies, or even gross margin is something that we look at, and we try and compare you against your peers. If it's extra high, why is that?

Allen Bo:

If it's extra low, why is that? How much are you spending? Here's another one. How much are you spending on R and D? So when we look at a company's financial statements, if they're not spending 20 to 30% on R and D, are they maintaining their product?

Allen Bo:

But if their r and d spend is 10%, okay, well, who is making sure that your product is up to date? Who is working on the next generation of the product that's gonna keep you ahead of the competition? So that's something that you look at it from a financial perspective, r and d as a percentage of revenue. And if it falls below what we know to be kinda normal, it raises a red flag.

Bo Motlagh:

The opposite would probably be true as well. Right? If you're spending like 40% on R and D, but your customer retention is going down and you're just basically keeping the lights on.

Allen Bo:

Yeah. That's exactly right. And if you're spending 40% on R and D and there's no growth. Okay, well, where are the new products? You know, talk walk us through your road map.

Allen Bo:

If you're spending 40% on r and d and you don't have a road map with features that are like this long, what are they doing?

Bo Motlagh:

You and I chatted about a company a while back where the operational costs stepped up linearly with every new customer acquisition and little things like that where that shouldn't happen.

Allen Bo:

That's exactly right. SaaS companies in particular should be scaling.

Bo Motlagh:

Right.

Allen Bo:

Right? So so we look for, okay, what's the flow down model? At scale, how much of every dollar of revenue is dropping to EBITDA? And you should see that increasing with a really good SaaS company. And if marginal costs are increasing dollar for dollar compared to revenue, the flow down model that you look for in a SaaS company doesn't hold true.

Bo Motlagh:

I think we're kinda coming back a little bit, A lot of what we've been describing in terms of how to be successful, at least from a technology strategy perspective, I think what you're describing, which is great, is that these are not distinct concepts. If your tech strategy is off, your financials are going to show it. Yes. And there's only so much blurring you can do between them. And I think, you know, I see this a lot.

Bo Motlagh:

I'm curious. I think there are a lot of executives sort of think this piece will just sort of figure itself out. Engineering will get it. And you don't realize that it's part of the same machine. You have to be thinking about it the same way.

Allen Bo:

That's exactly right. I think it's important for the strategy of an organization to be communicated through IT. I think people need to be aligned. The knock that we hear and I'm not a tech guy, so if this you know, if you if if

Bo Motlagh:

I think that's what makes it more powerful.

Allen Bo:

Yeah. But the thing that we hear is that IT doesn't wanna do new projects. IT wants to just focus on what they're focusing on, and the thought of bringing something new makes their brain hurt. If that's the case and they're unaware of the vision of the organization is to bring in something new, and it's really important that our team be pumped up to make it all work and create, you may have organizational issues that you need to address.

Bo Motlagh:

It makes a lot of sense. The other thing I was gonna say is I think a lot of what you talked about in terms of what are we actually saying needs to be working correctly is data. Yeah. Right? At the end of the day, what makes your old tech work or your new tech work and them work together?

Bo Motlagh:

It's how data is being processed and flowing between them.

Allen Bo:

Yes. 100%.

Bo Motlagh:

Yeah. It's really interesting to me that so much of this is really just a data problem and and always viewed that way.

Allen Bo:

Well, it's a data problem and a pipe problem.

Bo Motlagh:

Yeah.

Allen Bo:

Yeah. But but you're right. I think you're spot on. I'm

Josh Smith:

seeing also people problems.

Bo Motlagh:

Well, yeah. Yeah. Of course.

Josh Smith:

We said this is hidden chasm. And I and I say, you know, it shouldn't be hidden. Why is it hidden? Why aren't people looking at it? Why do we like to battle symptoms so often and not spend time looking at the underlying causes and see the connections between these things.

Allen Bo:

At big organizations in particular, they may not know at the senior management level that the pipes are held together by duct tape. Just frightening. It is frightening. And you would think that they should know, but you need a cohesive organization where you've got good lines of communication between senior management down to the systems guys who are holding everything together. And they need to feel, at the lower levels, empowered to say something's breaking or something's bending, and we need to focus on this.

Allen Bo:

And if and and and a junior guy needs to raise their hand because a lot of times stuff ages and there's no more modern things. But a lot of times it's not as simple as that. And if you've got good communication up and down an organization, there's no repercussions to identifying a problem.

Bo Motlagh:

Right. You

Allen Bo:

know what I'm saying?

Bo Motlagh:

What would you advise a CEO who's basically finding that they have all of these issues? And if you were in that position and you're looking around and you're going, we probably need to talk before we put out a letter or anything like that or put you on the market. What do you advise in those situations?

Allen Bo:

I would advise that either internally or externally, they have somebody who can understand at depth what the issues are and understand what needs to be done to mitigate the issues and what that's gonna cost. Yeah. And you don't and then you have a choice. I am gonna present to a buyer. I will tell them upfront what the issues are, and I will tell them upfront what our road map is to mitigate those issues.

Allen Bo:

And I will full disclosure on it, And there may be an impact on valuation, but that impact won't be something that happens post LOI because I want to provide as much information as possible before I enter an exclusivity period with somebody. So when I still have all the momentum or when I still have all the leverage, I've got 5 buyers who are interested in me. I'm gonna let them know what my tech issues are, what needs to be addressed, what my plan is to do it, how much it's gonna cost. They're gonna know that when they bid. Mhmm.

Allen Bo:

That way, you can, full disclosure, you're still in a competitive process, bid with that knowledge, but also bid to win.

Bo Motlagh:

Right.

Allen Bo:

Right? So you could so that's that's one way. If you wait until you get into under exclusivity, the buyers get all the leverage at that point. And if you haven't disclosed an issue, there you were gonna get hammered. So you'd rather disclose when you have all the levers.

Allen Bo:

Sorry. So that's one route. The other route is to just address it.

Josh Smith:

Yeah.

Allen Bo:

Identify it, quantify it, address it and implement a plan. And you don't necessarily have to be all the way through your plan potentially, but at least you need to be starting on it and making some progress on it so that people can feel good about the fact that this area of risk is something that I don't have to worry about.

Bo Motlagh:

Yeah. I'd imagine the story of I mean, every sale is a story. Right? The story of how this is going to be resolved is almost more important than having had completed.

Josh Smith:

The failure to disclose or the disclosure route always reminds me of the Tom Hanks film The Money Pit.

Allen Bo:

Yeah. Yeah.

Josh Smith:

Beau, you said, yeah. It ultimately was a data issue because, like, if you treated every issue in that house as an infrastructure issue. But the second route you mentioned, Alan, seems much more advantageous to identify, assess, and address. Yeah.

Bo Motlagh:

Yeah. Well, but there's a cost. Right? There's an upfront cost.

Allen Bo:

So you're gonna bear the cost. And I think with your advisor, you need to try and figure out, okay, what's the impact on my process if I don't have this done? Well, if you're growing at a 100% a year and you've got great retention metrics and you look like a star or an A plus asset, you may be able to get away with not addressing it. If you look like a B asset, you're gonna materially impact in today's market, you're gonna impact your buyer interest. And when you impact your buyer interest, you don't have as strong of an auction, which just getting to an auction phase where you've got multiple people bidding on you itself will create value.

Allen Bo:

Right. If if you've if your underlying problems are significant and we're gonna be very expensive to address, you're gonna limit your interest so that you may not get to the point you may only get one buyer. And we and, you know, we'll always we'll always try and maintain the illusion of a competitive process when it's not there. But our job becomes much more difficult when it's not as high quality of an asset and somebody chooses not to do the things in advance that are really important. And that and our our guidance is typically take pause, get it fixed, make sure it works.

Allen Bo:

If it delays going to market by a year, that's okay, but you'll have a much stronger process.

Bo Motlagh:

I'd imagine that the other sort of, I don't know, factor there would be who you're targeting as a buyer as well. Because if you're targeting a buyer who has the technical infrastructure and elements to sort of bypass what you have and they're just gonna tuck you in, the value prop changes is that as well.

Allen Bo:

Yeah. That's exactly right. If there's a way to sort of uncouple the products from the challenges

Bo Motlagh:

Right.

Allen Bo:

And layer them into the buyer's tech stack, then it doesn't matter. You're right. They might still try and ding you for it from because they'll always try and find something to ding you.

Josh Smith:

So the valuation potential is dependent somewhat on the buyer. The technical integration, the ability to integrate right now, would you say more or less dependent on the buyer as well at this point in time?

Allen Bo:

Well, it depends. If you've got a broad platform that can integrate with a lot of things Mhmm. Then that's great. If the buyer is limited in terms of what they can integrate with and they don't integrate with you, it's kind of both your problem.

Josh Smith:

Okay. Both sides.

Bo Motlagh:

Then it really just becomes who's got the bigger checkbook.

Josh Smith:

But if you on the seller side, would it be wrong, Allen, to assume or write out to assume that on the seller side, if if they vetted and realized these issues and address them, and we're now at a point where they have more integration options than ever. Their tech debt is reduced significantly so that it can pivot faster as they learn. And Yep. Would you say that those things have an impact on the potential for their multiples?

Allen Bo:

Yeah. It can. It can. Right? So if you've got so if you've got a clean organization that is now highly scalable and has the infrastructure to scale, you look like a different organization than one that doesn't.

Allen Bo:

And so there's naturally some multiple expansion that comes with something that is a very modern, highly scalable asset versus one that's not. And you can't really quantify. Is it a half a turn? I don't know. You can't really quantify it.

Allen Bo:

But really where you see it is in the interest in the company in a transaction and the valuations that come out of that level of interest. Strong, scalable, modern architecture companies get a lot more interest than ones that are not. And so it's that competitive nature that's really what pushes on the multiple.

Bo Motlagh:

Makes sense. Well, we have covered a lot of ground. Thank you so much, Alan. This has been, I think, one of the more interesting conversations, and I think a lot of people are gonna be fascinated to listen to this. Wanna give you the opportunity here.

Bo Motlagh:

If there's anything you'd like to plug or anything you'd like people to know about, please go ahead.

Allen Bo:

Yeah. So just, you know, I I will tell you that if you are an emerging growth technology company that is sort of scaling towards 10 and is growing and has a pathway to profitability and you're thinking about your exit options, we are here to help. We wanna get involved with companies early. If you're a year out from transacting or more, that's better. We like to invest in relationships and invest in companies that we think we've got an opportunity to do business with and it doesn't cost you anything.

Allen Bo:

So reach out.

Bo Motlagh:

And how would they reach out?

Allen Bo:

They can reach out on LinkedIn or my email is allen.born@fairmountpartners.com.

Bo Motlagh:

Very cool. Well, thank you again, and you've been listening to The Hidden Chasm. Join us next time.

Josh Smith:

Thank you, Allen.

Allen Bo:

Thanks, guys.

Josh Smith:

Thanks for listening to The Hidden Chasm Podcast with your hosts, Bo Motlagh and Josh Smith, and sponsored by United Effects. We hope you enjoyed our deep dive exploring the impact of legacy technology on enterprise agility. Follow along as we explore this further by subscribing to the podcast at thehiddenchasm.com. Thanks again, and we'll see you next time.