M&A market new hope for software CEOs

Revenue growth seen through rose-coloured glasses: survey

Emerging Canadian software companies are still struggling to find revenue, according to a recent report by PricewaterhouseCoopers (PwC).

Despite advances in technology and financing in the last five years, those software firms still face the same challenges, says PwC’s fifth annual Report on Emerging Canadian Software Companies: The CEO Perspective.

The biggest issue, according to the 160 CEOs who responded, is growing their revenue with quality customers.

Other issues include establishing a reputation and brand, and building effective sales-channel partnerships. While direct sales are still the preferred method of distribution, many CEOs acknowledge the importance of channel partnerships, which are agents, systems integrators, wireless dealers and consultants who sell software products and services.

The only aspect that has mitigated these dilemmas is the recent upsurge in the mergers and acquisition (M&A) market. Given the M&A climate in Canada, the report says 95 per cent of emerging software CEOs believed they would be acquired within the next four years.

“Current activity levels and deal pipelines suggest that deals are still very much on the boardroom agenda of technology companies,” says Peter Matutat, PwC partner and national emerging company practice leader.

“The larger buyers are looking for well-placed emerging companies to diversify or complement their current product and service offerings,” he adds. “The financial dynamics that have been driving the accelerating consolidation in the software sector are expected to continue, thus the expectation of companies to be acquired is well placed.

“The challenge now is for these emerging companies to make sure they are well positioned financially and strategically, before making any move to putting up a for-sale sign.”

However, successful entrepreneurs in the biotech and tech industry – those that have created, built and competed on the global market – are not as enthusiastic about the potential of M&A to take emerging tech companies in Canada to the next level.

“(Emerging) companies in Canada tend to be acquired by U.S. companies at early stages,” says Lisa Crossley, president and CEO of Nysa Membrane Technologies, a biotech firm based in Burlington, Ont. “It’s very difficult to follow a path, if you can’t see a path,” and when all the startups are sold off, no path is being created to enable others to follow and grow.

As one of three speakers on a panel about challenges facing Canadian entrepreneurs at the seventh annual Re$earch Money Conference, held last month in Toronto, Crossley said that her experience in the U.S. enables her to appreciate the difficulties business owners in the Canadian tech and biotech industries face.

“Canadians are more risk averse,” she says. That means that there is a “socialist mentality” in the investment policy of our government and our investors. “They invest a little in a lot – a shotgun approach,” she adds.

“Rather than backing a real winner, we invest in a lot of companies and this puts pressure on these companies to either move to the U.S.,” to compete for real money or look for a buyer.

“By giving a little piece of the pie to everybody, no one wins,” she says. “You have to pick winners and then back them, really back them until they can grow into flagship Canadian companies.”

Her comments were in relation to the primary struggle expressed by CEOs of obtaining funding throughout the growth process.

According to the PwC survey, more than 90 per cent of CEOs were concerned with the challenge of growing business revenue.

Yet, despite this common challenge, almost half of the respondents predict their revenue will grow by at least 50 per cent next year, with one-quarter expecting to at least double sales in 2008.

Matutat believes these predicted earnings are optimistic.

“The history of our survey results shows that CEOs are likely overstating their growth prospects,” says Matutat. “This year, the gap between forecast and actual growth is on the rise.”

For example, in last year’s survey, 40 per cent of respondents forecast revenue growth of more than 50 per cent for 2007.

Yet, this year’s survey shows only 24 per cent of respondents achieved that 50 per cent or more of expected growth.

This gap is a slight increase from last year’s survey, in which 41 per cent had forecast greater than 50 per cent growth and 30 per cent achieved that target.

“This increase is a trend that should be monitored carefully,” says Matutat. “Accurately forecasting revenues and results is critical to emerging software companies and contributes to the success of many key strategic goals, including raising needed venture capital, securing key partnerships and attracting senior management.”

Wayne Karpoff, co-founder and CTO of Yotta Yotta Inc., a storage technology firm based in Edmonton, also believes that accurate financial forecasts are essential for the growth of emerging tech firms.

More important, though, is a company’s ability to become competitive on fewer funds.

“A systemic problem in Canadian startups is that they look at capital as a goal,” Karpoff told a group of tech-based executives at the Re$earch Money Conference.

“But (capital) is a tool. The big difference in the U.S. and Canadian entrepreneur mentality, in the wake of the dot-com failure, is that U.S. companies are growing and becoming competitive on as little capital as they can.”

Karpoff believes that Canadian startups get so consumed with the idea of raising capital that it prevents them from the real goal of competitive industry initiatives and advancements.

While he agrees that access to capital is essential, he suggests that businesses stop focusing on the tool and start focusing on the goal. “It requires action.”

Part of that action is building partnerships and creative industry alliances – alliances that include sales, marketing and distribution.

In the PwC survey, CEOs also responded to this aspect of the business. Many cited continuing difficulties in executing their sales-channel strategies, a situation that has not changed for a number of years.

In fact, rather than find workable solutions, many CEOs reported a significant decline in both the use of channel partners and their satisfaction with channel partners.

In 2005, approximately 70 per cent of the companies surveyed were using sales channels. This declined to 62 per cent in 2006 and has now declined to 50 per cent in 2007.

When asked to rate the success of their channel partnerships, approximately 52 per cent of the CEOs said their channels were not yet successful or had displayed limited success.

The level of dissatisfaction was greater for CEOs using original equipment manufacturers (OEMs) at 53 per cent and system integrators (55 per cent), and slightly lower for value-added resellers (VARs) at 47 per cent.

Still, the option to ignore channel partners becomes an increasing concern for CEOs, particularly considering the importance they place on virtualization – the creation of a virtual workspace that can be used to divide hardware to enable more complete functions and a greater range of software applications.

More than 90 per cent of CEOs surveyed agreed that “virtualization will drive efficiency.”

More than three-quarters expect it will enable new types of enterprise applications.

The PwC survey also found:

* 31 per cent of CEOs believe achieving profitability and positive cashflow will not be a challenge;

* 50 per cent characterize profitability as only somewhat challenging;

* 34 per cent of CEOs are upbeat about raising capital within the next two years;

* 42 per cent characterize raising capital in that time as only somewhat challenging.

Originally published in Business Edge on June 13, 2008