When a large software company makes an acquisition in a particular niche, several other comparable acquisitions soon follow. This article discusses this market dynamic and the importance for owners of similar software companies to reevaluate their exit plans.

A Single Company Acquisition Often Creates Multiple Similar Acquisitions

Our firm was engaged as a merger and acquisition advisor in 2011 to sell a Content / Document Management Software Firm. We put together a database of likely buyers in that software category and began our contact process. Fast Forward to early 2014. We have been engaged by a second Content / Document Management Firm to sell their software company. From our earlier engagement, we dusted off our database of mid-market software companies in that space and began making our phone calls.

A very interesting thing happened. 40% of these middle market software companies had been acquired by one of the large software companies. None of these companies was operating under the name we had listed for them i our database. Each had been acquired by one of their larger competitors.

Wow. Between mid-2011 and early 2014, there was a buying spree by the enterprise software vendors shoring up their product offering to become a much more comprehensive offering. This is now called ECM, or enterprise content management. It was almost like a heavyweight fight—IBM punches, EMC counters, and Oracle lands a blow while OpenText dodges a punch.

Always Be Ready to Sell for the Right Opportunity

For the mid-sized software companies in this space, these were exciting times. This rapid consolidation and active buying caused the transaction values to increase rapidly. It sets up nicely for the companies that have anticipated this market action and have prepared their company and themselves for a sale.

This consolidation takes place quickly, so you must be prepared. This is an ideal time to capitalize on strategic value as a seller. Strategic value can be created in a number of areas such as a technology upgrade, access to a growing market niche, acquiring a blue chip account base or the ability to cross sell and up sell each other's install base. In this case, however, the driver of strategic value is the defensive factor. Large companies do not want to lose to their competitor that has made an acquisition which could enhance his total offering. Their competitors often interpret this as an attack on not just the little niche, but an attack on the mother ship.

If you are a seller in this environment, this dynamic causes a sense of urgency with the buyers and they simultaneously position a similar acquisition as a top priority. This brings multiple strategic buyers to the table at the same time. This is the holy grail of business sales because it generally will produce valuations that go well beyond a rule of thumb EBITDA multiple. We recently represented a managed services provider for sale and received bids from 7 different buyers. They were all looking at the same EBITDA and contractually recurring revenues, but the high bid was double what the low bid was.

If you fail to get a competitive bidding process going, you will most likely receive far less than you might have.

Rapid Industry Consolidation Is a Double Edged Sword

This market dynamic is a double-edged sword if you are not one of the sellers. Once the enterprise companies have added what they need, the buying stops, the market returns to normal, and sellers no longer command a premium price. Now the bad news. If you were a mid-sized competitor of the acquired companies, you are now competing with very large, powerful companies that are determined to justify their acquisition with aggressive growth initiatives. They will dwarf your company in terms of sales force size, marketing resources, brand awareness and pricing power. Their product now becomes the safe choice in a head-to-head competition with yours.

Competing effectively will now require even more skill. Your firm can continue to provide outstanding service and responsiveness. You can provide the small company customer attention that many customers require. You can be nimble and innovate with new products and features as another way to successfully compete. You often hear the stock market pundits say, "the trend is your friend" or "don't fight the trend." There is a certain wisdom to this sentiment. If you are in a software category that suddenly has become the target for the big software vendors, you may do best to exit according to the market conditions rather than your original retirement schedule.

Sell Now and Retire Later

Actually, the buying company will most likely want you to stay on board for a period of time to transfer customer relationships and intellectual property. So you can take your chips off the table today at an opportune time for rich valuation multiples and then retire a few years later. If you are younger, you can secure your family's financial future, work for the new company for a few years, gain valuable experience and then exit. Now you are ready to launch your next great idea. This time it will be far easier. You will have a large base of resources and influential contacts. Also the venture capital guys might even give you money under reasonable terms.