Achieving the Exit  |  The SRS Executive Q&A Series   

SRS has produced this series of Q&A interviews to highlight how great entrepreneurs have beaten the odds to exit their companies successfully. As shareholder representative, SRS works with the world's best entrepreneurs once they reach this milestone. This series explores how they got there and what they learned along the way.

Q&A  |  Portico Systems (acquired by McKesson)

Ned Moore
Former Founder and CEO, Portico Systems
Current VP of Network Performance Management, McKesson

Ned Moore founded Portico Systems and led the company through an acquisition by McKesson in July 2011. Moore was a key visionary behind the Portico product platform and implemented a business strategy that combined organic growth with opportunistic acquisitions. He discusses the value of investment bankers and key considerations around structuring deals with earnouts.

Q :  What was the primary market need you were trying to address when you founded Portico Systems?

We had three separate lives. When we started in 1997, everything on the Internet was very retail focused, but we wanted to focus on the enterprise software market. So we started doing custom software development for the enterprise using the web. Our first customer was a healthcare insurance company and we realized quickly that they could use a lot of help. We figured that if we could specialize in healthcare, we would be presented with opportunities.

Then all the software vendors started coming out with their own browser-based products. No one in the software market knew how to deal with web applications from an enterprise perspective, so we started doing a lot of implementations of those applications and learned more about the business. In 2001 and 2002, the bottom dropped out of the services market, and we were left with the decision of what we were going to become. At the time we had this little piece of intellectual property that we owned and we had $50,000.00 in revenue in it.

So, in 2004 we decided to bet the company and work on solving the problem that Portico eventually came to be known for. It was enterprise software, using the intellectual property that we eventually licensed and sold into the health insurance market place.

Q :  What are some considerations CEOs and their management teams should keep in mind when they own an important piece of intellectual property?

There are a couple things to keep in mind. Something we did at an early stage of the company was to make sure we had all the agreements with our employees properly set up to make sure that everyone understood that while they were working at the company, the IP they created belonged to the company.

As it relates to protecting the company's IP, make sure you are working with a decent attorney who understands it's not all just about patents. There are several different things you can do to come up with a comprehensive strategy. Most importantly, decide what you want to do as early as possible. There are some timing windows that run out in a year. You have to make sure you know what the timelines are before you file.

Q :  How did you go about securing venture capital?

We were an enterprise software company and knew we needed outside money. Our strategy was to bootstrap the company until we had a couple of products and one or two customers. Then, we aggressively started going out to raise money. It's interesting that we ended up with an early stage investor fifteen miles away from our office--Safeguard Scientifics, a small public company located outside of Philadelphia.

Healthcare is a unique space in that the sales cycles can be quite long, so you need to have patience. We needed an investor who matched that profile, and Safeguard's publicly-traded structure was attractive to us. It also came down to the people there. You have to look at your VCs as partners and people you want to be in business with. They have a very strong team that fit well with our management team.

Edison Ventures led our Series B round, so they came in at a later stage. We looked at cultural fit, where we wanted to take our business and how we wanted to grow. We were really interested in talking with investors who had experience in our mix between services and licensing, and the products we wanted to build out from a management and sales perspective.

Q :  What did you find to be most effective approach in your sales strategy?

Our sales process was very consultative. We didn't even start talking about our products until the third or fourth meeting with prospective clients. It was really about understanding what they were doing and the problems they had. We found in healthcare that if you can put together a more complete solution for the customer, they're going to be more apt to do business with you.

We developed a consulting group to just do assessments and help the customer build a business case for our applications. It was very partnership driven. In our plan, we underestimated how much our existing customers would buy from us once they were on board. We were able to monetize our future investments from the partnerships we created with our existing customers.

Q :  How did your sales team navigate large healthcare organizations?

It was a very complex sales process. We would have business line leaders and IT directors at the table at the same time. In some cases, IT served as the buyer because they actually ran the budget, while in other cases the business executive was the customer and IT was essentially a supplier to their internal organization.

There are a lot of different dynamics there. If IT is buying software then the business is saying, "we need this solution, go buy it and make it happen." In the case where the business executive is the buyer, you can get them excited about the solution, but the IT department often has a veto stamp. So, if you can't get the IT guys on board with the technology and how they will benefit, they can put up roadblocks.

Q :  What was the basis for the acquisition strategy you implemented at Portico?

We were opportunistic about M&A, but we were not an M&A roll up, so we didn't need to do a set number of deals every year to make our plan. We were growing organically and we had a lot of strong relationships, but at the same time we were looking for acquisitions that we could fold into our platform. We made three acquisitions along the way--two were almost purely technology purchases and one had a decent amount of revenue with about fifty people in the organization and seventeen new customers that we didn't have.

Q :  Did you rely on investment banks or assemble an in-house team of corporate dealmakers to do these deals?

On the buy-side transactions, we ran the process in-house. I led the team on three acquisitions and we tapped into our investors for help. Safeguard has a legal staff with good analysts on their team to review acquisitions. One target company had its own investment banker, which was very helpful in getting that transaction done because I was able to explain where we were in our business and they ran an open process.

I did spend some of my time as CEO talking with investment bankers familiar with our industry. When it came time for us to sell or if there was a buy-side transaction that we needed representation on, we had a group of bankers we could tap into so we wouldn't be starting from scratch on who to turn to for advice. To me, the main value an investment banker can provide is valuation--what's going on in the market, what do the multiples look like, what is the market value at this moment in time, and how do you position yourself with your potential acquirers. Talking with bankers along the way gives you good market intelligence. The ones who know your market really well, those are the bankers you want to stay close to.

Q :  How did the deal with McKesson come about?

It was the classic case of them calling us. They were trying to build some functionality that they thought we might have. We also got lucky with what was going on in healthcare industry. We provide a platform for healthcare insurers to manage their providers and their provider networks. New reform changed the way providers got reimbursed to deliver care and our software is key in helping providers affiliate with each other and exchange information. McKesson sat down to build their strategic plan and looked for a player to partner with, which led to our front door.

Q :  When McKesson approached you, did you feel you should hire an investment banker?

When I got the phone call asking if we interested in being acquired, I talked to a few investment bankers. I knew that a banker would be helpful in driving a deal to a positive outcome and also in preparing our board. Having a banker that knows your potential acquirer is beneficial to the overall process.

There were three bankers that knew us and the problem we were solving in the marketplace. The banker we picked had worked with McKesson before, knew their team directly and worked on deals of our size. That was very attractive to us because the banker knew the market. We made a list of four to five companies we were going to target and tested the waters. We received some inbound calls because we had marketed ourselves well. Once McKesson got serious, we wanted to make sure we checked the market and were getting a reasonable deal. This particular banker knew a lot of the companies on the list, so the stars just lined up at the right time.

Q :  How did you structure the transaction with McKesson? Did the deal include an earnout?

Ninety five percent of the deal was done in cash. We did have a small earnout portion, but the key economic levers we considered were the cash and the escrow period. I think we got pretty favorable terms and our entire deal was done in about seven months from start to finish.

When you get into earnout negotiations, consider the worst-case scenario. If the earnout is profit-based, you may have a lot of overhead allocation picking up on your P&L. You need to make sure you understand exactly how costs are allocated. If it's a revenue-based earnout, that's another Catch 22 because the acquirer's revenue-recognition policy depends on whether or not the company is public or on the size of the company, which may be very different than for a small, private company. They are going to be really sensitive to the FASB rules around revenue recognition, particularly around a software company. If you are tied to a revenue earnout, the acquirer is going to recognize that revenue and that will have an effect on your payout. We looked at all those points from an economic perspective, putting them all up against the other options. Our preference was to do as much as we could in cash and then clean things up over the shortest period of time.

SRS serves as shareholder representative on the acquisition of Portico Systems by McKesson. SRS manages all post-closing matters, including working capital and other purchase price adjustments, tax reviews, earnouts, the handling of claims, disputes and litigation, communications with acquirers and selling shareholders, and management and distribution of escrow and expense funds.

SRS | Shareholder Representative Services is the global expert in professionally managing the post-closing process to safeguard the selling shareholders' interests in private company M&A transactions. As the shareholder representative, SRS manages all post-closing matters, including working capital and other purchase price adjustments, tax reviews, earnouts, the handling of claims, disputes and litigation, communications with acquirers and selling shareholders, and management and distribution of escrow and expense funds.

SRS has a senior-level team of more than 30 attorneys, financial professionals, and operations and systems experts and the most sophisticated operational, tracking and reporting systems ever used by a shareholder representative. On deals valued in aggregate in excess of $25 billion, SRS has represented more than 400 venture capital and private equity firms and over 25,000 shareholders in 44 countries. No one has as much knowledge and experience in serving as a shareholder representative and navigating the issues that arise post-closing than SRS.

For more information visit www.shareholderrep.com

This email is intended to provide information of general interest to the public and is not intended to offer legal or tax advice about specific situations or problems. You should consult a lawyer or accountant if you have a legal or tax matter requiring attention.