Myth: Large companies won't acquire small/mid sized companies.

Not so. Large companies will indeed buy quite small firms provided there is a tight strategic fit, one that resonates with one of the buyer's operating groups. Seller has to be correctly positioned, though.

Large corporate buyers in the government technology sector reward sellers with one or more of the following characteristics: a significant percent of employees with secret/top secret clearances, ownership of prime contract government wide vehicles used nationally (and typically underutilized by the seller), funded contracts in well-funded mission areas (special operations command, unmanned vehicles, bio-chem, information security, C4ISR, for example), high degree of revenue derived from prime contracts (performed by the seller's employees), and, though more common to mid-sized buyers - business area diversity (see $200 million STG's purchase of DTSI in the fall of 2002). While other attributes are valued, the list above merits particular attention.

Myth: Mid sized buyers ($100- $300 million) make better 'homes' for smaller company sellers than do large corporations.

One might think so, due to the fact that the mid-sized firm is closer in size and less removed from the entrepreneurial ways and systems of smaller firms. The truth is that seller should probe the culture of both types of buyers.

Overly bureaucratized companies come in all sizes. Elements of entrepreneurship can be found in the very large (note the many modestly sized operating units at SAIC). When contemplating the right buyer, look at control issues, reporting systems, management performance, benefits, and the buyer's 'communication culture.' Talk to CEOs of other firms acquired by the buyer to see how that firm was treated post- transaction.

Myth: The public market for government technology firms has created a pricing bubble for smaller sellers.

Not really. While the valuation for smaller sellers, on average, has increased some, there still exists a fairly strong disconnect in valuation from the newly and long- term public companies in this sector.

Why? Generally, time-honored finance theory comes into play - the smaller company cannot command the same marketplace presence as larger, public firms while finding it more difficult, if not impossible, to raise equity capital. In the government sector, in particular, smaller firms tend to be more reliant on contracts based on size, gender or nationality preferences. These contracts may not be transferable to buyer, creating a valuation problem for seller.

The rebound (despite the recent fall-off) of the IPO market for public government technology companies after being moribund for years does have a positive impact on sellers. The public firms are valued on the basis of at least 20% a year growth, a challenging wall to hurdle internally once revenue reaches into the hundreds of millions of dollars. Combined with the growing DoD/Government IT budgets, this argues for a continued strong stream of closed transactions in this sector.

Myth: If I decide that M&A is the path for my company, the only option is to sell my business.

There are ways around outright sale, especially if the offered prices from buyers do not meet expectations. Some smaller companies have bought yet smaller firms, then leveraged that, in part, to become a more attractive acquisition target years later (note the successful Andrulis strategy). Other smaller firms agree to merge, creating opportunities for larger market share. (See the recent merger between SYS Technologies and AP Labs.)

Selected Defense/Government Technology M&A Transactions
Closing or Announcement Date	Buyer	Seller	Purchase Price	Seller Revenue	Enterprise Value/Revenue
March 31, 2003	General Dynamics	Creative Technology	N/A	300 employees
March 17, 2003	Resource Consultants, Inc.	Innerbase Technologies, Inc.	N/A	$6 million
March 4, 2003	Engineered Support Systems (EASI)	TAMSCO	$66.5	$115m	58%
March 3, 2003	CACI	Applied Technology Solutions	N/D	80 employees
March 3, 2003	Mantech International (MANT)	MSM Security Services	$5.25m	$19.9m	26%
February 25, 2003	Mantech International (MANT)	Integrated Data Systems	$50.5m	$40m	126%
February 24, 2003	SFA	The Analysis Corp. (TAC)	N/D	$7m
February 6, 2003	SCB Computer Technology, Inc. (SCBI)	Remtech Services, Inc.	N/D	$29m
February 5, 2003	Perot Systems Corp.	Soza & Company, Ltd.	$96m	$137m	70%
February 7, 2003	BAE Systems North America	Mevatec	N/D
February 6, 2003	EDO Corp. (EDO)	Advanced Engineering	$50m	$38m	76%
February 5, 2003	SAIC	Quality Research, Inc.	N/D	$63m
February. 5, 2003	SAIC	Scientech (defense unit only)	N/D
February 3, 2003	SRA International (SRX)	Adroit Systems	$38.9m	$42.8m	91%
January 28, 2003	SAIC	VGS, Inc.	N/D	$17m
January 27, 2003	American Systems Corporation	Business Plus Corporation	N/D
January 21, 2003	Computer and Hi-Tech Management	ECI Systems	N/D
January 10, 2003	Information Management Consultants	KEVRIC	N/D

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As a CEO striving to build company value, the growth of revenue and the return-on-investment from business development expenditures are two key factors. Are your business development efforts paying off in a meaningful way that can be translated to increased company value? Below is a short-hand scoring system to develop a simplified view of the relationship between revenue growth, business development ROI, and company value.

Revenue Growth - What is the average annual rate of revenue growth over the past four years for your firm?



Clearly there is no argument regarding the impact of the negative revenue growth ratings in A and B. But what about C? The zero for C reflects the notion that revenue growth is just barely staying ahead of inflation. Consider that revenue growth varies from year to year for most firms; that may mean some year's revenue growth matches or is less than inflation. Look at your firm's specific performance and adjust the scoring numbers as appropriate. You may also need to make an adjustment in scoring for D, E, or F if your year-to-year numbers vary significantly.

Win Rate - What is your average win rate for competitive contracts? Measure your win rate using the maximum potential revenue value of all submitted proposals in a given time period compared to the proposals you win. (If your firm does not track win rate it is likely that business development improvements are needed.) Also note that repeat business, while extremely important, is not likely to be a good indicator of increasing equity value.



You may measure win rate using a rolling two-year period and measuring a) the number of proposals won divided by the number of proposals submitted and by b) the total contract value won (including all options and potential modifications) divided by the total contract value submitted.

If your company captures more than 65% of the competitive proposals submitted, it is likely that you have the capability to expand your market position or it may be an indication of you being too conservative. You are proposing only on the safest opportunities.

Interpreting your combined score

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What qualities were you looking for in a buyer?

BU: I placed a lot of importance on the cultural fit offered by buyer candidates. Those who made my short list were very people oriented, looking beyond the financials and wanting to understand the resident talent at Synetics and values that defined our company. Second, we wanted a buyer that would keep the company together at least through the transition period. Third, the ideal buyer would have in place a program that recognized and rewarded employee performance. Also, both the 'deal-makers' and the operators need to display substantial integrity. My feeling was that if these out-front company representatives exhibited those qualities at the outset, our dealings with the buyer post-transaction would also be positive.

What are your three best pieces of advice for selling CEOs?

BU: Involve your direct reports throughout the process. I informed my six key executives. If you have built the right degree of trust through the years, they will support you. These people are essential during the M&A process and they actually increase company value once the buyer observes their obvious talent.

Second, work with a good M&A advisor, an intermediary who both knows the M&A practice and has long experience in government technology markets. Build a good relationship with the firm principals. They can take a lot of burden off the CEO. Having said that, the CEO and intermediary need to be interchangeable before the buyer - the negotiations at any given time can play to the strength of one party or the other.

Further, be able to walk away from a deal if the deal on the table sours. And, before you even contemplate this process, think through what you want to do after the deal. You may end up with the buyer, or not.

How do you see the current M&A market for Government/Defense technology companies?

BU: Very positively. Many buyers project a 20% growth plan, half through organic growth, half through acquisition. For companies under $50 million, I believe they should always be looking at selling as one option on the table. The difficulty of being smaller and having to grow in an environment where large procurements dominate is a real challenge.

Do you have any particular advice for 8(a) companies as they contemplate sale?

BU: Yes, if more than 30-40% of company revenue is derived under contracts set aside for 8(a) businesses, delay the M&A process. You need to transition the contracts to non-8(a) status or show the buyer how the contracts will be transitioned post-transaction.

Buyers will place very little value on 8(a) contracts unless they are transferable. One way to somewhat mitigate this is for an 8(a)-heavy contractor to sell to another 8(a) certified firm, but even these contracts will not get market value.

What have you been doing since the sale?

BU: I had a one-year consulting agreement with ACS to support the transaction. I have also been playing a lot of tennis and traveling, as well as helping other emerging companies in their business strategies.

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No other entity matches the federal government as a source of funds. But with government funds comes conditions.

One category of unique terms is the government's rights in intellectual property (IP). These rights must be considered in business plans, in attracting investors and, ultimately, in positioning the company for maximum value when contemplating sale of the business.

For CEOs, the IP ownership issue pertains to government technology services firms as well as those selling products to government customers.

Bear in mind that these rights depend, initially, on who pays to create the IP.

Companies with privately developed IP should sell products or services without giving the government any greater rights than commercial customers receive. These typically are called "commercial-item" contracts and subcontracts.

Companies that perform some research and development (R&D) with federal funds must usually give the government extensive rights of use, and rights to disclose to third parties, in the resulting IP. These are government contracts in the traditional sense, and incorporate by reference pages of clauses from the Federal Acquisition Regulation.

There exists, of course, a middle ground. Some of my most successful clients - defining success as having a business plan and meeting it - first have developed a core set of IP, and then have sought and received traditional government contracts to develop products for specific government needs, based on that IP. The government receives its extensive rights in the applications - sometimes mere bells and whistles; sometimes whole new products designed for uniquely government uses - but the government still pays the market price and receives the standard license for the core IP on which the applications are based. Each time. And, it has no contractual right to share the core IP without your consent, which you may withhold.

Clear as mud? Trying categorizing each of your company's divisions, programs, or other groups, first in terms of who paid to develop useful IP:

• Privately developed all or nearly all IP;



• The government funded (or gave you) all or nearly all IP; or



• A mixture.

Click here for more information on Clayton S. Marsh, Esq. »

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Minuteman Ventures does two things. We help small and mid-sized company owners sell their businesses, and we help corporate and private equity buyers acquire strategically aligned companies.

We specialize in companies that sell services and products to federal government agencies and the Department of Defense.

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