Why are these companies opting for M&A to augment internal growth initiatives? The following examples illustrate.

A growing $50 million firm, concerned that its growth rate could not be sustained and fearful of becoming dependent on one U.S. Army customer, opted to launch a M&A program.

At another, a $75 million business providing advanced technology solutions to DoD, the founders had no intention of selling the firm. However, they needed to improve the liquidity - and ultimate value - for the company's widely held employee stock. That meant accelerating growth through acquisition, positioning the company for greater value than it could achieve under organic growth.

One of the most successful small company M&A stories is that of Andrulis Corp. With revenue under $15 million and no suitable buyers available, the company added two firms by acquisition, growing the firm to $36 million over three years. The company caught the attention of publicly traded Dynamics Research Corporation, which acquired Andrulis in 2002.

Another recent winning story is that of C-CUBED Corp., in the process of being acquired by CACI International (see analysis in article below). At $49 million in revenue, the government contractor had grown both via internal means and strategic acquisitions of smaller firms.

One success story in the making is Innovative Technology Application (ITA), Inc., a provider of knowledge management and counter terrorism products and consulting services. The company, reported to have run-rate revenue of nearly $30 million, acquired two smaller firms in quick succession this year, IT Specialists Inc., a provider of information technology consulting services, and DKCS, Inc., an information technology (IT) security firm.

Often these new-to-acquisition firms have revenue under $200 million, with the intent to build up for IPO, eventual sale of the firm, or looking to take timely advantage of the government double-digit IT spending growth. While ‘building shareholder value’ is a phrase you may associate with larger, public companies, it is absolutely relevant to smaller company founders and executives, their employees and their families.

Program Launch
How best to proceed if your company wants to start or expand a corporate M&A program. Some essential steps:

• Start with a Strategic and Capture Plan - Just as you would approach a major proposal or overture to a new agency customer, ensure that operational leads, corporate leadership and the board agree on the M&A ‘capture plan’ and target company characteristics, e.g. size, customer profile, profitability level.
  
  
• Expand the Company Board. Many smaller firms have only insiders or very long term non-executives on the board. Consider adding one or more new persons to the Board, especially those with a keen strategic sense, M&A experience and knowledge of the federal market. Once the M&A process is underway, keep the board appraised on progress.
  
  
• Involve the Operators. Business unit owners and line managers – those with the most exposure to customers and the market in general – know those companies and individuals who have the customer’s respect. They also are aware of smaller firms who operate under the radar of large acquirers.
  
  
• Visit your Banker. Since most new acquirers do not want to part with company equity or have sufficient internally generated cash to transact a deal, their lender becomes integral to the M&A process. Collaborate with your banker or other lending source in advance of approaching target candidates to understand the boundaries of affordable deal size and structure.
  
  
• Have the Right Legal Counsel. M&A is a practice unto itself. Make sure your law firm has transacted several M&A deals, or else interview other firms that have.
  
  
• Consider Dedicated Responsibility. At least one person on staff, someone with good financial and strategic sense and close to the corporate decision makers, should be named to spearhead the effort.
  
  
• Consider External M&A Support. External advisers, be they investment banks or M&A advisors, can augment your internal resources by managing the M&A process, keeping the client focused on this effort, researching the market, winnowing the candidates, advising on value and structure and supporting the negotiations with the lead target.

M&A in the federal sector is very competitive, especially when looking for top flight candidates. Large companies have vast resources, a strong track record of successful M&A execution and a team ready to address the acquisition process. Small and mid-size firms must arm themselves with as much corporate mindshare, financial resources, and M&A acumen as they can to be as successful in M&A as they are internally in proposal development, human capital management and contract execution.

In a future issue of the Federal Growth Report, we will cover the elements of a successful M&A process once a target firm has agreed to be acquired by your firm.

FGR: How long had the idea of selling AmerInd germinated in your mind?

TP: We had been approached by several firms over the last 10 years due to our reputation and solid past performance. I always listened; you never know when an intriguing opportunity may come. Only in the last two years did we get serious, interviewing and finding the right M&A intermediary to represent us.

FGR: Were there certain milestones or market conditions that triggered your decision to sell?

TP: Yes, several. We had captured three re-competed contracts in the past 12-18 months, all of which were long term awards. This gave potential buyers excellent visibility into our projected revenues and cash flows.

The company had just passed the 20-year marker. Further, I was approaching retirement age. Also, I had become concerned about pending regulations and legislation that had the potential to make life more difficult for smaller firms to operate in the federal sector. (Ms. Parson referenced the potential requirement for small firms to recertify each year as qualified small companies to retain their preference status under the GSA schedule as well as many other prime and subcontracts.)

Irrespective of these new rules, AmerInd anticipated growth that took us beyond the revenue threshold to qualify as a small business. I didn’t want the company to be just outside the small business size threshold while not being able to take advantage of the benefits of being a smaller business. The size standards have not kept pace with the many years of inflation.

FGR: Do you feel that firms such as AmerInd are better suited to join mid-sized professional services firms such as FCBS rather than larger system integrators.

TP: All things being equal, I believe firms in the $15-50 million size are better off in joining mid-sized businesses. We targeted under $200 million revenue companies. The shock to culture and philosophy (from the combination with mid-sized firms) was not as great.

In the case of AmerInd and FC Business Systems, we complement each other nicely, bringing to the other different customers and core competencies. The opportunities for cross-marketing are significant.

FGR: What steps should founders/CEOs take in preparing their firms for sale?

TP: Make sure your financial house is in order. By the time we went to market, our balance sheet was strong. Get an outside audit of you financial statements if possible. It does cost more but will give the buyer that much more comfort about your historical figures, and your projections by extension.

Talk with several external sources, including accountants, lawyers and M&A advisors about your company, your prospects and the assets your company truly brings to buyers. I strongly recommend that the entrepreneurs retain an investment bank. They are a third party tasked with getting you the optimal price – while keeping your emotions out of negotiations. The company is your ‘baby,’ entrust it to a party that treats it as you would!

FGR: What advice do you have for CEOs selling their company as they approach the integration of their firm with the buyer?

TP: Use a tiered approach in communicating the opportunity and the state of negotiations with your team. These people enabled you to attain success to this point and should be part of the process.

Initially, as we approached candidates, I only involved the Executive Vice President. Once we narrowed the process to three candidates, we brought in the Vice President of Operations, Director of Business Development, Controller and HR director. Upon the letter of intent with FC Business Systems, the senior program department managers joined discussions. These are the people on the front lines. A buyer will want to get to know them.

While in the heat of negotiations it is too easy to not emphasize integration planning. This is critical however. Had I to do it again, I would have pushed for more sharing of business development initiatives, going into much more operational detail on past performance and pipeline development for example. In AmerInd’s case, it is a wholly owned subsidiary, maintaining its successful reputation and visibility.

The FCBS President and I continue to meet regularly to address transitioning issues.

FGR: What do you plan to do over the next few years?

I’ll be consulting for the company for six months. But I’ve already begun to enjoy the fruits of the last 20 years’ labor – taking my grandsons golfing, to Disneyland, planning an Alaskan trip, and being able to devote more time to various organizational boards.

DISCUSSION
On September 23, 2003, CACI International, Inc. (NYSE: CAI) signed a definitive agreement to acquire all of the outstanding shares of C-CUBED Corp. (Springfield, VA), which provides specialized services in support of command, control, communications, computers, intelligence, surveillance, and reconnaissance (C4ISR) initiatives for clients in DoD, federal civilian, and intelligence communities.

C-CUBED offers solutions in five primary business areas: network enterprise solutions, systems integration, integrated logistics support, combat systems, and deep submergence engineering.

CACI chairman, president, and CEO Dr. J.P. (Jack) London said, "The acquisition of C-CUBED will enable us to enhance our C4ISR offerings to an expanded client base in the defense, civilian, and intelligence markets. C- CUBED offers a highly skilled and specialized workforce with a solid track record of continued growth and long-term customer relationships. They are a good complement to CACI's corporate goals, and we look forward to welcoming them to our team."

C-CUBED founder and CEO Edmund J. Bednar said: "The sale of C-CUBED to CACI will ensure the future growth of the company, and will provide increased opportunity to the employees of C-CUBED."

TERMS
Terms of the transaction were not disclosed. The transaction was announced on September 23, 2003. Closing is anticipated during the month of October.

Most of the company's 400 employees hold high- level security clearances. For their fiscal year ending June 30, 2003, C-CUBED recorded revenue of $49 million and operating income of $3.2 million.

The transaction is anticipated to be accretive to CACI's financial performance for the fiscal year ending June 30, 2004.

ANALYSIS
Despite CACI's bulging systems engineering and integration muscles, the company has never been able to organically develop a significant business base with the U.S. Naval Air Systems Command (NAVAIR) (Patuxent River, MD) and its subordinate activities.

Enter C-CUBED, which last year did more than half of its $49 million in revenues with NAVAIR's Naval Air Warfare Center - Aircraft Div. (NAWCAD), looking for a nice exit strategy for its employee-owners.

Assuming CACI still wants to grow its presence at NAVAIR, which contracts for hundreds of billions of dollars worth of support services every year, these two firms are a match made in heaven. And better yet, the deal builds upon CACI's October 2002 acquisition of Acton Burnell, Inc. (Alexandria, VA), which had developed a relationship, albeit a small one, with NAVAIR over the years. Looks like CACI will get its NAVAIR market share, one way or another.

USAF WR-ALC Chooses Four for C-130/C-141 Aircraft System Engineering Support (ASES)
On September 24, 2003, the U.S. Air Force Warner Robins Air Logistics Center (WR-ALC) (Robins AFB, GA) awarded four, parallel, five-year, time-and-materials, firm-fixed-price, IDIQ contracts, worth $44 million collectively, to provide engineering, logistics and program office support for the C-130 and C141 System Program Offices (SPOs) under the Aircraft System Engineering Support (ASES) program.

The recipients were:

• Jorge Scientific Corp. (Arlington, VA)
• TCS Design & Management Services, Inc. (Warner Robins, GA)
• Support Systems Associates, Inc. (SSAI) (Melbourne, FL)
• Innovative Technologies Corp. (ITC) (Dayton, OH)

Under the multiple-award program, these four companies now will compete for task orders to provide engineering support for electrical, avionics, mechanical, and aeronautics on the C-130 Hercules and C-141 Starlifter aircraft. More specifically, the task orders will cover systems engineering for modification programs, independent studies and analyses, engineering for special modification programs, engineering support for test programs, engineering support for the production of C-130J Hercules II aircraft (the C-141 is out of production), and software support for existing programs.

The contract was competitively procured through solicitation F09603-02-R-30029, which was issued on October 11, 2002, and called for multiple awards under competition limited to small businesses only (NAICS 541330, $20 million).

USAF AIA Picks Six for ETSS II Program to Support Information Warfare Battlelab
On August 27, 2003, the U.S. Air Force Air Intelligence Agency (AIA) (Lackland AFB, TX) awarded six parallel, six-year, IDIQ contracts, worth $252 million collectively, for the Engineering and Technical Support Services II (ETSS II) program.

The recipients were:

• Computer Sciences Corp. (CSC), Federal Sector, Enforcement, Security & Intelligence (ESI) (Falls Church, VA) (F41621-03-D- 6100).
• MacAulay-Brown, Inc. (MacB) (Dayton, OH).
• SAIC Information & Technology Systems Sector (San Diego, CA)
• Titan Corp., Systems Integration Sector, Special Programs Div. (San Antonio, TX)
• General Dynamics’ Veridian Information Solutions Div., Information & Infrastructure Sector (Oakton, VA)
• AdTech Systems Research, Inc. (Beaver Creek, OH)

Under the multiple-award program, these six companies now will compete for task orders to provide professional and engineering services, and other services in the information warfare (IW) arena, to include offensive and defensive warfare capabilities in support of the operations, acquisition, and testing activities at the Information Warfare Battlelab (IWB) of the Air Force Information Warfare Center (AFIWC) (Lackland AFB, TX).

The technical areas covered by the task orders will be information operations, analysis, training, IW, application of technology to IW, communication/computer infrastructure, strategic and modernization planning, and test and evaluation (T&E).

The contract was competitively procured through solicitation F41621-03-R-0002, which was issued on March 18, 2003, and called for multiple awards under full & open competition. Two awards were set aside for small businesses only (NAICS 541330, $23 million).

NAWCAD Chooses Navmar to Support Avionics and Sensors Product Line
On September 24, 2003, the U.S. Naval Air Warfare Center - Aircraft Div. (NAWCAD) (Patuxent River, MD) awarded Navmar Applied Sciences Corp. (Warminster, PA) a five-year, $31 million, IDIQ contract to provide engineering and technical support for the Avionics and Sensors product line.

Under the contract, which has an estimated level of effort (LOE) of 84,480 labor-hours per year, the company will perform support services for the development of improved and new avionics systems and subsystems for naval air platforms. Areas of support include flight information systems, electronic warfare (EW), electro-optics (EO), acoustics, and mission sensor integration. Work will be performed in Lexington Park, MD.

The contract contains a one-year base (worth $6.1 million) and four one-year options that, if exercised, would increase its cumulative value to $31 million (estimate) and extend the period of performance through September 2008.

SPAWAR Picks BMH to Support NWDC Experimentation and Training Exercises
On October 2, 2003, the U.S. Naval SPAWAR Systems Center Charleston (SSC-C) (Charleston, SC) awarded BMH Associates, Inc. (Norfolk, VA) a five-year, $42.3 million, cost-plus-fixed-fee, IDIQ contract to provide engineering and technical support services for experimentation, exercises, and training tasks.

Under the contract, the company will support SSC- C’s Surveillance and Systems Engineering Dept. (Code 32) by providing software development, engineering, operational planning, technical expertise, technical support, and management support for operational modeling and simulation, experimentation support, C4ISR interface support/joint semi-automated forces (JSAF) simulation support, systems configuration, exercise logistics, training and documentation. These activities support primarily the Navy Warfare Development Command (NWDC) (Newport, RI), but also SPAWAR and other customers. Work will be performed in Charleston, SC (40%); Newport, RI (30%); Norfolk, VA (30%); other DoD and government sites worldwide.

The contract contains a one-year base (worth $8 million) and four one-year options that, if exercised, would increase its cumulative value to $42.3 million and extend the period of performance through September 2008. Contract funds will not expire at the end of the current fiscal year.

The contract was competitively procured through solicitation N66604-03-R-1059, which was issued on March 6, 2003, and called for competition limited to small businesses only (NAICS 541512).

Minuteman Ventures LLC’s Paul Serotkin addressed ‘Small/Mid Tier Defense M&A’ before the recent SRI San Diego Conference on Aerospace and Defense.....To see slides of the presentation, click here.

Minuteman Ventures LLC joined the Professional Services Council, the venerable association that advocates for government policies affecting federal and defense contractors.

A quick literature survey will unveil many articles and studies on the ways that incentive compensation fails or is problematic. I suspect you will find few articles on ways it succeeds. Some of the challenges I have found include:

• Aligning the incentive plan with the overarching corporate strategy
• Matching the incentive performance criteria with the realities of the employee’s responsibilities
• Fitting the incentive plan to the drawn-out business cycle of federal contracting
• Fitting the incentive program within DCAA parameters
• Aligning incentives and revenue growth

One of the more difficult areas to apply pay for performance is business development in the government marketplace. That is, aligning incentives and revenue growth. The reason is simple - winning government contracts requires a team effort over an extended period.

Further, business development, winning new contracts and contract execution are often highly integrated activities and involve many of the same individuals. The length of time from identification of a new business opportunity to award of contract and revenue actually hitting the books can be several years. This means that the team that brought in the win may have a variety of participants and may totally change all personnel in the long procurement process. Let us look at a few typical situations which could actually take place in a single firm.

Claire, Brian, Sarah and Judith are all making valuable contributions to the company’s success. Their stories serve to illustrate the difficulty in creating a fair incentive program. Key elements or factors in their individual success are really the result of the work of others. Plus, only Claire is actually earning and growing revenue and she did nothing to win the contract. Brian, Sarah and Judith have all succeeded in winning contracts that will earn revenue in the future, but not right now. And, the future revenue potential of each new contract is quite different. Sarah’s new contract immediately becomes backlog but in 18 months the contract is completed and there is no more revenue. Brian’s new contract might produce $20 million in annual revenue for the next five years, a very significant figure but a very big “might.” Designing an incentive system that fairly rewards performance in a variety of complex performance situations is hard and difficult work.

A mistake some companies make is to attempt a “bounty” system for business development incentive. That is, they formulate an incentive pay package strongly linked to winning new contracts. As they get into the details the complexity increases and the distortions grow.

Bounties overlook team effort, do not account for the long time span of the marketing and sales effort, and must be economically contrived to accommodate the lack or small amount of revenue available at contract award. When the contract won is an IDIQ contract, the concept of a bounty incentive is especially difficult to defend. Further, awarding bounty incentive compensation is often perceived as inequitable and team participants are disincentivized.

This does not mean that elimination of incentive compensation for business development efforts is a solution. The practice of pay for performance is far too wide spread in American business to deny employees a benefit they see as an entitlement.

Rather, firms must devise business development incentives that recognize the team effort and the lengthy government procurement process. Individuals who consistently demonstrate effective business development leadership are more effectively rewarded by promotions, titles, and salary increases with expanded responsibilities (and, of course, some incentive compensation).

Within the context of your firm's compensation system, creatively devise a pay for performance program that deals with the time span of government procurement and the numerous individual efforts required to produce a winning effort. Simple systems, with metrics that are easily understood and transparent to employees are likely to be more effective than complex scoring systems or algorithms that only management really understands. In summary - reward the team for their effort over a long procurement cycle using a simple straightforward system.

Gary A, Dunbar, Inc., a business development consulting firm specializing in helping federal technology providers and firms in other industries create consistent, long-term revenue growth. For additional information, contact Gary Dunbar at gary@garydunbar.com. or see www.garydunbar.com.