When Fast Growth's Not Enough2:17 PM EST Fri. Sep. 24, 2010
Doug Ford had a painful dilemma.
As founder and president of The I.T. Pros, Ford had promised himself that he would always use his own money to grow his solution provider business and would not -- under any circumstances -- take funding from venture capital firms.
And grow I.T. Pros did, and then some. The San Diego-based company, which Ford officially incorporated in 2001 during the onset of a recession, went from a small, one-man consulting operation to a managed services firm that for seven years in a row increased revenue at close to 100 percent or more each year. I.T. Pros became a rising star in the channel and was honored with numerous awards over those years, including rankings on CRN's Fast Growth 100, making the list for the first time in 2007 after reaching $2.6 million in annual sales for 2006 with an impressive two-year growth rate of more than 150 percent.
Ford had conceived I.T. Pros with a firm belief that a managed services offering was a perfect fit for the SMB market. And he most certainly was not alone.
"From 1998 to about 2001, there was a gold rush," Ford said. "And it was absurd. It had gotten to the point where there was no competition for a big client. You'd just walk in, uncontested, give the client a proposal and they'd buy it without any pushback."
Ford's business proposition to small businesses in Southern California and, later on, the Southwest, was simple: Instead of worrying about IT support, security and infrastructure, let us manage your systems and you can focus on what you do best. The formula worked, and soon I.T. Pros was off and running.
"Managed services was no longer a secret," Ford said. "It's a very competitive market, and we realized the differentiator was good, reliable customer service."
Ford's company made a name for itself as a strong regional managed services player that could reduce IT costs for small businesses. I.T. Pros bet much of its business on what was then an unusual vendor partner: Dell. While the direct computer maker was widely seen as an enemy of VARs at the time, Ford made the decision to team up with Dell early on. That partnership grew stronger as the computer maker acquired other vendors that I.T. Pros partnered with, such as EqualLogic and SilverBack Technologies.
"Dell has been a great partner for us," Ford said. "We relied heavily on them, as well as other vendors, for joint marketing opportunities because we did very little strategic marketing or advertising on our own. And Dell really supported us."
Already strong with managed services offerings such as remote monitoring, I.T. Pros began moving more toward virtualization and, later, cloud computing solutions behind partnerships with VMware and others.
"There was definitely a paradigm shift toward virtualization, even at the small-business level," Ford said. "Then cloud computing became huge, and Infrastructure-as-a-Service became one of our specialties. Even when we started seeing a decline in professional services sales last year, interest in cloud computing was extremely high because clients wanted to reduce their monthly IT expenses."
Capitalizing on virtualization and cloud computing served I.T. Pros well as the company continued to increase revenue at nearly 100 percent and earned spots on the CRN Fast Growth 100 list again in 2008 and 2009, finishing 2008 with $4.9 million in revenue.
Fast-forward to 2009 and another recession -- and this one was much worse. A financial collapse had struck Wall Street a year earlier, sending the economy into the toilet. I.T. Pros was continuing to increase its revenue, but the rate had slowed in 2009 and, furthermore, fueling the growth was expensive.
And here's where Ford's dilemma came in. He could keep I.T. Pros as "lifestyle business" -- one content with the status quo -- and settle in as a regional player. Or he could build it out into a nationwide business, which took capital. Taking I.T. Pros across the country was a daunting task, even with the company's impressive revenue growth.
"We found out that banks just aren't going to continue to loan you money like they used to," Ford said. "Either I.T. Pros had to go out and raise capital or team up with another company."
NEXT: All Covered's Acquisition Fever
All Covered's Acquisition Fever
In Redwood City, managed services player All Covered was growing rapidly as well. Founded in 1997, the company started out as a 10-person IT consulting firm and grew not only through SMB-focused managed services but also through an aggressive acquisition strategy. CEO Todd Croteau had arrived at the company in 2000 when All Covered bought his consulting firm.
Like I.T. Pros, All Covered's approach of offering managed services and IT outsourcing to SMB clients was incredibly successful -- as was the company's acquisition strategy. Croteau said All Covered made strategic purchases of small, regionally focused solution providers to expand geographic coverage and open up new offices.
After Wall Street's collapse in the fall of 2008, Croteau watched as IT spending dried up, and finding new SMB clients for its managed services business became harder and harder as months dragged on.
"If you had asked me two years ago if we at All Covered thought we were recession-proof, I would have said yes," Croteau said. "The idea was always that you have a big number of small-business clients, and losing any one client or even a few clients won't hurt you that bad because your business is so spread out. But we were wrong. And we had a problem."
Soon, All Covered wasn't acquiring small VARs just for its regional expansion plans. As the SMB market became more competitive, the company saw acquisitions as key to adding new clients.
"We spent the better part of 10 years experimenting with the best ways to go to market with small businesses, and we've learned that it's hard to find new small-business clients," said Croteau. "And about two years ago in late 2008, it really got bad."
NEXT: Roadblocks Ahead
The credit crunch and capital drought worsened in 2009. The solid banking relationships I.T. Pros' Ford enjoyed turned brittle; credit lines for a quarter of a million dollars shrank to $100,000 or less.
"Distributors tightened our credit lines, too," Ford said, "even though we had good relationships and had done business with them for almost a decade."
As a result, I.T. Pros found itself in the same position as many VARs: struggling to fulfill orders on what limited demand they could find. So despite its exemplary revenue growth and established track record as a rising star, Ford's company in the end was viewed no differently than resellers wracked with debt and laboring to break even.
Securing product was tough enough, but there were other, expensive challenges for I.T. Pros. "Managing rapid growth was a challenge even before the crash of 2008," Ford said. "But then it got even harder. Finding talent was tough before 2007 but it got easier as more people unfortunately lost their jobs, so that wasn't a problem. We didn't have a lot of big expenses. We had affordable office space, so we were all set there. But the real challenge was in sales -- going out and marketing and branding the company and winning new clients."
I.T. Pros was soon spending more time, energy and resources on building sales. Typically, Ford wanted a staff ratio of 3-to-1 for billable vs. nonbillable employees. But as the sales environment worsened in 2009, that ratio fell to almost 1-to-1. As a result, I.T. Pros had fewer consultants and engineers to service clients. And that was a big concern for a solution provider that had 23 total employees.
"We saw what was happening," Ford said, "and rather than sit around and wait for things to get worse, we put together a very proactive plan to get us through 2009."
First, Ford said his company had to get more aggressive with accounts receivable. Second and more importantly, I.T. Pros searched far and wide for banks that could lend it money, looking at everyone from national financial services firms to local community cooperatives.
"Ironically, we ended up going with a national bank and got a great deal, relative to the economic conditions," he said.
And third, when things were slow -- as they often were -- Ford invested in his technical staff's training and certification for top partners like Dell, VMware and others. "Sharpening the saws during downtime was critical for success," he said. "Some of the training was free. Other courses were expensive, but they were worth it."
NEXT: All Covered Revs Up
All Covered Revs Up
Over at All Covered, Croteau was discovering more and more that having a client list with hundreds and hundreds of small and midsize businesses and not relying on a handful of large rainmaker accounts was good in theory, but it had disadvantages as well. As the recession took its toll on IT budgets, All Covered realized it couldn't acquire brand-new, small-business clients as fast as existing clients were pulling their dollars. The company had to a find a new way to bring in fresh clients, and fast.
So All Covered came up with a plan to beat the recession: increase the number of acquisitions. The solution provider picked up the pace and in the past 16 months alone, All Covered has made 10 major acquisitions. Not only did the purchases help the company expand its geographic reach, but it added valuable clients to All Covered's already sizable roster.
Croteau saw many a solution provider looking to sell their business last year. "Some of it was probably just bad timing," he said. "Maybe they made some bad bets [on technologies] at the wrong time, or built out their staffs or infrastructure and then had to contend with such a difficult sales environment."
Whatever the case, All Covered had plenty of potential targets. But there was one company in particular that stood out.
NEXT: Let's Make A Deal
Let's Make A Deal
I.T. Pros survived a turbulent 2009, but the ordeal left Ford wondering about the long-term prospects for his company. He had wanted to build I.T. Pros into a national managed services powerhouse, but the prospect of doing so seemed increasingly daunting. With venture capital investments out of the question, Ford had two options: secure more loans -- and take on more debt -- or merge with another company.
Even if Ford could get additional funding from banks, the price was just too steep. "I'm a fairly young guy. I'm in my late 30s," Ford said. "All of the capital commitments for I.T. Pros were guaranteed by me personally, and I was assuming a lot of risk."
By the end of 2009, Ford had received a call from All Covered. He hadn't made the decision to begin shopping I.T. Pros and was surprised to find that All Covered, an occasional competitor, was interested in buying his company. "We knew about All Covered and had competed with them a few times," he said. "When we found out we were on the short list, it was really an honor."
For the next few weeks, Ford and All Covered had additional discussions about coming together and realized they shared a common vision for SMB-tailored managed services. And All Covered wasn't the only potential suitor. "We talked with other companies to see what the valuations were for I.T. Pros," he said. "But it wasn't just about valuations. It was about finding the right culture, strategy and vision, and All Covered had all that. It was a good company to hand my baby off to. Everything that All Covered said it would do, it did."
For All Covered, I.T. Pros was exactly the kind of company it wanted to add -- a growing solution provider with strong customer ties and a highly respected network operations center for managed services offerings. "VARs are essentially break-even businesses with a lot of debt, and most have no real prospect of growing to the point where the return justifies going forward and assuming more personal financial risk," Croteau said. "But most of the companies we've acquired or looked at didn't have the kind of growth and expertise that Doug's company had."
By April, the paperwork was finished, and the two companies announced the deal in May. While the details of the acquisition remain confidential, both All Covered and I.T. Pros seem extremely happy. Virtually all of I.T. Pros' staff joined All Covered, and Ford himself became a director of consulting services at the company. "The deal was done in about 60 days, but it took a while for it to sink in," Ford said. "The decision to sell I.T. Pros was not taken lightly."
Croteau recognized how hard it was for Ford; having sold his own business to All Covered years earlier, he was familiar with what Ford was feeling. "It was a difficult decision for Doug because the company was nearly 10 years of his life and all the blood, sweat and tears that went into it," Croteau said.
For his part, Ford feels that while he could have kept I.T. Pros independent, the company would be stuck in neutral instead of on the fast track. And Ford didn't want to be stuck in that lifestyle VAR mode struggling with a break-even business like so many others. "I would not want to be starting a managed services business right now, because those companies are going to have a tough time in this economy," Ford said. "But for the companies that are already doing managed services, I think they have a great opportunity."
While both Ford and Croteau feel the economy is recovering, especially at the small-business level, they anticipate that IT spending and industry growth will be challenged for the foreseeable future. And that likely means even more owners looking to sell their solution provider businesses.
The Credit Crunch: Has Financing Returned?
After the cataclysmic bankruptcy of Lehman Brothers and subsequent Wall Street collapse in late 2008, credit dried up faster than chardonnay at a Tupperware party. Solution providers were forced to hunt for alternative financing sources as business loans disappeared and frightened banks froze or eliminated credit lines. 2009 was a painful year for many in the channel because of the credit crunch; capital was scarce both for solution providers eager to grow their business and the solution providers struggling to stay afloat.
That was last year. What about now? Is the credit crunch over?
Solution providers say the economy turned a corner this year in at least one regard: Credit began to open up again late last year, and now many VARs say it's much easier to secure a loan or line of credit and banks are now courting customers. "The banks are throwing credit at us now," said Audrey Levi of Altek Computer Group in Miami. "We've had three major banks calling us and offering us credit."
Steve Alexander, president of Third Eye Technologies in Nanuet, N.Y., agreed and stated the credit crunch is over. "If you're well managed, then you can get the money now," Alexander said. Banks will certainly scrutinize prospective borrowers, but the endemic reluctance to lend money that suffocated credit lines a year ago has been cured--at least for the time being.
"There's more stress around credit right now, but we haven't seen any material changes to the way our financing partners are operating," said Pete Peterson, Tech Data's senior vice president of U.S. sales. Peterson added that Tech Data's third-party finance partners like GE Capital and Hewlett-Packard have introduced special floor planning and leasing options for SMB-focused resellers. "We know our customers need financing options," he said, "and certainly haven't made any changes to the way we do business, and neither have our partners like GE."
But with unemployment still high and fears of a double-dip recession beginning to creep in, some VARs are getting worried. "The SMB market is getting better this year," said Todd Croteau, CEO of All Covered. "But in a normal economy, we'd see more companies increasing their services with us because they'd be growing and hiring more people. But we're still nowhere near the normal services level because businesses are still fearful of what's to come."
Consolidation Churning Up The Channel
All Covered plans on making roughly a dozen acquisitions a year for the next few years. In fact, the company even has a section of its Web site dedicated to acquisitions with sales pitches about why All Covered is the right choice for VARs looking to sell their businesses. "It's a land grab right now," said All Covered CEO Todd Croteau. "There's a lot of consolidation happening and a lot of interest in acquisitions."
Other VARs agree. "I think there's going to be increased consolidation throughout the IT industry," said Henry Fleches, co-founder, president and CEO of United Data Technologies (UDT) of Doral, Fla. "There's a lot more M&A activity in the channel right now."
Like All Covered, UDT made an acquisition earlier this year to broaden its geographic coverage, purchasing a small IT services firm in Tennessee and using it as a springboard to expand its business in the Southeast. Within its home state, UDT is already one of the strongest and fastest-growing solution providers in the K-12 education market, but the company is intent on building momentum in other states such as Alabama, Georgia and, of course, Tennessee. "One of the ways we're aiming to grow is through acquisitions," said Marvin Dejean, director of marketing at UDT.
But acquisitions can be perilous territory, too. Fleches said UDT would take a very cautious approach, letting the consolidation shake out the weak companies instead of casting a wide net. "We just didn't see the ROI in going out and acquiring a bunch of smaller resellers," Fleches said. "Unfortunately, there's a layer of complexity in our market that involves things like government authorizations and specific competencies, and a lot of resellers don't have those things."
Croteau said All Covered is keeping an eye out for VARs with strong cloud computing and virtualization practices. After purchasing I.T. Pros, All Covered acquired another SMB-focused managed services firm with a growing cloud computing practice in Analysys. Steve Kolbe, founder and CEO of Baltimore-based Analysys, said he made his first investment in cloud computing in early 2009 after being in business for almost 15 years.
"It was a wildly successful move," Kolbe said of Analysys' cloud computing practice. "About 85 percent of our net-new clients had some type of cloud component. We were very much in a leadership position in our market."
That cloud move greatly enhanced Analysys' business and valuation, which helped Kolbe get the kind of deal he wanted when he finally decided to sell his business. "It was a no-brainer for us. Everything that All Covered said it was going to do, it did," Kolbe said.
Unfortunately, Croteau said too many solution providers don't have exit plans prepared and seem to have been caught off guard by last year's economic turmoil. Their financials are in disorder, and they have been slow to adopt lucrative new practices like cloud computing and virtualization.
"I haven't seen a lot of VARs that had good balance sheets and a lot of growth. We usually see companies that fit this kind of profile: a half a million dollars in debt with a million-plus in sales and around 10 to 12 staff members," Croteau said. "It will be interesting to see which VARs dig in and try to stick out the next few years waiting for things to improve and which ones decide to sell."
Still, some solution providers appear to be proactively planning for consolidation. Pete Peterson, senior vice president of U.S. sales at distributor Tech Data, said he's seen more strategic acquisition activity this year. "Guys are starting now to look at making strategic acquisitions instead of doing deals for financial reasons," Peterson said. "I've received a lot of calls in the last few months from VARs shopping for other VARs, so I'm almost playing matchmaker."
Whether the economy improves or not, M&A activity in the channel may continue to spike the same way it has at the vendor level with buying sprees from Hewlett-Packard, Dell and Oracle, to name a few. Consolidation is a natural force that eventually occurs in almost every market, but are the days of the small, regional "lifestyle" VAR numbered? Can the I.T. industry continue to support so many diverse solution providers? How much longer can the reseller channel remain this fragmented?
"VARs really have to start thinking about the future," Croteau said. "You have to ask yourself, what's the endgame for your business? What's your exit strategy?"