Banking On The Channel

When building a business, it never hurts to have an angel on your side...especially one with sacks of money.

In 2002, four years after its founding, IT consultant and longtime IBM partner Perficient hoped to bolster its IT services business with a broader range of offerings targeted at Global 2000 organizations. To do that, it figured it would need to add new people, new technology and even applications. But it needed money to make its dreams of greater revenue and profits come true.

Enter Mort Meyerson, the former CEO of Perot Systems and president of EDS. After leaving EDS, Meyerson moved on to create 2M Technology Ventures, a venture-capital (VC) firm. Meyerson offered some private investment in public equity (PIPE) funding after being introduced to Perficient by one of its existing investors. Good thing, too, considering that the Austin, Texas-based Perficient--which was originally funded by angel investors in 1998 before going public during the dot-com boom--had since found the secondary IPO markets much less welcoming.

Perficient CEO Jack McDonald says Meyerson recognizes value where other don't, which gives business executives such as himself not only the confidence to try, but the fuel to burn. For example, the money provided by Meyerson gave Perficient the security to conduct two more PIPEs in the following two years with other private equity firms, helping it survive the IT economic meltdown.

"The investments made us very well-positioned to survive the nuclear winter we were all living in back then, and gave us the ability to remain cash-flow positive during the downturn," McDonald says.

While many struggle to find secure capital, the truth is that plenty of other well-positioned companies are finding the funds they need to survive and thrive. That's especially true of solution providers in high-growth, high-margin businesses. Think wireless, VoIP, home networks and even the nascent but booming and still largely untapped midmarket. VARs and IT consultants in those sectors are finding access to new financing opportunities (see "Notable VC Investors," page 29), which, in turn, are motivating some to expand their businesses from local shops into regional or even national operations.

The risk is not for everyone, however, and the VC community still places the vast majority of its bets on classic IT product start-up companies. But the right VARs in the right markets at the right time could find the private-equity route the best way to propel their businesses to the next level.

Perficient certainly found that to be the case. The $58.8 million it generated last year in sales landed it at No. 306 on the VARBusiness 500 list. This year, its sales are expected to hit $80 million. The volume of business and transactions Perficient is turning have enabled it to borrow money from Silicon Valley Bank and Key Bank, two of the Valley's best-known lending institutions.

A Change In the Air

The last time service providers looked this good to investors was during the late 1990s, when the companies behind the dot-coms were believed to have unlimited futures. But their failures, coupled with the stock-market crash in 2000, essentially eliminated capital funding in services for nearly four years. During that time, the amount of money flowing to IT services companies was lower than at any time in recent memory. Yet as a general rule of thumb, IT services companies have always struggled for money because they simply do not scale the way product companies do, and because of the constant margin pressures they face. Until recently, many VC firms used VARs primarily as sounding boards for when they were researching potential investments in IT start-up companies.

"The channel is definitely on the rise because the software trend toward cheaper products and broader markets means technology vendors have to be multichannel companies," says Steve Bowsher, a general partner at Interwest Partners, a VC firm in Menlo Park, Calif. "We spend a lot of time talking to VARs while doing our due diligence on a potential investment; they have a pretty good sense of what they can and cannot sell, and they aren't going to BS you."

But now some of these one-time sounding boards are becoming welcome targets for equity investors, due largely to the nature of changing technology delivery. As the tech-sector recovery continues, private investors have more money than they did a few years ago, and they've begun to broaden their definition of what a technology company is. It's no longer just about selling software or hardware, but solutions. And where there are solutions, there are solution providers.

"We tend to view technology less as a business sector than as an underlying component in every sector," says Mark Barnhill, senior vice president of corporate and investor relations at Platinum Equity, an M&A and investment firm in Beverly Hills, Calif. "In the past few years, we've acquired companies that aren't traditional IT in any sense, but they play in sectors that are being roiled by technology advances. There are a lot more funds lately in M&A and private-equity firms that are looking for a place to land, which has made us much more attentive to looking look for companies that can help us make more acquisitions."

One of Platinum's investments was in CompuCom Systems (No. 50 on the VAR500), a Dallas-based reseller and IT consultant that Platinum bought last October and combined with General Electric's IT business-solutions unit. The merger created a new company under the CompuCom name with roughly $1.7 billion in revenue, roughly $500 million of which is services.

"Business sectors are undergoing some kind of transformation toward services, and some IT companies are starting to build critical mass with some sort of services component, and that's particularly the case with CompuCom," Barnhill says. "Their services are still a relatively small percentage of overall revenue, but there's a transformation taking place."

But merely having a services component doesn't necessarily make a business a good investment. San Ramon, Calif.-based Martin Wolf Securities provides M&A advisory services to its clients. President and managing director Martin Wolf says VC firms, angel investors and other institutional financiers are beginning to recognize certain types of resellers the same way they would any other IT company.

"They're interested in people who know what they're doing and whose earnings and growth look good for the future," he says. "Clearly, any VAR with low growth or high debt wouldn't be an attractive candidate."