A Founder’s Perspective: The Journey on the Private Equity Highway

Glenn McCarty and his partners built an innovative software company that transformed the quality standards movement. Glenn recently sat down with TCV General Partner Kapil Venkatachalam to talk about the early days of the company and deciding to sell it 25 years later. He also shares advice for founder CEOs of technology companies looking to scale their business and what to expect if they decide to go down the private equity path. Key topics include:

  • ETQ’s origins and early pivots
  • How to assess your buyout options and find the right partners
  • Preparing for success in the due diligence process
  • How to bring your team on board

The Early Days…

Kapil Venkatachalam: How would you describe what ETQ does?

Glenn McCarty: Most people today know ETQ as a provider of a quality management software platform that automates the process of organizing operating data for managing compliance and quality improvement across a variety of industries, including automotive, healthcare, pharma, energy, food and beverage, and chemicals. It’s designed to layer onto a company’s existing processes while opening up much better visibility into opportunities for increasing quality and competitive advantage.

Kapil Venkatachalam: I’d love to hear more about the roots of the company…the cocktail-napkin story. As I understand it, you were a consultant rather than a technologist when you launched ETQ.

Glenn McCarty: Technically, I was an auditor. In the 1980s the U.S. had gotten behind the curve for manufacturing quality. The rest of the world was pushing ahead with ISO 9000, an international standard for improving manufacturing processes, as a way to improve product quality. It was becoming hard for U.S. companies to sell products in Europe and Asia that didn’t come from factories with ISO 9000 certification.

Kapil Venkatachalam: How did this lead to the formation of ETQ?

Glenn McCarty: I was working as a quality engineer for Underwriters Laboratories in the U.S., and I was getting bored with testing hairdryers. ISO 9000 was the big international trend in manufacturing at the time. So I joined a group that was doing ISO 9000 audits.

We were giving failing grades to tons of manufacturers, because their processes just didn’t measure up to the standard. We would get together with other auditors after work and feel terrible. I was a 20-something quality auditor sitting in a boardroom of a large company and telling the executive team all the quality issues they faced.

Kapil Venkatachalam: Did you see the vision for ETQ given the demand and had it figured out from that point on?

Glenn McCarty: Not even close. We started a consulting firm, because we saw that the big accounting/consulting firms did not offer services to address ISO 9000. So we pioneered that market. The thing is, we were able to help a lot of companies achieve ISO 9000 certification, but then they struggled to maintain it. American manufacturing was heavily oriented toward inspections and testing, while ISO 9000 focuses much more on process management with continuous improvement.

Pivoting to Software

Kapil Venkatachalam:  What led you to pivot from consulting to software?

Glenn McCarty:  Two things. First, we knew from our auditing and consulting experience that every company was different. They really valued the processes they had developed to become successful, but there was so much variation from company to company. While consulting was a great business that filled a need, it was not scalable — we had to start over with every company to learn their business. The other issue was that to maintain ISO 9000, U.S. companies had to collect tons more information about their processes than they were ever used to and capable of. It was a serious data management problem.

Kapil Venkatachalam: And this was decades before what we now call the “digital factory.”

Glenn McCarty:  Exactly. No one was offering software focused in this area.

Kapil Venkatachalam: What did you initially envision for the product?

Glenn McCarty: We knew there was a need for something more versatile than the document management systems of the time, which had some nascent workflow capabilities. Companies needed real workflow-based systems to lead their operating personnel through the process, track/capture their process data, to capture their decisions. So we decided to develop technology to track everything:  all the training records, audit findings, document approvals and revisions, different corrective actions or non-conformances that went on in a factory.

When we made the software, the first epiphany was that we had to develop software that could be configurable, not customizable. And it all came from our auditing/consulting days, knowing that companies have distinct processes. They had to be able to layer the software over their own processes.

Assessing the Private Equity Route

Kapil Venkatachalam: When did you start thinking about an exit? What drove that decision? 

Glenn McCarty: Things were going well for us, growth was high, and the profits were great relatively speaking to where we came from – we started in a basement. And we said, “Let’s continue growing this, we can do this.” We kept our heads down and kept hitting our targets. As a founder, you think there are no limits to growth. And while I still believe that’s true, I began to realize that home-grown leadership had its limitations. That’s simply reality. I began to wonder what was out there.

Kapil Venkatachalam:  How did you put that realization into action? 

Glenn McCarty:  The truth is, we used to get letters from various companies saying they were interested in investing in us or acquiring us. We didn’t even respond to them. Then one of our competitors was bought by a large company. I called that company up and said, “Hey, why did you buy our competitor? We’re stronger than them, we’re bigger than them, we’re better than them.” They said, “Well, you wouldn’t talk to us.” That’s when we started to explore our options to bring on a partner.

Kapil Venkatachalam: Did you have a framework to evaluate partners?

Glenn McCarty: We didn’t have much of a framework, but we did have some goals. The main goal was to maximize the value and the potential of the business. That, for us, meant we wanted two things in our partner. One was keeping ETQ intact as a business. We had seen scenarios where competitors were bought by a platform company and integrated into another model. We didn’t want that. The other key aspect for the partner was to bring a lot more than money. To maximize the value and potential of the business, we needed a partner with domain expertise, someone who could understand what we built and take it to the next level.

Kapil Venkatachalam: What about a good fit in terms of culture?

Glenn McCarty: Really important. Working with like-minded people, who see things the way you do, makes everything easier. That realization came quickly, after we began meeting with potential investors. A lot of them had their standard approach, and we were supposed to just fit into it. For example, there were the folks that said, “When we buy you, we’ll keep you folks as the executive management team. We want to come to board meetings and have you report to us on how great you’re doing.”

Kapil Venkatachalam: Was that appealing?

Glenn McCarty:  When we asked, “How are you going to help us with our products, with sales and marketing?” they said, “Well, we know people.” And I said, “No, that’s not going to work.” Then we had other people say, “We’re going to send you back to “school.” You’re going to have to do this our way.”

I’m an engineer and went to many years of school before I graduated. The last thing I wanted was to change everything we had built and stood for. What we were hearing was either status quo or a reeducation program, but our main goal was to maximize value and potential.  We recognized that we needed a partner who offered value creation via a true partnership.  Once that came into focus our next steps became clear.  I would advise founders to seek a partner who can think about your business and your goals the way you do and bring in improvement and new sources of value. Because you’re going to be talking about that value, and working on that, side by side, for months to come.

Kapil Venkatachalam: Once you knew what type of partner could offer the right fit in terms of your objectives and culture, you headed into the private equity journey. In hindsight, what lessons would you offer to other people who are thinking about taking this journey?

Glenn McCarty: In retrospect, the most important thing is to prepare. Like everything else in life, luck favors the people who are ready for it. You have to think ahead about what buyers want, so you don’t wind up doing fire drills down the line because you weren’t prepared. You want to show them a smooth-running business with a ton of potential.

Kapil Venkatachalam: What are the keys to good preparation?

Glenn McCarty:  I would say there are two things. First, surround yourself with good advisors. You are not in the business of selling companies, so get people who are experienced. Your cousin, your sole proprietary accountant or lawyer, the people on your softball team might say he or she can advise you, but it’s unlikely. The reason it’s unlikely is, if they were experts in buying and selling companies then they would be doing that for a living. You don’t ask your CFO to write code, because that’s not what she/he does.

Kapil Venkatachalam: Also, no one expert or firm is going to be the best at everything.

Glenn McCarty:  That’s right, you want experts in each area of financials, taxes, legal, and so on. And this gets us to the other big thing about preparation: you have to get your management team ready. In most cases, they are going to be the ones working with your expert advisors, and then with the experts from the acquiring company. As the CEO you are relying on your management team to raise the bar to meet the due diligence level. You need to make sure that the right people on your team are aware of what’s coming their way and connect them with the right coaches, so they can be prepared in terms of their time, their systems, and whatever information they are going to have to present.

Kapil Venkatachalam: What are some of the points you might use to differentiate buyers?

Glenn McCarty:  You want to know how many founder-owned companies the potential partner has acquired in the past. How many of those companies did the buyer scale up successfully? What is their expertise in sales and marketing or product development? How many other companies in their portfolio could become customers or business partners for you? You want to know all these things, because the potential buyers are doing exactly the same analysis of your company.

Kapil Venkatachalam: Let’s dig a little deeper here and talk through the different areas of preparation for the due diligence process.

Glenn McCarty:  The first thing to realize is that it’s going to be time-consuming. It’s easy to think that you already have your house in order, because your business is humming along. But the buyers have a completely different perspective. They will require you to participate in a due diligence process to demonstrate your companies past and future potential.

Kapil Venkatachalam: Explain why financial systems matter, along with the numbers.

Glenn McCarty:  In hindsight, while you might think the world of your business and its strategic value, at the end of the day the objective measures of success are financial. If you think you are headed for private equity, you may want to invest in better financial systems first. If you do not have a CFO, you might want to seriously consider bringing one on even though you only have one to three years to go before exiting.  One of the benefits is that your financial advisors won’t have to work so hard to explain your financials. They are going to spend some time at this no matter what, but better systems speed it up.

Kapil Venkatachalam: Many founders are aware of the need for strong financials, but they are surprised by the amount of purely legal work that also has to get done.

Glenn McCarty:  We had not realized that our contracts with customers and suppliers would be scrutinized. You have to prepare an amazing number of documents for a transaction. So yes, you need good legal advice and some leverage for document creation, and it should be from a firm that specializes in the type of transaction you are doing. Even with support from an outside legal firm, your General Counsel will be spending a huge amount of time on a transaction, so you have to make plans for them to continue with the business operations while the transaction process is in play.

Kapil Venkatachalam: So now you have your advisors lined up. They’re all experts. But the people on your team may not be experienced in the process ahead. What do you tell them? How do you prepare them?

Glenn McCarty:  First, it’s important to understand the implications of what you are asking. In our case, we had a lot of long-term employees who had worked their way into senior management, so they had never seen this process somewhere else. In that situation, you have to ease them into the whole idea, bring them into your thinking, and get them aligned before you start explaining what they’re going to have to do.

Kapil Venkatachalam: Is this an area where you can get advisors involved?

Glenn McCarty:  I think you have to get them involved, because they know the drill and probably most of your team doesn’t. They can provide education about the process before it starts and coaching all the way through it. You need this because the same employees you are asking to help you sell the company are also running it. No matter how you look at it, this is an ask that is an additional task to their day job. The danger of distraction is there. You need your team to be on top of the due diligence process, while also making sure the ship doesn’t lose speed or direction.

Kapil Venkatachalam: That’s great, thanks, Glenn. My final question is about the takeaways for founders who may be looking at these options. What’s your advice in a nutshell?

Glenn McCarty:  Private equity firms provide an interesting alternative to help you maximize the potential of what you have already built. That said, you have to take the time to find the right firm for you – whose values, experience, and vision are aligned with yours. As we discussed earlier, you have to prepare your team for the journey before you lead them on it. And finally, recognize the value of good advisors. They are worth the money because they bring you the right partners and prepare you for a successful partnership. Selling your business is both exhausting and exhilarating, and I am grateful for all the support I received.

Kapil Venkatachalam: Thanks so much, Glenn.

###

The views and opinions expressed in the transcript above are those of the speakers and do not necessarily reflect those of TCMI, Inc. or its affiliates (“TCV”). This transcript is not an offer to sell or the solicitation of an offer to purchase an interest in any private fund managed or sponsored by TCV or any of the securities of any company discussed. TCV has not verified the accuracy of any statements by the speakers and disclaims any responsibility therefor. The TCV portfolio companies identified above, if any, are not necessarily representative of all TCV investments, and no assumption should be made that the investments identified were or will be profitable. For a complete list of TCV investments, please visit www.tcv.com/all-companies/. For additional important disclaimers regarding this document, please see “Informational Purposes Only” in the Terms of Use for TCV’s website, available at http://www.tcv.com/terms-of-use/