“Software is the best business opportunity on the planet”
-Joe Liemandt, circa 1988
This is part of my operating manual series opening up the playbook of private equity and company building luminaries. Check out past ones with Mark Leonard, Andrew Wilkinson, Robert F. Smith, John Malone, Felix Dennis and Mike Speiser.
If you are interested in buying, growing, and selling small companies, check out my course & community on it at IndiePE.com.
Who is Joe Liemandt? What is ESW Capital?
Joe Liemandt is the billionaire founder and CEO of Trilogy Software and ESW Capital (short for enterprise software) a holding company that buys software companies. It is essentially Liemandt’s family office funded by his $3 billion fortune.
ESW buys US software companies and turns them into cash machines by replacing employees with closely monitored foreign contract workers paid by the hour.
Before ESW, Liemandt was well known for founding Trilogy Software, a product and sales configuration software company, that was prominent in the 1990s and crashed in the dot com bubble.
What is the scale of ESW today? How many businesses has ESW bought?
Since 2006, ESW has bought more than 100 companies, mostly in the US, with deal sizes ranging from less than a million dollars to at least $460 million.
Crossover, which is the recruiting wing of ESW, has amassed an army of 5,000+ workers in 131 countries from Ukraine to Pakistan to Egypt. They are exporting as many as 150 high-tech jobs every week.
ESW aims to do a deal a week in 2021.
What is the story of Trilogy Software?
Joe Liemandt dropped out of Stanford to start Trilogy Software in 1990, at age 21, against his parents’ wishes.
Trilogy Development Group sold product configuration and sales software to companies like Hewlett-Packard and Boeing. Trilogy became the hot place for young coders to land in the late 1990s on par with eBay and Microsoft.
They were known for a testosterone-fueled work environment and an alcohol-infused mix of long hours and parties. Its programmers were paid like rock stars and partied like them.
Back then coding was a rare and unique skill. Companies like Trilogy, eBay, Apple, and Microsoft were making groundbreaking first versions of everything from Web browsers to e-commerce platforms.
Six years after founding the company Trilogy’s sales were $120 million and Joe was on the cover of Forbes as the youngest self-made person on the Forbes 400, with a net worth of $500 million.
Much of Liemandt’s initial wealth came from spinning off a Trilogy unit called PCOrder.com, which sold thousands of computer parts via the internet to resellers and individuals. In 1999 PCOrder.com went public.
Soon after, Trilogy, which was mostly owned by Liemandt, sold $124 million of PCOrder.com stock in a secondary offering. Liemandt set up other subsidiaries like CarOrder.com, but he was unable to IPO his flagship Trilogy before the internet bubble burst in early 2000.
When the dot com bubble popped, Liemandt dropped off The Forbes 400, stopped giving press interviews, outsourced Trilogy’s U.S. workforce, and took his public company private. He bought back the shares of PCOrder that Trilogy didn’t own at $6 each, for $32 million.
Why did Joe Liemandt start ESW Capital?
Joe had long admired Charles Wang of Computer Associates, who had become a billionaire by methodically buying enterprise software companies, including Liemandt’s father’s in 1987, cutting costs, and controlling big industry segments.
After the .com market crash of 2000, Liemandt consolidated control of Trilogy and went to work. Trilogy still produced cash thanks to its software maintenance contracts, particularly with auto manufacturers like Ford. It also had software patents.
In 2006 Trilogy bought Versata, a beaten-down data management software outfit, for $3.3 million. After the deal closed, Versata merged parts of Trilogy into the company, and Liemandt began using Versata for acquisitions and to sue companies like Sun Microsystems, Sears, and Toyota for infringing on Trilogy’s various software patents.
Versata, part of ESW, launched a flurry of patent lawsuits between 2006 and 2013. Most of the cases were settled. But some went to trial. In 2011 a federal jury delivered a $391 million judgment to Versata in a patent case it filed against the German software giant SAP. The case was ultimately settled during SAP’s appeals. Liemandt’s other legal wins, plus income from his remaining software contracts, provided ample firepower for buying software companies.
What else is known about Joe Liemandt?
Joe Liemndat’s father, Gregory, worked directly under legendary GE executive Jack Welch, and the Liemandts vacationed with the Welches.
After his father left GE to be CEO of a mainframe software company in Dallas in 1983, Liemandt began programming but also took an interest in entrepreneurship, frequently reading the business plans his father brought home.
As a Stanford economics major, he was determined to create the kind of business that either Jack Welch or his father would want to buy.
“Most jobs are poorly thought out and poorly designed—a mishmash of skills and activities . . . poor job designs are also quickly exposed with a move to remote work”
- Joe Liemandt, internal doc 2021
What does ESW Capital do after a sale? How do they operate?
They ruthlessly cut costs, R&D, and employee benefits and then replace existing employees with overseas contractors. Innovation and growth take a back seat to sheer profitability.
For virtually all of ESW’s acquisitions, the headquarters are promptly moved to ESW’s Austin offices and the CEO is replaced by one of Liemandt’s key lieutenants.
Some CEOs like Andy Tryba were CEO of multiple companies. Tryba was the CEO of 12 of ESW’s portfolio companies before leaving to start his own firm, Ionic Partners, with a long-time Vista Equity partner.
They are pretty clear their model is to reduce costs as much as possible.
Their goal is for all engineers to be working at globally competitive rates within a year. After stripping acquisitions, the staffing required to run them is turned over to ESW’s Crossover unit.
Crossover recruits people from countries like India, Ukraine and Venezuela, who are paid hourly, work remotely on their own computers, and are spied on with software that tracks their mouse and keyboard, and periodically takes screenshots and photos from webcams.
For example, after buying Jive for $462 million in 2017 when it had 250 employees, ESW closed Jive’s main Portland office, and after a mixture of buyouts, layoffs, and voluntary exits, nearly all of its 250 employees were gone in a year. Less than a dozen remain as contract employees working from home. Those they kept they turn into contractors.
For many people living outside the U.S., Crossover’s compensation is a dream. Software engineers with two years of experience make $15 an hour, five years, called software architects, earn $30 an hour, and eight years, called chief software architects, earn $50 an hour.
For ESW’s contractors, there are no paid vacations, healthcare benefits, or bonuses.
There aren’t even company-issued PCs. Contractors use their own hardware. And it’s up to the contractors to report and pay taxes in their local jurisdictions. ESW doesn’t deal with the paperwork and regulations.
ESW’s hourly workforce is largely expendable, with its operation casting off and replacing workers on a routine basis.
The average tenure is 370 days and only 35% of ESW’s workers leave voluntarily. The rest of the remote workers have their contracts canceled due to low performance, projects ending and “non-compliance”.
ESW has recently been relying more on U.S.-based contract workers. In 2021, there were about 420 U.S.-based contractors working for Crossover, about 17% of ESW’s workforce.
After hiring their remote workforce, ESW tracks everything that they do.
They use a WorkSmart productivity tracking tool, which Crossover’s CEO, Andy Tryba, calls “a Fitbit for how you work.” Andy claims WorkSmart is used to empower the workers to better analyze where they are spending their time. Not for audits from management.
Their workers must agree to install spyware on their computers so Crossover’s productivity team can track the number of times they click their mouse or stroke their keyboard. The tracking software takes screenshots every ten minutes and occasionally snaps photos from webcams. It is unclear how often this is enabled.
Crossover is looking for anyone who can commit to a 40 or 50-hour workweek, but it has no interest in full-time employees. It wants contract workers who are willing to work from home.
Tryba argues that the current cloud wage for a C++ programmer is $15 an hour, the minimum wage at many US companies.
New Crossover workers complete four weeks of “remote university” after they are hired to be trained to fix software bugs or handle customer help requests.
The training, often called camp, “teaches leading-edge programming practices based on the software factory theory.”
During remote university, new employees must pass additional proctored cognitive tests. Workers must get 35-40 of the 50 math and word problems right. They don’t trust resumes and interviews. They prefer to rely much more on unbiased tests.
Most people who start remote university are either dismissed or quit after four weeks.
Once they start working, the tasks Crossover workers perform are constantly assessed. They can be demoted and dismissed at any time.
The attrition rate is about 69% annually.
“Many managers design their jobs as if they are a small startup which requires everyone to be a jack of all trades. Many managers have a view that it is ‘natural’ for an organization to get slower and less efficient as it gets bigger. If instead of designing your org around highly skilled and broadly unfocused people, you design your organization around specialized work units, the opposite happens. Quality goes up, velocity increases and costs plummet.”
- Joe Liemandt
How does ESW Capital source and find businesses to buy?
In 2021, Liemandt decided to supercharge ESW’s acquisitions.
He drew up an updated playbook with a series of if/then steps to find acquisition targets and get them under LOI.
The playbook is carried out by “sales development representatives” and “inside sales representatives” who make $30 to $50 per hour making lists and reaching out to acquisition targets.
They send a drip campaign of “thought leadership” content out on a set schedule to the CEOs of target companies to create brand awareness before requesting introductory calls.
Introductory calls with company owners are semi-scripted, but not fully scripted, because scripting can detract from authenticity.
Then team members attempt to contact the CEOs every two to three days for two weeks to stay top-of-mind. If they don’t hear back, they stop reaching out for six months.
Introductory calls are semi-scripted and then graded. Anyone with low levels of success must attend a “coaches corner” session to learn how they can improve.
If a CEO is responsive to the idea of selling their company, a second call is often conducted to set up non-disclosure agreements to better understand how much recurring revenue there is and to see if there are any insurmountable issues. Calls are also focused on reinforcing the ongoing theme that selling to ESW is the right business decision.
When a good acquisition target has been identified, ESW makes a phony two-day “exploding offer” to “urge CEOs to make quick decisions and prevent them from looking for competing offers.” ESW does not actually let the deal expire and will allow decision-makers more than two days.
What does ESW Capital look for in businesses to buy?
ESW gives each acquisition target company a score out of 100 based on the below criteria:
- 25 points for software
- 10 points for IT services
- LinkedIn headcount growth
- 10 points for a greater than 15% quarterly decline
- -20 points for greater than 30% annual growth
- 25 points for U.S.
- 10 points for Canada and the U.K.
- 5 points if there is leverage
- Founding date
- 5 points for seven-year-old companies
- 2 points for four-year-old companies
- Last fundraise
- 5 points if more than two years ago
The scoring incorporates Liemandt’s assessment that companies that recently raised money or are debt-free are unlikely to sell cheaply.
Newer companies are also less likely to sell. “Founders and CEOs with consistently mediocre performance become fatigued over time.”
ESW’s hunting grounds include smaller, ailing software businesses destined for bankruptcy court. Since 2015, ESW has bought about 10 bankrupt companies, including at least three in 2020.
Why does ESW Capital acquire the entire company, not just assets?
ESW doesn’t just buy up bankrupt businesses’ assets, software, and patents like most PE firms. It acquires the entire company including the potential for tax breaks. The big losses that pushed the companies into bankruptcy translate into tax-break opportunities once ESW owns the business and starts generating profits.
Losses usually stack up in tech companies’ early years as they plow millions into product creation. Bankrupt companies are often sold for parts in chapter 11, their tax breaks wasted.
ESW’s deals typically are designed to preserve net operating losses, basically using the previous CEO’s losses to reduce ESW’s taxes.
For example, ESW recently bought Security First, a California-based cybersecurity software company, for around $6 million, after they burned through at least $140 million in debt and equity financing since its 2002 founding.
In the two years before filing for bankruptcy, Security First had recorded just $92,000 in revenue. It entered bankruptcy with three employees and no office. Its net operating losses could translate into more than $150 million in tax breaks.
Since ESW is private, only the IRS knows how successful this approach is.
What does the selling process look like? Why do Founders sell to ESW Capital?
ESW offers founder-friendly terms: quick cash for often struggling businesses. There are no earn-outs or contingencies, IOIs with valuation within a week, LOI and closing within 45 days. 98% of LOIs close.
ESW is known to blast out a lot of lowball offers in the range of 0.5x to 1x ARR. Often these target companies are less popular assets with declining or stagnant business, tech debt, or other issues.
How connected are businesses in ESW Capital?
ESW operates the software businesses it buys and centralizes some of its processes like Crossover handling recruiting for all companies.
Many acquired software companies are bundled into Netflix-style software library subscriptions for sales and marketing, collaboration and integration, and other business essentials.
How does ESW Capital launch new businesses?
They don't from what I can tell.
Example businesses ESW Capital has purchased?
If you are interested in buying, growing, and selling small companies, check out my course & community on it at IndiePE.com.
If you know of anything I should add to this please reach out @ColinKeeley or Colin@ColinKeeley.com. I’ll continue updating as I learn more.