Friday, March 2, 2012

Another equity investment in the library marketplace – what does it mean for librarianship?

(c) iStockphoto

Yesterday’s announcement that Innovative Interfaces, long a privately owned library automation supplier, is now substantially owned by equity investors, created a number of conversations in social media across the library profession. They centered on: What does it mean and what should librarians expect?

As with those that have happened before (SirsiDynix, Ex Libris), these changes in ownership usually represent one of the following things happening within the company:
  1. A company founder wishing to monetize their substantial work and investment for reasons of greater diversification of their personal portfolio or as a move towards retirement. 
  2. An existing equity owner reaching the end of their typical 5-7 year investment cycle.
  3. A desire to bring greater financial resources into the company to finance further acquisitions or for new product or services creation or development.
What it sometimes means is the identification of a firm with low profit margins that the equity investors believe they can substantially improve.  However, despite one site that made such a claim, in the case of this announcement, there are plenty of librarians who suspect from the prices they find themselves paying for this company’s products and services, profitability is not an issue in this case.  

Of course, the mere mention of “equity investors” in today’s highly charged social, cultural and political environment brings to mind the 99% vs. the 1% and tends to taint the entire discussion. However, a more rational discussion is deserved and necessary to understand what’s happening.

Some of the Basics

Understanding some of the basics of equity investing is a good starting point.  Equity investors basically pool financial resources for investment, which, as we all know and understand, means to take measured risks in order to gain measured returns. I also think it is important to understand the following, which I quote from a very informative post about private equity:   
“The capital comes primarily from large institutional investors like pension funds, foundations, and endowments. Large investors in private equity include Calpers (the California Public Employees Retirement System), New York State Teachers' Retirement System, and even the National Public Radio (NPR) Foundation. When private equity fund returns are strong, a lot of workers, teachers, and pensioners benefit.”
So while many of the discussions around private equity firms leave people thinking that only the very wealthy benefit from these companies, the above provides some balance to the discussion.   In fact, your personal retirement accounts might well be a beneficiary from the work of these types of investment firms.  

Once the money is aggregated, the equity firms select and make the investments.  Here, it is also important to understand the basics since debt is one of the tools used in engineering these deals  Again, I quote from the article above when they say that private equity firms:  
“often use debt financing, hence the common name of leveraged buyouts. This is particularly true in the case of more mature companies. These days, the leverage is usually on the order of 60 or 70 percent of the purchase price—less than the leverage in most home purchases.”
The reason why it is important to understand the debt portion of the equation is because this debt must be repaid, with interest, usually by the operation of the company being purchased.  In addition to that, the equity fund management charges a fee for managing all of this process which is typically in the range of 1.5% - 2% of the amount invested.  In addition, they’ll typically take 20% of the profits (after the investors earn their return).  All of this will be important to remember when we later discuss what this means for the profession.

What does this mean for the company purchased?

Inevitably, when a company sees a change of this type in the ownership, one of the most commonly uttered phrases in the press release announcing the deal will be an assurance that it's: “business as usual.”  Rarely does that truly prove to be the case for long.  It is usually more a question of how subtly the changes will be made, when and where.  However, there will be changes.  Private equity firms do not buy companies for the status quo; they see ways to improve market share, productivity, performance and profit. To do that, as outlined in this Harvard Business Review article, they will focus on:

  1. “Reducing idle cash setting in bank accounts”.  For instance, this might be done by using such cash as part of the purchase to buyout the owner or to otherwise help finance the purchase of the company.
  2. “Take on more debt”.  As discussed above, this is done as part of the purchase process, but the goal, in general, is to reduce the cost of capital for the company.
  3. “Design value-enhancing operating plans.”  This is where customers of the company will find the changes more apparent.  As outlined in the article cited and in quotation marks below, these could include: a) “Cutting back costs.”  This will typically soon focus on the staff within the organization, as that is always a major cost for any organization.  Peripheral positions will be eliminated and others consolidated.  Benefit packages for employees may be trimmed and all other operational costs closely examined for possible reductions.  Things like customer entertainment, parties, etc. might be reduced or eliminated, b) “Sales of non-core businesses.”  Obvious in its explanation, but this can also be exemplified by elimination/consolidation of product lines, c) “Investing to expand revenues.”  Likely to be seen as bringing financial resources into new product development to speed the products to market and/or create other new products and services, or d) “Acquisitions… that will consolidate market position.” 
  4. “Tie executive compensation to shareholder value”.   Many founder owned companies will likely have very nice compensation schemes for the founder, but they aren’t necessarily tightly tied to how the company is performing on a consistent basis.  The private equity firm will change this and tie these two things together to ensure, whoever is now managing the company, is very focused.

And while not mentioned in the article, very likely, if it wasn’t already there, a very strong and heightened focus on selling by the company. 

What do these kinds of investments mean for Librarianship?

As with most anything, there is no simple good/bad answer to the effect of private equity investments in the companies serving librarianship.  The very fact that they are investing in the marketplace means they see a healthy enough market, with enough potential growth in it, to warrant investment.   That’s reassuring.

It’s also important to note that there are examples in this marketplace of other companies owned by private equity firms, for instance Ex Libris, which are producing leading products and services for the profession. That’s also reassuring.   (SirsiDynix is another firm owned by private equity but I’ll leave it to the reader to assess if, in this case, it is an equally strong example).  

On the other hand, given the way private equity leveraged buyouts happen, as I’ve outlined above, and the debt they incur, one thing librarians have to realize is this: To some extent, this process diverts money from within the profession to outside the profession.   Whereas the profit these companies made previously was being used primarily within the company, now this money is being substantially diverted to pay the private equity firm enough to service the debt, pay its investors back with a return and finally, pay the equity firm its management fees.   These are not insubstantial amounts of money which are now being invested in retirement and foundation funds that aren’t directly associated with the profession of librarianship.  

In the end, the assessment swings on questions like these: Would librarianship be better off if the money being diverted out of the profession was being invested in products from the open source software community or in a library owned collaborative like OCLC?

Or, do the actions of private equity firms produce stronger companies servicing the profession?  Do they help pull together the necessary resources needed to fund massive scale investment in solutions like cloud computing, citation indexes, digital preservation, etc.?  Do they help to accelerate products and services to the market?  Are they more efficient and effective producers of these technologies and services?

And finally, what about those remaining firms that are privately held by their original founders/entrepreneurs selling to libraries and that, while maybe smaller, are more focused on the customers, staff and not so much on making the highest profit?  Would you be better off spending your funds with them?

The answers to those questions, you’ll have to supply.    

[Notes:  1) In the interest of full disclosure, I've been and still am a company founder/entrepreneur as well as a minority investor in other companies that have, or are currently, selling products to the library marketplace.  2) Photos used in this post are the property of iStockPhoto, are used under license and can't be further re-used or distributed without your purchasing them from]