Evora Case Study

06/09/2011

Evora Software *

Mike O’Connor’s Evora Software Company, one of the largest trade order management product firms in the financial services industry, was poised to approach $8 million in revenues in 2005. Evora’s flagship product, Traders Express, delivered state-of-the-art tools to over 80 security trading firms for managing all aspects of the security execution process, including analysis, rebalancing and real-time portfolio performance monitoring. While the opportunity for Traders Express was as ripe as the day he single-handedly launched his firm in 2000, Mike worried that if he didn’t take advantage of the market opportunity, someone else would.

Evora’s greatest growth occurred between October 2002 and March 2005 as a result of a strategic deal with Wilson, Brookings and Cooper (WBC), one of the nation’s largest brokerage firms. Although the contract guaranteed Evora an income stream, it also limited Evora sales to WBC client companies. By contract’s end, Mike was eager to attract new clients beyond WBC’s client base. While he was confident Evora would be successful, he needed money to build a sales organization and continue development of Traders Express.

Opting for outside financing, Mike quickly found three investors interested in his company. As the final paperwork was to be completed, the investors dramatically reduced their offer price. Stunned and angry, Mike rejected their offer and once more faced the immediate needs of a growing company without financing.

Mike O’ConnorIn 1997, one year after graduating from Harvard University, Mike became a Wall Street analyst. He was soon inundated with paper work from portfolio managers and other senior analysts. He thought there had to be a better way, and so to ease the burden of paperwork, he programmed systems to accommodate it.

This case was prepared by Sheryl and Larry Overlan under the direction of Professor Edward P. Marram with the assistance of Glenn Kaplus. Funding provided by the Ewing Marion Kauffman Foundation. Copyright 2001 Babson College. All rights reserved.

* Some of the names in this case have been changed.

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Center for Entrepreneurial StudiesBabson Park, MA Phone: 781-239-4420

02457-0310 Fax: 781-239-4178http://www.babson.edu/entrep

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The brokers invest money on behalf of numerous accounts. When brokers make decisions, it's necessary to determine how much stock to buy for each account, which requires consideration of many factors. I built a system that pulled in all the raw data and calculated how much should be invested in each company, for each account.

Just three years later, in 2000, Mike’s software managed the company’s entire allocation, processing and compliance functions. It could check out restrictions on a client’s trading capability, perform risk analysis and real-time P&L that let the client know minute-to-minute whether his purchases were making or losing money, ranking winners and losers. It also provided an accurate record and audit trail.

Around this time, Mike was hired to become the head analyst at another firm. The job provided him with great pay, but after one year he quit.

I found the analyst’s job to be very frustrating. It’s a very non-empirical business. You could know the industry cold, know what the company was going to report the next quarter and still lose money in the stock. There was no direct relationship between effort spent and reward given, and I didn’t like that kind of model. Even in that job, I was trying to build a quantitative process under which to be an analyst.

He kept track of the product he had built for his first employer and believed no one had built anything as good. Recognizing that his real interest was in programming systems, he decided to form a business around the system he had developed for his first employer. In 2000, he launched Evora Software and one of his earliest customers was his first employer (to whom he sold the new version).

A combination of personal and business contacts, as well as word-of-mouth, brought in more business throughout the remainder of 2000 and 2001, including three “evergreen"1 clients. One of his biggest deals came about in the fall of 2001 when a friend tipped Mike off that one of his bank clients was merging. The bank had announced it was going to use UNIX for its operating system, but Mike felt he had a better solution.

I had been reading a lot of information in the trade rags about the many features of Windows NT. In the middle of a meeting, I asked them if they had thought about using Windows NT instead of UNIX. They agreed that it looked promising but needed multiple heads and didn’t know if Windows NT would suffice. 2

My grade school friend (Tim Ahern) had recently shown me how he had put multiple heads on his Windows NT machine. It was sitting there in his basement! Tim agreed to make a presentation to the bank with me, and we convinced them to build their infrastructure on Windows NT by demonstrating that it could do everything the UNIX system could do for a cost that was 25 percent lower than UNIX’s. After that everything fell in place.

1 “Evergreen” clients are those who provide recurring revenue. 2 “Multiple heads” refers to a system’s having more than one screen.

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In addition to winning the contract, they also won the notice of Microsoft. Evora’s work for the bank was the largest Windows NT trading floor installation completed, and Microsoft issued press releases announcing their achievement. Mike brought Tim into the company, gave him a 40 percent interest and renamed the company Evora Consulting. For the next four months, Evora Consulting consisted of these two men and no outside money. Still working out of the attic, they took the $150,000 that Tim had made from the deal with the bank, along with the $200,000 that Mike had made and used it as their operating capital. Mike continued to develop Traders Express, while Tim focused on providing their clients installation and integration services.

A Bold StepTheir next big contract was with one of the best-known portfolio managers in the country who was starting a hedge fund.3 Mike contacted him near the end of 2001 when he and Tim had only been in business for about four months.

I called information and got his home telephone number. When I called his home, he actually answered the phone! So I told him that he really wanted us to set up his infrastructure because we were the best at doing it. He agreed to come over and talk about it. I ended up having a conversation with this guy you read about every day in the papers in my attic with exposed beams and a cracked floor. But we won the business. We developed computer models that let him trade remotely. Microsoft sent out press releases again.

Microsoft began feeding leads to Mike and Tim. Mike also billed the work they were doing for the bank as their “grand experiment” and took potential clients on tours of Traders Express. By the end of January 2002, Evora Consulting began to take off as more traders purchased the software.

The First Strategic DealToward the end of 2002, Mike landed the company’s first strategic deal. WBC learned about Traders Express through a chance conversation with the hedge fund portfolio manager to whom Mike had sold the system a year earlier. WBC contacted Mike.

WBC oversaw the startup of a number of hedge funds. These are notorious for being a favorite choice among the typical entrepreneur, the guy with a couple of million dollars in the bank. This person starts a hedge fund but doesn’t really know how to run a business. He usually comes from a big firm where everything is done for him. So the brokerage firm thought that if the owners of these new hedge funds used our product, we could automate their world a lot faster and facilitate a more controlled environment during the startup phase of their hedge funds, giving them a competitive advantage over the other prime brokers.

3 Broadly defined, hedge funds are private partnerships wherein the manager/general partner has a significant personal stake in the fund and is free to operate in a variety of markets and to utilize investments and strategies with variable long/short exposures and degrees of leverage.

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WBC wanted an exclusive contract with Evora for Traders Express. Mike agreed to sell only to those startup hedge funds under the WBC umbrella. The agreement guaranteed Evora $200,000 per quarter to develop three WBC clients per month. It also made a one-time payment to Evora of $200,000 to be exclusive to WBC. Also, Evora was given three opportunities to take on whatever client they wished during the course of the contract. Furthermore, if Evora delivered on all the business contracted by WBC, and if Evora could prove they had extra capacity, then Evora could procure additional contracts.

In addition to the contract’s generous terms, Mike liked the arrangement because it guaranteed Evora baseline income for two and one-half years, which meant Evora could focus on software development. Another bonus was that, while the contract was in effect, Evora won all the integration work for every new hedge fund associated with WBC. This accounted for 65 percent of their business during that period and increased their profit margins dramatically.

Chafing Between Friends and Building an InfrastructureAs their business expanded, Mike and Tim added employees. They decided in January 2003 to move into real offices – four rooms they obtained in exchange for offering their product at a discounted rate. Tensions escalated as Mike and Tim fought about where new employees would be utilized and how company resources should be spent.

Though Tim and I had created this arrangement where we worked as partners, at the end of the day, I was the majority shareholder and held the ax on things. Tim just didn’t like the way I handled things. I was for systems and control, and he contended that integration needed more flexibility. During the year, things fell apart and got pretty ugly. Had we continued on this path, I think the company would have imploded.

At the same time, Mike was beginning to deal with Evora’s lack of infrastructure. Up to this point, secretaries were managing the accounting and HR functions. Trying to save money, Mike wanted to hire someone who “really wasn’t a COO but had the potential to be one.” In the middle of 2003, Mike hired John, the 24-year-old brother of one of the company’s top employees. A Harvard graduate, hard-working and frugal, John fit the bill and began building an infrastructure to serve both the software and integration components of the business. He brought in an accountant for $35,000 a year, made one of the secretaries a full-time HR person and hired a sales person.

A Solution To Growing TensionsAs 2003 progressed, the friction between Mike and Tim became all encompassing. It got so ugly at times that it involved their wives. Mike and Tim had known and competed with each other since they were 10 years old. Mike knew their competitiveness was the root of the problem. Each believed his part of the company held the key to future growth, and each was working to grow his part of the business faster than the other.

Toward the end of 2003, Mike decided to split Evora Consulting into two sister companies, Evora Software and Evora Integration. Mike would own 85 percent of the software business and Tim 15 percent. Similarly, Tim would own 85 percent of the integration business and Mike 15 percent. The service components, such as HR and accounting, would be shared and organized

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under the original name, Evora Consulting, but would receive no funding. (See Exhibit 1 for the evolving company structure). The reorganization involved between 25 and 30 employees: each sister company paid 50 percent of the salaries of those employees located in Evora Consulting. Technology employees were assigned to one of the two companies according to their specialty.

During 2004, the sister companies were equally successful. Each grew at a rate of approximately 147 percent, an expansion due in large part to the strategic deal with WBC (see Tables 1). Evora Software moved to a new floor, Evora Integration took over the space formerly used by Evora Software and Evora Consulting moved into a third space in the building.

Two Distinct Companies are CreatedBy the end of 2004, Mike realized that John, who was responsible for planning, infrastructure, HR and all the other areas of the business operations, was being pulled in too many directions. In addition, Evora Integration was a reseller, which is accounting intensive. Mike’s side of the business required minimal accounting since it only billed in arrears quarterly,4 but Mike wanted to get analytics on his business to find out where he was spending money. Mike and Tim were always fighting for time from the accountant. Finally, Mike and Tim agreed to further divide the company. The legal work had been completed during the first split, and despite initial conflicts regarding the placement of employees, Mike and Tim were able to come to an agreement: every relationship between the two sides became contractual, and each had certain non-competes. Mike wouldn’t enter the integration business, and Tim wouldn’t enter the software business. The terms of the contract also gave them the option to sell or buy from any company.5

The Decision to Raise MoneyWhile the exclusive arrangement with WBC was positive for Evora’s early growth, Mike believed it would hinder future growth for a couple of reasons. Since the Evora system gave brokers a competitive edge, Mike was afraid that if it wasn’t available to all companies, the void would give rise to competition. In addition, the exclusive contract heavily branded Evora Software as a WBC entity. Mike wanted Evora Software to have its own image and personality. Therefore, when the contract with WBC ended in March 2005, Mike decided to raise money to finance the establishment of a sales channel, to build out Evora’s development and structure and to provide the company with an adequate foundation for accelerated growth. With revenue and margin growth in 2005 expected to be strong and accelerating, Mike estimated the company’s value to be worth 10 times its revenue.

Mike first approached WBC with the opportunity to invest in his company. He was still on good terms with WBC. He felt that WBC officials believed they had made a mistake by not asking for some kind of compensation for the clients they fed to Evora. WBC offered to invest in a 25 percent ownership of Evora Software at a $60 million pre-money valuation. During the process of completing the deal, however, another company, Kenner Enterprises, offered to buy Evora

4 Mike would do the work and then bill for it on the quarter.5 The two domains were separated legally in January 2005. Mike and Tim maintained connections between their two companies, however, by: 1) being members on each other’s board of directors; 2) being officers in each other’s companies; 3) continuing a 15 percent ownership in each other’s companies; 4) sharing leads for potential clients; and 5) encouraging key employees to “cross-fertilize” the client bases, as well as to own stock options in both companies.

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Software for $40 million in cash. As part of their offer, Kenner would let Mike continue to manage operations. Mike thought the offer was too low and turned it down. Kenner’s second offer matched WBC’s offer. Kenner then agreed to co-invest with WBC. Before Mike could make a decision, a large bank, LC Trust, also offered to buy into the round. Mike believed the three investors would solidify Evora Software’s position in the market.

WBC represented the growth side of our business, Kenner represented the sell side and LC Trust represented the custodial side. We believed that by having the best partners in all three spaces, we could become an institutional standard.

Mike accepted their offer and managed the round. All three companies signed term sheets, which would give them each a 10 percent share in Evora Software. In September 2005, shortly before the deal was to be signed, the bank’s corporate division determined that the $60 million pre-money valuation was too high. Claiming that Evora’s high margins were not sustainable, they countered with an offer that radically reduced the company’s pre-money valuation. Confused and angered by the last minute change, Mike rejected the offer and once again faced a company with growing needs and no definite sources of revenue. Without a strategic relationship funneling business to Evora Software or an established sales department, Mike knew that if Evora Software was to survive, it was essential for him to find new investors quickly.

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Questions1. Describe the characteristics of the strategic alliance between Evora and WBC.2. Describe the pluses and minuses of Mike’s offer to Tim to split the company.3. Would you have walked away from the financial offer by WBC and its partners?

Exhibit 1: Evora’s Evolving Company Structure

2003 Company Structure

2004 Company Structure

2005 Company Structure

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Evora Software

Mike - 82%Tim - 15% John - 3%

Evora Software

Mike – 85%Tim – 15%

Evora Integration

Tim – 85%Mike – 15%

Evora Consulting

Evora Integration

Tim – 85%Mike – 15%

Evora Consulting

Mike – 60% Tim – 40%

Table 1

EVORA SOFTWARE COMPANYBALANCE SHEET

2000–2004 (YEAR END)

2000 2001 2002 2003 2004Current Assets

Cash $500 $33,105 $245,780 $510,907 $383,461Accounts Receivable $5,750 $21,884 $112,757 $700,650 $1,669,525

Prepaid $0 $1,125 $28,457 $52,900 $58,775Other Current Assets $0 $8,750 $13,954 $87,525 $244,675

Total Current Assets $6,250 $64,864 $400,948 $1,351,982 $2,356,436

Fixtures & Equipment $6,500 $11,475 $164,524 $327,650 $448,945Other Assets $0 $6,504 $27,995 $67,520 $125,745

Deposits $0 $0 $9,850 $44,421 $82,505Total Assets $12,750 $82,843 $603,317 $1,791,573 $3,013,631

Current Liabilities

Accounts Payable $250 $12,850 $52,111 $211,486 $328,412Deferred Revenue $0 $10,000 $25,000 $55,000 $141,118

Total Current Liabilities $250 $22,850 $77,111 $266,486 $469,520

Retained Earnings $0 $0 $116,213 $401,266 $1,220,290Stockholders' Equity $12,500 $59,993 $409,993 $1,123,821 $1,323,821

Total Liabilities & Equity $12,750 $82,843 $603,317 $1,791,573 $3,013,631

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Table 2

EVORA SOFTWARE COMPANYEMPLOYEE COUNT AND INCOME STATEMENT

2000–2004 (YEAR END)

2000 2001 2002 2003 2004

Sales $62,500 $250,000 $650,000 $1,547,000 $3,821,090

Cost of Goods Sold $43,535 $112,574 $211,257 $683,485 $1,058,417

Gross Profit $18,965 $137,426 $438,743 $863,515 $2,762,673

Operating Expenses $18,965 $137,426 $291,868 $486,942 $1,673,383

Operating Income $0 $0 $146,875 $376,573 $1,089,290

Taxes $0 $0 $30,662 $91,520 $270,266

Net Income $0 $0 $116,213 $285,053 $819,024

Employees 1 2 4 10 33

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