Scott Frew, one of Australia’s most successful IT entrepreneurs, is back doing what he has done successfully in the past – building companies. He tells AMANDA GOME his plans, and how a sharemarket float figures in his longer term vision.
By Amanda Gome
An entrepreneur talking about a float! It’s true. Scott Frew is well known for starting LAN Systems and growing it to about $200 million revenue before selling it for millions.
He is now involved in a new business, Firewall Systems, which already has revenue of $110 million.
Frew talks to Amanda Gome about how he builds companies, his outlook for the IT industry, how he gets his channel to pay on time, and his plans for an IPO.
Amanda Gome: You are 43 and very successful in your former company. Why are you doing it all again?
Scott Frew: When I sold that business, I retired to Europe for five years, and then we moved back to Australia for the children more than anything else. The wife said to me “I married you for breakfast and dinner, not lunch, go and get a job”.
Tell us about LAN Systems and how you sold it?
My history is three distributors. Micro Networks was the first one, which was sold to NetComm, the modem manufacturer that is now owned by Banksia. Then the router market, which people were calling bridges in those days, came about with ISDN. This is before the internet, so it was all about giving resellers support to install and deploy wide area networks.
Then switching technology came about and ultimately the internet, and Cisco Systems, and we sort of grew through that. It was 10 years from start to finish. Then we got acquired by a US entity, lock stock and barrel, and they are still operating in this country.
When did you sell?
Two weeks before the dot-bomb in 2000, which was fortunate.
So what did you sell for?
It is enough to keep me comfortable. Let me put it this way, it was 10 times EBITDA; it was the largest multiple payment for a distributor globally as far as I am aware.
How did you negotiate that price? Can you give anyone who wants to sell their business at the moment any advice?
It is a very difficult process. Most importantly, you want to make sure your net profit is as high as you possibly can because that percentage is critical. There are a lot of businesses that operate on only 1% or 2% EBIT, and you would be better off putting your money in the bank and taking it easy. The higher that percentage is, the higher the multiple which you would typically get paid because you are a very profitable business.
Did you get an offer or did you actually go out to the market place?
We had multiple offers. I wasn’t looking to sell at the time. We were starting to gear up for a potential IPO, but basically that would have been a threat to this US distributor, coming into the country.
Building a $200 million revenue company is a big achievement. Looking back, what did you think about how it had gone?
It went significantly better than I ever thought it would. Originally it was a lifestyle business; I read a couple of the self-help books, specifically The E-Myth, and that turned LAN into just a lifestyle business to 70 odd employees and Cisco’s largest distributor in the region.
What was the turning point?
I started working outside the business, not inside the business, and that was the most fundamental change in philosophy.
How did you do that? Often when you start these things you are a control-freak and want to run everything.
Absolutely. It is trust and good employees. I have had some fantastic staff work for me in all three businesses. The core of my last business now works for me in this one, so there’s a lot of people that I’ve got a lot of history with that I can leave to run the business. My partner, Nick, who was my marketing director at LAN and here, he ran my business while I was away. I know that I can actually get run over by a bus tomorrow and this business would still succeed.
Did you give your employees equity in the business?
Options, not equity. One of the problems with giving equity is, if you give out equity, you can never get it back and if you have a problem with an employee that becomes an issue. If you give them options that mandate that provided they’re still working there at the time, you might trade or sell, so they get a piece of the action without having the regulatory issues.
And that works well?
I think it is the only way to work; you don’t build the business by yourself, you’re not in isolation. The employees need to have some feeling that they are like shareholders inside the business.
What else have you done looking back that really helped you succeed?
Look, as someone once said, I find the thin edge of the wedge and then drive it all the way through. My last business, there wasn’t a lot of expertise in wide area networking, so we had a lot of engineering people to support the reselling community. This time around, it is all about systems and process and taking the pain or the drudgery out of this whole channel piece.
Let’s go into your new business. What is it, when did it start and what need is it fulfilling?
Firewall Systems was the business I acquired when I came back in 2004, which was four people down in Melbourne. There are now 65 of us, all over Australia and New Zealand.
Our biggest differentiators? I disengaged all of the generic distribution pieces and called that Distribution Central. Firewall Systems still exists as a focused security distributor. Networld Systems is the focused networking infrastructure distributor, similar to my old business. SAN Systems is the storage focused distributor.
I also acquired part of a company called Red Education, which is an ATC authorised training centre for most of my manufacturers, and we are about to roll out Unity Systems, which is the voice part of the IT market. And we’ve also got another division called Annuity Systems whose sole focus is on the renewal and maintenance equipment that we have sold over time out there in the market place.
So who are your main customers?
Well, all the resellers from tier one down to small, from IBM to EDS and those sort of people to one-man-bands who sell CRM systems or little bits of integration.
How have you built your strategy? What changes in the market place have you built the back of your company on?
I think customer service above all. I am the worst customer in the world, so I expect my organisations to deliver the best customer service there is in the channel. A lot of my competitors are now obviously multi-billion dollar US entities, including my old company, that don’t have the ability to adapt to the market very quickly.
But probably the two biggest things that differentiated us very quickly was we deal with fundamentally complex IT systems that take a long time to even put a quote together, and we built configurators for all of our manufacturers, which in most cases the manufacturers have never had globally and that takes a two day quote time down to 19 seconds or a one day quote time to 19 seconds.
We’ve built whole asset management systems around Google Earth, where you can see whether you are the end user or reseller, distributor or the manufacturer, where those assets are physically located and whether they are under maintenance or coming up for maintenance, what serial numbers are with them and what purchase orders details.
So from a warranty and services point-of-view, this is fantastic. And some of the manufacturers are talking about using it when they do a replacement of a box that has blown up, because we can actually send them driving instructions to where the box is.
How is this changing? What do you see for the future of this industry?
The reason I picked the IT industry is because I am a typical type A personality…I am always looking for new things.
So what is changing? What do you see as the opportunities in the future?
As we move forward there are a couple of parts to this business that will adapt. The systems will get stronger and I have just acquired another company called ASK Learning, which will do the same thing we’ve done for asset management for trained people management out there in the channel. So my next objective is to make sure that my manufacturers have the best trained channel, either sales or engineers, against all their competitors.
The IT industry is going through some tough times at the moment. There are some companies that are very successful. What is your revenue now?
This year, revenue will be $110 million.
What do you see overall across the industry?
Look, I think at the end of the day we are coming to the end of a period of great economic growth and that there are a lot of people who could have a business that wasn’t particularly difficult because we were awash with money for whatever reason.
Now what you’ll find is, the people that have had an easy run because the economy has been so good will start to fall off, because if you don’t have real differentiators or you don’t really have some sort of connection with your customers or your suppliers, you are going to be in a whole world of hurt because IT is very commoditised at the end of the day.
Is this what you are seeing? Are you seeing companies or people in your supply chain starting to hurt?
Yeah, absolutely. The interesting thing is that we are still growing and we don’t feel it yet, so we are being alert but not alarmed. But you have seen some big guys fall over like Commander, so the risk is certainly there.
My channel is probably a little more solid than the average channel because we’re very hard on credit, for obvious reasons, and we’ll love our resellers to death but they have to pay on time, whereas some of the other distributors may be a bit more relaxed as far as credit goes. But I assume that that will change over time.
How do you get them to pay on time?
Well you can’t get them to pay on time. Over time you work out whether you are likely to get paid on time or not. We use a simple process of three strikes and you’re out. So, if they miss their credit terms three times in a row they are gone. I would rather them drag out my competitor’s cash than mine.
Looking back, what have been some of the biggest mistakes you have made growing your business?
Probably being too conservative. My biggest fault is I have had to move buildings too many times and I am about to do it again because we are about to run out of space again. Because salaries and rent are things you can’t get out of very quickly; I mean you can but it’s a lot of pain.
We tend to go well; we should double in the next two years or whatever, and we double in a year and you just run out of space. I don’t want to go and stretch too far, because if it doesn’t, then you’ve got a huge lease hanging round your neck that you don’t want to deal with.
Getting that right is tough in this environment. What else?
I have fantastic people that don’t think like I do, that’s why I don’t get trapped up in a lot of problems or mistakes. They’ll spot them and argue with me, which is why I employ them. I don’t tend to employ people who just agree with me.
How do you find those people? What do you look for in interviews?
I look for cultural aspects. For instance, we’ve got a new CFO coming on board; he went through an interview process of three different interviews then we took the last two guys to the pub. And I tell you, the pub interview, the last interview is the one where you really find out what they are like.
How do you work that?
He’s got to form the guts of the senior management team, he’s also one of the most critical guys in the business because he is keeping score for you, so you’ve got to be able to trust this guy.
But the most important thing for a CFO in my books is he has to be able to lead his people. And not a lot of bean counters can lead their people; they are technically very confident but they don’t motivate their own staff so you’ve got to dig deeper into their attitudes and their response to the rest of the senior management team to make sure that they will fit.
Do you have any favourite questions that you ask?
Not really, up until I read a book called The Tipping Point, I always classified myself as a terrible interviewer, but I can tell you in five minutes if they’ll fit in the company culture.
How?
Well, in The Tipping Point they go through the process that your brain sees patterns and the more times you see the same thing the more time you’ll pick up the pattern, and this applies to sports and anything. So guys that are seeing balls flying at them are already lifting their bat and know where the ball is going to be before it gets there.
I see patterns in people because I have interviewed so many people over time, I can tell you in that first five minutes whether they are likely to succeed or fail. And I have only been wrong in this particular business twice out of 65 or 70-odd interviews.
And how did you get caught out then?
I just think that they were very good sales people with no substance behind them.
How though, do you see the substance?
Call it a gut feel, call it intuition, call it whatever you like; you either bond with someone or you don’t and I can’t tell you any more detail than that. I have my other staff take them apart technically for whatever role they are going for and I’m there to make sure they’ll fit.
What are you going to do with your business? Are you going to build it up to another $200 million revenue and then get rid of it?
Well the plan is to get it to $209 million, I have done it twice before…
With LAN. What was the other business?
Micro Networks was before that.
And when was that?
That was ‘87 to ‘90.
Right. So how old were you then?
Very young.
So what did you sell that one for?
An undisclosed sum again but it wasn’t anywhere near as big as LAN was. But it was very profitable in those days for the IT industry.
So this time you want to get it to $209 million revenue…
Well look, it’s a running joke, people ask me what I’m here to do, and as I told you the wife said I had to get out of the house, so the first plan was a five year plan, $60 million in five years. We’ll do $110 in five.
So what is the next plan? Well I am rolling this Annuity Systems piece out. Annuity and software engines I expect to roll out on a global basis, so that’s kind of off on the side. Distribution Central is a core which we are setting up to float, I don’t think there is another potential acquirer globally from a distribution point of view, but I could be wrong. We’ve had a couple of people run at us but I think float is definitely the way we’re going to go.
And when would you float?
Well, once the market has stabilised for obvious reasons. Another couple of years maybe.
And then what would you do?
Buy the next boat.
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