Vetting HR Software Vendors

The SEC filings of one software vendor in advance of its IPO showed significantly bigger losses and smaller revenues than it had reported to industry analysts and the media only weeks earlier. Some industry experts offer their views on how HR executives can get a good read on a company's financial health.

Monday, July 30, 2007
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When SuccessFactors filed a statement of operations earlier this month with the Securities and Exchange Commission as part of its initial public offering, the numbers looked downright glum compared to what the company had earlier told business magazines and analysts.

Rather than the $100 million in annual revenue as reported in a recent Business 2.0 article by the San Mateo, Calif., start-up provider of automated HR solutions, the company's projected revenue this year is closer to $60 million -- amidst growing losses for the past few years.

The SEC documents also showed that sales and marketing expenses are 100 percent of revenue, and the company is investing heavily in research and development.

Experts say the gap in the SuccessFactors numbers were shocking to some observers, but that such discrepancies are not unusual when a private company is forced to disclose audited financial statements in an SEC filing.

"There's a gap between what SuccessFactors has been telling the internal community and what their numbers were," says Jason Corsello, vice president of Knowledge Infusion, a Minneapolis-based strategic consultancy focused on human capital management technology. "But I don't want to say that they were lying."

According to Corsello, it's not unusual for a company to change its accounting methods as part of the S-1 process. "They reassessed their accounting of how people buy software," he says. "I think they weren't misleading. I think they were aggressive."

Nonetheless, Corsello calls the gap "pretty large," and notes that SuccessFactors "didn't provide a lot of clarity before the S-1 statement."

Corsello and other industry experts stress that Web-based software-as-a-service vendors, such as SuccessFactors, have different revenue models than traditional software-solutions companies -- with considerably more deferred income; money they'll see over the course of a multi-year subscription, instead of up front.

When contacted for this article, SuccessFactors' spokesperson Jennifer Gazin said the company could not comment because it is in an SEC-ordered "quiet period" prior to its public offering.

When vetting privately held HR software vendors, how can human resource executives get a good read on a company's financial health?

"From my perspective of securities litigation, there's one question: 'Were you audited?' " says George Gowen, partner and vice chair of securities litigation for the Philadelphia-based law firm of Cozen O'Connor.

Gowen says he sees a lot of privately held companies that have not had their financial statements audited. "Ask about balance sheets, sales and revenues, and profitability," he advises.

Adds Corsello: "If you're looking to make a purchase and the company is small, it's fair to ask for their financials and show them to your financial experts."

Ask how much cash they have, he advises. How are they growing? What is the roadmap for the product? Where will they be in five years? "You want to make sure the vendor you select will be around."

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"If they're not profitable," says Lisa Rowan, program manager of HR and talent management services for IDC, the Framingham, Mass.-based global provider of market intelligence, "ask when they expect to be profitable and what they are going to do to get profitable."

But, sometimes, the information to be digested prior to a purchase may depend on what the vendor opts to say.

"Everyone was caught a little off guard" by the discrepancies between what SuccessFactors had previously announced and its audited SEC filings, says Rowan. "SuccessFactors wanted everyone to take notice. They were looking to have as appealing a story as possible, but they can't obfuscate with the SEC."

Analysts say the differences between the pre-SEC financial discussions and the post-SEC financial statements of other HR software vendors that have gone public were not as immense as those found with SuccessFactors.

According to James Holincheck, the Chicago-based research vice president of the Gartner Group, observers were "shocked" by the company's spending, as noted in the SEC documents.

"SuccessFactors spent a lot on sales and marketing," he says. "They're making a big bet that the market will grow."

"It's unusual to see it to that degree," Holincheck says. "What [SuccessFactors] is spending is higher than what you see most vendors spending."

There is risk, he says, but, given the competitive dynamics, it's not an unreasonable way to approach the industry.

Still, according to Holincheck, he sees the company's biggest issue as cash flow.

"They've been burning cash at a pretty high rate. If they throttle back on sales and marketing will they be able to continue to grow?"

In general, however, the analysts say the market has been very receptive to the IPOs of HR software vendors and there are all indications the industry's public future is bright.

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