Business Description: B2B Software for the Transportation Industry
Let’s take a field trip!
Today, we will look at the details and the decision-making process that went into preparing a specific company for sale in the competitive world of software providers. The subject company in this case study is a B2B software provider in the transportation industry that integrates multiple functions for fleets, such as accounting, scheduling, and payroll. The industry is fragmented, with sufficient room for niche products, and is not a winner-take-all market, as is the case with many industries in which software is sold.
The majority of the company’s revenue is generated from a recurring quarterly support fee. The owners are retiring after operating the business for three decades. They wish to sell before a competitor introduces a new innovative product that may end up dominating the market, thus rendering their software obsolete and destroying the value of their business. The market is fragmented but ripe for consolidation, possibly by a large competitor who could vertically integrate software in the industry, or by smaller, more agile competitors who could out-innovate the company’s software and their value proposition.
Where to start? With the value drivers, of course …
Table of Contents
- Solo Value Drivers
- Strategic Value Drivers
- Value Detractors
- Risk Factors
- Potential Strategic Reasons for Acquisition
- Crossroads: Issues & Decisions to Consider
- Valuation & Pricing
- Letter of Intent (LOI)
- Deal Structure
- Due Diligence & Closing
Solo Value Drivers
The value drivers were first identified and then carefully incorporated into the Confidential Information Memorandum (CIM). Care was taken to be conservative when describing the value drivers. Additionally, value drivers that were only available to strategic buyers were identified separately.
Following is a list of value drivers available to all potential buyers, whether strategic or not:
- Recurring Revenue: The business generates recurring revenue. Because the revenue is non-contractual, there is no need to assign contracts at the closing, which reduces risk for the buyer. Contractually-recurring revenue is viewed as less risky and is more valuable than revenue generated from new sales, thus demanding a price premium. This business is not dependent on revenue from new product sales — forecasted sales based on new product sales are viewed as riskier by buyers and are therefore heavily discounted.
- Low Customer Concentration: No single customer accounts for more than 5% of revenue — the business has excellent customer diversity and is not dependent on any one customer, thereby reducing risk for the buyer.
- Barriers to Entry: The software has a high switching cost for its customers due to the nature of the features it supports, such as accounting, scheduling, and payroll, which are considered integral to the operation of transportation companies. This presents a significant barrier to entry for a competitor. The difficulty in transitioning these services to an alternate software provider enhances customer retention and improves customer lifetime value, and increases the difficulty of competitors poaching this company’s customers.
- Favorable Industry Dynamics: There are few early adopters in this industry — old is considered good, even if less innovative. The customer base is considered less susceptible to being poached by more innovative competitors. This, combined with high switching costs, explains why the customer acquisition cost (CAC) is high and attrition rates are low. The business also operates in an industry that is not considered a ‘winner take all,’ as in most B2C software industries. This further limits risk for a buyer through a reduced perception of threat from competition.
- Long-Term Relationships: The business has a loyal customer base consisting of long-term relationships with its customers with high retention, low attrition, and low churn rates. The business’ strong metrics, which are due to the long-term nature of these relationships, support the argument that the software is considered a vital component of the customers’ business operations. It could also be argued that the business is recession-proof due to the vital nature of the services the software provides, which further improves the long-term nature of the relationships.
- High Customer Lifetime Value: The business has a high ‘lifetime value’ (LTV) for its customers — the average customer relationship generates revenue in the tens of thousands of dollars. As a result of this high lifetime value, the business can afford to invest a significant amount of money in generating new customer relationships. For example, if the average lifetime value (LTV) of a customer is $25,000, then the company may have a customer acquisition cost (CAC) as high as $2,500, meaning they may invest up to $2,500 in acquiring each new customer.
- Recession Resistant: The industry has been impacted to a certain degree by recent economic events, however, the business itself remains unimpacted due to the recurring and non-discretionary nature of the service it provides, such as payroll, accounting, scheduling, etc.
- No Staff to Relocate: There is no staff to relocate as the business operates 100% virtually.
- Relocatable: The business can be easily relocated anywhere in the country due to its virtual nature. As a result, the business can be marketed to potential buyers in multiple geographic areas simultaneously, thereby dramatically improving the chances of a successful sale.
- Scalable Business Model: The company could be quickly scaled via direct B2B sales.
- High Cost to Replicate: The cost to replicate the software and other processes is high. The cost to write the code internally using the Constructive Cost Model (COCOMO), which is based on the number of lines of code (3.6 months per 1,000 SLOC (source lines of code)), is considered high. Buyers calculating a buy vs. build comparison would see the value in acquiring the company versus writing the code internally.
- No Channel Dependencies: The business is not dependent on any distribution channels, such as Google PPC or Facebook Ads, and is not subject to risk in changes in algorithms by distribution channels.
Related Resource: M&A Talk Podcast — Jeff Wald, Founder of WorkMarket, on a $100 Million+ Exit — In this episode of M&A Talk, I interviewed Jeff Wald, who successfully founded and exited several technology companies. His most recent exit was a $100 Million+ exit to ADP.
Strategic Value Drivers
Value drivers that were only available to strategic buyers were separately identified, which enabled us to value the business on a strategic basis, as opposed to the Fair Market Value. The value drivers were then carefully incorporated into the Selling Memorandum.
Following is a list of value drivers potentially available to strategic purchasers:
- Price Premium Possible: Large companies could potentially charge a brand name price premium for the software due to the lower perceived level of risk in working with a larger, more established company.
- Strategic Value of Customers: The relationships with the customers may carry significant strategic value to an acquirer who offers similar products. The customer relationships serve as an opportunity for entry for an acquirer to sell their entire product line, thus dramatically increasing the ROI for the acquirer. It’s easier for an acquirer to upsell to an existing account than to establish a new account. Additionally, the customer acquisition cost (CAC) is high in the industry, meaning the value of the relationships is therefore high.
- Strategic Value of Products: A strategic buyer can add the software to their existing product line and distribution network to increase revenue. Doing so could enhance existing relationships by allowing the buyer to offer a wider suite of available services to their customer base, and simplifying operations for the buyer as the end-user would have fewer relationships to maintain. The software can also serve as a door opener to establish new relationships for the buyer, but the buyer must consider how well the software fits into their existing suite of products. The software would be most valuable to a company with a high number of installed accounts and a large sales team.
- Strategic Value of Distribution Network: The business has a high value to buyers with well-established distribution channels in the industry. The company could have a high value to a competitor with a large sales force, but the sales team must have sufficient motivation to sell the product. Therefore, there is a point of diminishing returns. The ideal buyer may be a large company, but they shouldn’t be so large that the software becomes lost in the company’s existing suite of software, meaning that the salespeople fail to offer it to their customer base. Such a scenario is especially important if any portion of the sales price is contingent on future sales, such as an earnout.
The value detractors were identified but were only mentioned in the Selling Memorandum if the impact of the value detractor could be mitigated. We discussed the value detractors with the owners and prepared a strategic response for those that could be mitigated to use in our conversations with buyers.
Following is a list of potential value detractors:
- No Management Team: The business has no management or development team. The business is primarily operated by its two owners, who are both retiring and do not wish to stay with the company post-closing. As a result, there is no obvious successor and a buyer must form their own team to operate the business post-closing.
- Legacy Code: The code is due for a rewrite and the value of the code must be discounted based on its age. A buyer would need to rewrite the code before heavily investing in sales and marketing to scale the business up. To keep up with the introduction of well-capitalized competitors in the industry, and to establish industry dominance, an acquirer would need substantial capital to rewrite the code, but the threat of competition may be mitigated due to high perceived switching costs by the customer base.
- No Long-Term Contracts: While the revenue is recurring, it is non-contractual. As a result, uncertainty can kill sales in the pipeline and customers can leave during the transition phase due to the uncertainty an acquisition can create in the mind of the marketplace.
- No Growth Plan: The business has no documented business plan in place with assumptions based on historically accomplished objectives. No milestones have been documented which could serve as the basis for any future plans and could allow the buyer to break down a growth plan into achievable short-term objectives based on historically achieved milestones.
- Minimal Product Diversity: The business has only one product — its software for the transportation industry — and risk is therefore highly concentrated in this one product.
- Declining Revenues: The business has a minimal sales pipeline and customer database with declining revenues due to the lack of active marketing investment by the current owners.
- Diminishing Competitive Differentiation: The value proposition has declined in value over the years as new entrants have created more compelling value propositions. As a result, a buyer would not only need to rewrite the code, but would also need to perform a significant amount of experimentation to add incremental value to the existing value proposition.
- Sales Person Concentration: All sales are dependent on the two owners so there is a high dependency on the owners for new software sales.
- No Advertising Campaigns: No scalable infrastructure exists for quickly ramping up sales and marketing, such as proven advertising tactics and collateral. A new buyer would need to invest heavily in building a scalable sales and marketing infrastructure before scaling the business.
- Minimal Documentation: The business has little documentation in the areas of employee manuals, systems, procedures, management systems, or a dashboard.
- High Customer Acquisition Cost (CAC): The high CAC is considered a value driver because it ensures customer retention is high, but it’s also considered a value detractor because it limits scalability.
In addition to value detractors, risk factors were also considered, but they were not mentioned in the Selling Memorandum unless they could be mitigated.
In making a potential acquisition, the buyer is likely to consider the following risk factors:
- What if we lose a major customer?
- What if a large VC-backed competitor enters the market offering a more appealing value proposition?
- What if a startup creates an innovative solution that renders our solution obsolete?
- What if a high number of customers cancel the service post-closing due to the change in ownership?
- What if we can’t develop scalable sales and marketing campaigns, and/or the customer acquisition cost (CAC) proves to be too high given our initial estimates?
- What if the cost to rewrite the legacy code proves much higher than our initial estimates?
- What if customer retention decreases, and thereby lowers LTV (lifetime value) and reduces our budget for the CAC (customer acquisition cost)?
- What if our cost to form a management and development team proves higher than our initial estimates?
- What if we experience a difficult time developing a more defensible value proposition?
Potential Strategic Reasons for Acquisition
During our strategic planning, we identified reasons a competitor or strategic buyer might purchase the company. We used these reasons as the basis for our marketing campaign to approach potential buyers.
Following is a list of reasons companies might acquire this business:
- Access to Customer Base: The buyer will essentially be acquiring the customer base. The software will need to be rewritten and significant infrastructure (management team, marketing campaigns, etc.) will need to be built post-acquisition. As a result, the primary value is in the customer base.
- Access to Markets: It’s possible another company may acquire the company as a fast entryway into the industry. For example, a company offering a similar suite of services may operate in an adjacent industry, such as construction, and may acquire this company as a means of entry into the industry to quickly gain knowledge of the market and increase their reputation and credibility within the industry. Such an acquisition would serve as the foundation for rolling out the buyer’s existing suite of products to the industry, and would limit both their risk and time to market.
- Access to Technology: A company offering services in the industry with a wide customer base may acquire the company so they can transition to a software as a service (SaaS) model.
- Wider Product Suite: A company in the industry may purchase the business to add the service to their suite of products, which may help lower customer attrition and improve retention. Studies have shown that the more services a company offers a customer, the higher the customer retention rates. This explains why a cable company may offer many services, or why Apple and Google have invested so much in creating their ecosystem.
- Industry Roll-Up: A large, well-capitalized competitor may acquire multiple small competitors and roll them up into one large entity in the industry. Such a strategy is common in fragmented industries and the buyer may seek to capitalize their multiple expansion (i.e. multiples increase as EBITDA increases). In these instances, the acquirer would initially purchase a platform company ($20+million in revenue) in the industry and then supplement the platform company with numerous tuck-in acquisitions in order to add customers, technology, or additional products to the platform company. In roll-ups, consolidation is rapid and premium pricing for targets is temporary. If you don’t sell, you are left to compete with the consolidated entity, which will have more resources, a larger sales force, stronger brand awareness, and premium pricing. If a roll-up is occurring in your industry, it’s a prime time to sell.
Crossroads: Issues & Decisions to Consider
Following is a list of issues the owners considered before deciding to sell their software company:
- Competition: In most industries, good ideas are being pursued by dozens of competitors simultaneously, often without them having knowledge of one another. In this company, the owners were acutely aware that competitors were developing more innovative software solutions in the industry and a consolidation of solutions was likely to occur in the near future within the industry. Given their preference for retirement and their desire to take some chips off the table and diversify their risk, as opposed to concentrating it, they felt the most practical solution was to sell the company.
- Scalability: To increase the value of the company, infrastructure would need to be built to improve its scalability. The problem with most tech companies is that they lack the infrastructure to leverage the inherent scalability of the software. Likewise, infrastructure would also need to be built to improve the profitability of the company. The owners’ choice was to either sell now and cash out at a good price, or treat the business as a cash cow and continue milking the business for several years. However, if they continued milking the business without reinvesting in it, it’s likely the value of the business would decline considerably. It was most sensible, both financially and personally, to sell the business now while considerable value could be extracted. They took to heart Henry David Thoreau’s thoughts when he posited that ‘the price of anything is the amount of life you exchange for it.’ They weren’t willing to trade more life for more money and decided to sell now so they could stop and smell the roses.
- Sales: Hiring salespeople is a risky proposition for most owners, especially if they have no background in hiring and managing salespeople. What happens if the salesperson is unsuccessful after one year? Such an investment would drain cash flow and negatively affect the value of the business.
Such a situation is common in tech businesses — great technology, but not so great sales & marketing. It usually takes at least one year to receive a return on investment when hiring a sales force and such an investment is risky if one lacks experience hiring salespeople. Most tech founders have no sales experience and hiring a salesperson decreases earnings and therefore the value of the business. Additionally, hiring salespeople is difficult for a small software company as many salespeople may come from larger companies. These employees may be accustomed to large company infrastructure and systems and may not fare well in a small company environment that requires agility and flexibility. If a salesperson costs $75k and your business sells at a 4.0 multiple, then one bad hire can decrease the value of your business by $300,000 ($75k x 4.0 = $300k).
When hiring salespeople, the Pareto principle applies as well — 20% of the salespeople you hire will produce 80% of the results. In other words, you have less than a 20% chance of hiring a salesperson who will produce a strong ROI for you. Such a proposition is risky if your timeline is short for selling your company. As an extension of the Pareto principle, the fewer sales people you hire, the lower your chances of hiring a superstar.
Before building a sales team, it is necessary to build systems and infrastructure, such as a CMS, databases, sales material, presentations, milestones, and so forth. If you lack sales management experience, it’s unlikely you will set up effective systems, which will limit the effectiveness of your team.
An alternative is to hire a consultant to assist you in setting up the infrastructure and building the sales team, but doing so is costly and still risky. If you fail, the value of your business will be negatively impacted and it may take 2-3 years for the value of your business to recover. An owner must also consider the lost opportunity cost of investing their time, energy, and money in building a sales team and if those resources could be more intelligently invested in other areas of the business that create a more predictable result.
After considering all of the points discussed above, it was time to present the business to potential buyers. Our primary objective was to create as much collateral as possible and professionally package the company to create an efficient sale process. By creating an efficient sale process, we could minimize the amount of time the sellers invested in each buyer (i.e. sunk costs), which would thereby improve their negotiating leverage. The less time and energy you have invested in one buyer, the stronger your negotiation posture is.
All collateral was produced in Google Docs so the information could be easily updated without the need to re-email information to buyers. For example, if the selling memorandum was sent to 30+ buyers, then we could simply update our copy, and the changes would be automatically propagated to each buyer’s copy without the requirement of re-emailing the document.
Following is a summary of the steps we took to prepare the company before putting it on the market:
- Confidential Information Memorandum (CIM): We prepared a 35+ page CIM that highlighted the value drivers of the company and mitigated the value detractors. Our strategy was to disclose everything to minimize post-offer retrading. We revealed the weaknesses early on and spun them in a positive light. Our strategy resulted in minimizing the potential scope of representations and warranties in the purchase agreement, and eliminated any form of contingent payments and holdbacks.
- Telephone Interview: We produced a professionally recorded telephone interview with the owners and provided a link to the interview in the Selling Memorandum. This approach had dual benefits — it saved the owners significant time from having to tell their story over and over to each buyer and it increased the convenience for the buyers since they could listen to the pre-recorded interview at any hour of the day.
- Teaser: We also created a Teaser Profile, which is an abstracted version of the Selling Memorandum, to use in approaching or responding to competitors. The teaser helped maintain confidentiality and was used with direct competitors, when the owners wanted to share limited information.
- Financials: We normalized the financials in Google Spreadsheets, with minimal adjustments.
- Code Audit: No code audit was performed as we were aware the code was legacy and needed to be rewritten.
- Time to Market: 4 weeks.
Valuation & Pricing
We conducted a valuation of the company, taking into account its value drivers, value detractors, and risk factors. Multiple methods were used to value the company.
Following is a description of the methods used and our overall rationale in valuing the company:
- Value Based on Revenue: The company sold at a value close to 2.0 times its revenue.
- Value Based on EBITDA: A valuation based on EBITDA was highly subjective due to the involvement of two owners in the business. What would a fair salary be to replace one of the owners? Such a figure is subjective and likely to result in a skewed number. Obviously, the multiple of a software company is higher than other businesses due to its scalability and recurring revenue, but calculating EBITDA for this transaction proved especially problematic. The range of potential values for this company was wider than most due to the subjective nature of calculating EBITDA.
- Price vs. Risk: The price of any company is based on risk and the easiest way for buyers to reduce risk is to reduce the price they pay. Buyers will use every possible tool they can to reduce the price. To increase price, you must reduce risk for the buyer. We employed numerous risk mitigation strategies, such as an extended transition period, to reduce the perceived level of risk to the buyer. Regarding the transition period, if you want to receive maximum value for your company, count on staying involved post-acquisition for a while. You don’t need to stay on as CEO — in negotiations with the buyer you can discuss staying on in a different role that you enjoy, reducing risk for the buyer, and creating a win-win situation for both parties.
- Comparable Transactions: Finding comparable transactions is difficult with small businesses, even more so with tech companies. Comparable transactions for this business sale were bleak at best, with limited information available. In private transactions, the parties wish to keep the price and terms secret. The only time the price is public knowledge is if the acquirer is a public company and the acquisition is material, which is rare for companies in the lower and middle middle-markets.
- Buy vs. Build Comparison: A detailed buy vs. build comparison was not performed, but the cost for the buyer to write the code internally and build the business from scratch was considered in our overall analysis.
We created a strategic marketing plan as part of our initial planning prior to putting the business on the market.
Following is a description of our marketing strategy:
- Web Portals: We felt that approaching competitors was too risky — some competitors might attempt to poach the customer base and word would quickly spread in the industry. We also felt that competitors were unlikely to pay a price premium due to the need to rewrite the legacy code. We determined that we could obtain a premium price via online web portals. Then we marketed the business in multiple geographies since the business could be relocated post-closing.
- Inquiries: We received a total of 113 inquiries. The inquiries came from wealthy individuals, financial buyers, and direct and indirect competitors. We initially eliminated financial buyers, as they were considered unlikely to buy the business since the owners planned to immediately retire and were not willing to remain in the business post-closing. The only exception was financial buyers who owned a competitive platform company and could integrate the software with their company and fold operations into theirs without involving the current ownership of the company.
- Signed NDAs: We received a total of 54 signed non-disclosure agreements.
- Letters of Intent: We negotiated with dozens of buyers and received seven LOIs.
We conducted serious negotiations with approximately a half dozen parties. One buyer was a financial buyer, however, we declined to counter his LOI after our initial review due to its numerous onerous requirements, such as the inclusion of working capital and the accompanying post-closing adjustment. We considered such deal parameters to be unreasonable given the size and nature of the transaction.
We received several offers that were well below the asking price and we immediately dismissed those. We wasted no time with lowballers. We did not waste time arguing their position but simply told them that we would see what other buyers had to offer. There is no sense in reasoning with someone who submits a low offer. The justification of a lower offer is irrelevant if another buyer is willing to offer more.
We prepared a spreadsheet comparing the half dozen offers. The spreadsheet compared the offers on the most important criteria, such as price, terms, due diligence, certainty of closing, and other soft factors, such as the buyer’s background and the possibility of renegotiations later on in the deal.
During the final rounds of negotiations, we were in discussions with three parties. As negotiations progressed, we traded up the price of the company as offers increased. We eventually settled on one LOI and converted it to a binding offer to purchase, then we immediately began due diligence.
During the negotiations, we spent a considerable amount of time setting expectations with the buyers to ensure that due diligence was completed in a timely fashion and to minimize the possibility of retrading. Our strategy was ultimately successful as due diligence went exactly according to plan and no subsequent re-negotiations occurred during or after the conclusion of due diligence.
We advised the seller to limit the exclusivity period and to retain backup options in the event that the buyer attempted to renegotiate the price during due diligence. Indeed, several LOIs included restrictive exclusivity provisions, which would have greatly decreased our negotiating leverage and exposed us to the possibility of retrading.
It is only possible to create leverage through positioning. The essence of positioning is creating options, or retaining the ability to negotiate with multiple buyers. The buyer must know that their competitors or other buyers are also considering the acquisition. The key to maintaining positioning is negotiating with multiple buyers. Due to the high response we received to our strategic marketing, and as a result of our efficient process, our plan generated an auction-type scenario and we were able to bid the price up and ultimately received 90.74% of the asking price.
While the sellers desired to sign an LOI and move on as quickly as possible, we strongly encouraged them to take their time. Time is on the seller’s side prior to accepting an LOI. Once an LOI is signed, the deal can only get worse for the seller — it will never get better for the seller once the LOI is signed.
Letter of Intent (LOI)
We converted the buyer’s LOI to a binding offer to purchase, along with a $75k earnest money deposit. Such a deposit is rare, however, we were able to negotiate a deposit due to the auction-type environment we created and the competition among the buyers. We also negotiated for the seller to hold the deposit, which gave the seller significant leverage during due diligence, and minimized the possibility of re-negotiations. We also included language in the offer to purchase that effectively canceled the offer in the event the buyer attempted to re-negotiate the price during due diligence.
Following is a description of how the transaction was structured:
- Financing: The buyer was a serial entrepreneur with strong banking relationships and the ability to obtain SBA financing. Our preference was to choose a solid buyer who had multiple financing choices.
- Cash Down: The sellers received approximately 90% cash at closing, with a promissory note equal to 10% of the purchase price, which is a high percentage of cash down compared to normal.
- Legal Structure: The sale was structured as an asset purchase.
- Prepaid Revenue: The prepaid revenue was allocated to the buyer and the seller based on the time of possession. This was an issue because revenue was collected at the beginning of the quarter but support had to be provided for the following three months. The prorated amount was deducted from the closing proceeds.
- Working Capital: No working capital was included and no adjustment was necessary, which is a common source of disagreement among buyers and sellers. Excluding working capital from the assets reduced the potential for disagreement.
- Allocation: The majority of the price was allocated to goodwill, which favored the seller, and caused the majority of their gains to be taxed at capital gains tax rates. These rates are significantly lower than ordinary income tax rates and were historically low during the Trump administration.
- Transition: The owners assisted in an 8-week transition plan but did not agree to stay involved with the business beyond this timeframe. Both owners signed a five-year non-competition agreement.
- Contingent Payments: There were no contingent payments — earnouts, holdbacks, or escrows.
Due Diligence & Closing
Following is a description of the process from due diligence to closing:
- Confidential Information: Financials and other limited information was released to the buyers prior to due diligence. Once the offer was signed, due diligence began and the seller and buyer exchanged information that is customarily shared in a transaction of this type. No material issues were discovered during due diligence.
- Due Diligence Length: 30 days.
- Due Diligence Issues: No material issues were discovered during the due diligence period. The buyer expected that the software needed to be rewritten before due diligence began and this did not become a more significant issue during due diligence.
- Fees: We ended up saving the seller over $50,000 in fees and commissions due to our fee structure.
- Retrading: Retrading is when the buyer wears the seller down over several months using multiple strategies designed to put the seller in a position where they are likely to be willing to renegotiate the price. The buyer’s strategy is to get the seller to invest as much as possible in the transaction in terms of time, money, and energy. The buyer may intentionally include vague terms in the LOI, delay meetings and due diligence, and introduce other parties (e.g. partners, advisors) to raise issues late in the process, in an attempt to uncover as many issues as possible during due diligence. The buyer may also be working with multiple business owners simultaneously so they reduce their commitment to any one transaction. The buyer may also bring in their team to tear apart a business and uncover as many issues as possible, and therefore reduce the price, or increase the terms or other deal parameters, such as the amount of a holdback or increase the scope of the reps and warranties that are signed at closing. In most cases, the seller suffers from deal fatigue and caves as a result of these strategies. If the seller walks away, the buyer knows the business is stigmatized. In this transaction, we implemented numerous strategies to prevent the possibility of retrading. The end result was that no retrading took place and there were no changes to the LOI from the time it was signed until closing.
- Confidentiality: There were no leaks in confidentiality.
- Purchase Agreement: Surprisingly, the purchase agreement was subject to minimal negotiation, and our standard closing documents were accepted with no material changes. Normally, a seller can expect to sign representations and warranties that are broad in scope and the purchase price can be subject to holdbacks, escrows, or other forms of protective measures for the buyer. In this case, no such measures were included in the provisions of the agreement.
Following is a summary of the transaction by deal point in comparison to our typical transaction:
- Industry: This industry is fragmented with room for niche products and is not a winner-take-all market. It’s easier to complete a transaction in this type of industry than in a winner-takes-all industry which has dominant players.
- Value Drivers: Value drivers are unique for every transaction but in this case, they consisted primarily of recurring revenue, long-term relationships with high LTV and low customer concentration, favorable industry dynamics, high switching costs, recession resistance, no staff, a relocatable business, and no channel dependencies. The value drivers mitigated the two primary value detractors — legacy code and declining revenues. Collectively, the value drivers painted a picture of an attractive acquisition candidate for the right buyer.
- Value Detractors: Value detractors are also unique for every transaction, and in this case consist of the lack of a management team, marketing infrastructure, and long-term contracts; legacy code; declining revenues; product and salesperson concentration; and a diminishing competitive differentiation. In many transactions, these value detractors would collectively make a company unsaleable, however, the strong collection of value drivers made this company an attractive acquisition despite its value detractors.
- Decision to Sell: The decision to sell for the owners was clear, as is the case for most owners of retirement age. They were of retirement age and aware that competition was increasing in the industry and they didn’t desire to make a significant investment in scaling the company, which would require building infrastructure and a sales team, both of which are costly and risky plans.
- Preparation: The preparation we did prior to putting the company on the market (Selling Memorandum, Telephone Interview, Teaser Profile, and financials) was typical for a company of this size and resulted in an efficient process, which helped maximize the price and reduced the possibility of retrading.
- Valuation: We valued the company based on both a multiple of revenue and EBITDA, however, calculating EBITDA was more difficult than usual due to the involvement of two owners and the subjective interpretation of an appropriate replacement salary for one owner. Comparable transactions were limited, as they are for most transactions of this size.
- Marketing: Our marketing process focused on web portals and generated a high response rate (113 inquiries with 54 signed NDAs). Overall, the process was hyper-efficient due to the amount of preparation we performed prior to putting the business on the market. For most software companies, we consider approaching competitors, but we did not do so in this transaction due to the increased potential risk and the low chance of receiving a higher price.
- Negotiating: We negotiated with multiple parties and received 7 LOIs, which is not uncommon for a business in the tech sector.
- Deal Structure: The overall deal structure was highly favorable to the seller as they received 90% cash down at closing with no contingent payments or holdbacks and working capital was not included in the price. Additionally, the majority of the price was allocated to goodwill, which highly favored the sellers. The purchase was structured as an asset sale, which is customary for a business of this size. Prepaid revenue was allocated to the buyer and the seller and was paid out of the sale proceeds, which is customary for any company with prepaid revenue.
- Due Diligence & Closing: Due diligence was much smoother than usual with no retrading, and few changes to our standard purchase agreement. The process from accepting the LOI to the closing was smooth, uneventful, and highly favorable to the seller.
Overall, the process was smooth and uneventful. The sellers were highly cooperative and easy to work with and followed our advice to the ‘T.’ We couldn’t have asked for a better client to work with. The process of preparing the company was streamlined due to our efficient process and the cooperation and fast response time from the seller. Once the company was on the market, our confidential marketing strategy generated a significant number of responses that enabled us to negotiate with multiple parties and select the buyer that was least likely to result in problems and renegotiations from accepting the LOI to closing. This is precisely what happened — the process of accepting the LOI was predictable and uneventful and all parties were highly cooperative. The result was that the sellers received exactly what they expected to receive and no renegotiations took place once we accepted the LOI.
If you own a business in the tech sector, such as an online business or a software company, contact us today for a free consultation to see how we can help you.