Saturday, March 19, 2011

Selling Your Software Company - How Important is the Sale Process

It is common knowledge that timing is very important when selling a software company in determining the value the owner receives. This article discusses what actually is a far more powerful determinant in selling price - the process employed in selling your software company.

As a general rule, there is a greater variance in company valuations for software and information technology companies than for brick and mortar type companies. If you took a manufacturer of bottle caps out to ten different private equity groups (the most disciplined group of financial buyers), the purchase price offers would be within 10% of each other at around 4.5 X EBITDA.

If you took a software company out to that same group of buyers, their purchase price would still be within 10% of each other at 5.5 X EBITDA. If you located ten software companies that were actively making acquisitions and took the same software company out to them, the offers could vary by over 100%.

I was talking with a financial advisor who related the following story to me about one of his clients that was the owner of a software company. One day the software company owner was approached by a private equity group with an unsolicited offer to buy his company. The two parties executed a confidentiality agreement and exchanged financial statements. Within a very short time the private equity group submitted a qualified letter of intent. The owner was thrilled and told his financial advisor that he was about to sell his company for $10 million.

His financial advisor's alarms sounded and he encouraged his client to engage a mergers and acquisitions firm that specialized in selling software companies. The owner resisted, evidently thinking that the process would be a breeze and that he could avoid the fees of the investment banker. His advisor persisted, however, and after a great deal of persuasion, finally agreed to hire a mergers and acquisitions firm that specialized in software company business sales.

The first concern of the owner was that hiring an investment banker would somehow upset the buyer and jeopardize this lucrative offer. The investment banker explained to the seller that he should contact the buyer and explain that since this was his first experience at selling a business so he was going to engage an advisor that could help him with the process. The owner instructed the buyer to work through his investment banker from this point forward.

The software investment banker included this identified buyer in his mix of other private equity groups and a large list of software company strategic buyers. This software was in a niche that was getting a lot of play lately as big legacy providers were being supplanted by smaller, more nimble new comers that were delivering their SaaS solution through the cloud.

As a result of the mergers and acquisitions Advisor's efforts, thirty potential buyers executed confidentiality agreements and reviewed the memorandum. From that group, twenty firms dropped out of the process after reviewing the memorandum, but ten interested buyers remained. Those ten then had conference calls with the owners and three completed a buyer visit.

After the company visits, all three companies started working on qualified Letters of Intent. This is a non-binding letter that basically says that if we complete our due diligence process and do not uncover any negative surprises, we are willing to pay XX amount for your company under the following terms (define an earn out, seller notes, owner continuing obligations, etc.). The serious negotiations come at the letter of intent stage because once the owner counter signs the LOI, the buyer is granted a quiet period in order to perform his due diligence. This means that the investment banker is precluded from soliciting any other offers during this period.

The seller and his software investment banker were able to be more demanding in the negotiations because they knew that they had the original unsolicited offer in hand as well as three very qualified strategic buyers that were willing to negotiate a letter of intent. Fast forward thirty days and the seller countersigned the LOI from one of the strategic buyers with a total transaction value of $120 million.
This was 12 times the original unsolicited offer. Quick disclaimer here like on the TV diet commercials, your results may differ.

This is an extreme example, but we have seen it play out many times. Our firm has been engaged to consult with several software companies that have been approached with an unsolicited offer. Maybe offer is not the right word, so let's say they were approached with interest from a buyer. We were brought in because the business owner could not get the potential suitor to actually make an offer.

They were circling, asking numerous questions, kicking the tires, and maintaining a dialogue with the would-be seller, but were not coming up with any terms and conditions for a potential offer. This is no man's land for the seller. We have been engaged to move the process forward or to stop this endless brain drain. We advise the owners to let us be the bad cop and not to take on that role themselves because it is important to preserve their relationship with the suitor as a potential reseller, channel partner or business development resource.

When we force the issue with the potential buyer, more often than not we find out that their intentions all along were to buy this high growth, cutting edge software company for an EBITDA multiple. Needless to say, our client is disappointed because he was already sizing his yacht. He was envisioning the lofty valuations that he had read about in a recent acquisition by a marquee industry player.

There is absolutely no reason for the single buyer to offer anything other than a "justifiable" EBITDA multiple offer as long as he has no competition in the process.

Compare this to HP or Dell making an unsolicited offer for a publicly traded, cloud enabled, virtualization software company as they did recently. They started out at a 30% premium to the current stock price and know that the target company will hire a Wall Street investment banker to maximize their transaction value. This public company buying process is, by law, a very public and transparent process. In an offer for a private company, however, it is a very private process. The seller does not want his customers, employees, or his competition to know that his company is in play.

Opportunistic buyers understand this dynamic and try to exploit it. We tell our clients that they should not feel so special because these buyers are doing the same dance with multiple target companies simultaneously. It is like the real estate guru who wrote the book and gives the classes to buyers to go out to 100 home sellers and offer a really low price and maybe one will take it.

We recently experienced this phenomenon directly. We were brought in to flesh out an unsolicited approach on an IBM iSeries partner software company who had been approached by a private equity consolidator in that space. When our client provided the buyer contact information, we recognized it immediately because we had completed an engagement with a similar target company six months earlier. They circled but did not offer. When we forced their hand, lo and behold it was an EBITDA financial offer. This dance was ended quickly and our client returned to managing and growing their business.

Dave Kauppi is a Merger and Acquisition Advisor and Managing Director of MidMarket Capital, providing business broker and investment banking services to owners in the sale of information technology companies. To view our lists of buyers and sellers click to visit our Web Site MidMarket Capital

1 comment:

  1. Software Development Company

    Hi Dave great post dear thanks for your wonderful sharing and its a great information how anybody sell software companies. Such a useful post.