Monday, December 31, 2018

How a Letter of Intent to Buy Your Company is Like an Apartment Lease

This is our latest article published on Divestopedia.

Takeaway: In a business purchase letter of intent, just like in an apartment lease, the party producing the document will attempt to stack the deck in their favor.

Surprisingly, there are many similarities between signing an apartment lease and a letter of intent. They relate to risk reduction, the balance of power between the parties to the transaction and the level of experience of the buyer and seller.

Why Would I Sign This Document?

As a seasoned business owner, If you were to read an apartment lease today, your reaction would probably be, "Why would I sign this document with everything possible favoring the landlord?” Thinking from that perspective, let's compare this to an unsolicited letter of intent to buy your company.

It's All About Risk Reduction

The apartment lease accounts for everything that could possibly go wrong between landlord and tenant and makes the contractual outcome favor the landlord in every case. From rent late fees to security deposits to notice requirements to stains on the carpet, these agreements cover it all. The landlord is completely protected for every eventuality and bears very little risk from this relationship — to the extent that the landlord writes the contract to reduce her risk, the tenant is the recipient of this risk.

Business Buyers Have the Experience

Just like the apartment lease, the letter of intent is written by the experienced party. The landlord has completed hundreds of successful rentals, while the renter is a novice. The buyer has likely acquired several companies and attempted to acquire dozens more, while this is likely the owner’s first sale. So just like the apartment lease favors the landlord, the letter of intent is written to the advantage of the buyer.

A Non-Binding LOI Provides the Buyer Plenty of Wiggle Room

The first clue is that it is a non-binding letter of intent. During the early stages of the mergers and acquisitions process, limited financial data and high level customer information is exchanged. This enables the buyer to judge whether or not the company is a good fit and meets their acquisition criteria. If the buyer wants to proceed further, they produce a letter of intent that requires a buyer sign-off and guarantees that the seller will not shop the deal while due diligence is completed. This is fair, because both parties will invest significant resources going through due diligence. The due diligence period typically lasts from 45 to 90 days and is exhaustive. The principal of the letter of intent is to spell out the terms and conditions for the acquisition, pending no due diligence surprises that are material to either the value or the risk of the transaction.

Buyers Often Abuse the Due Diligence Process

Buyers have their team of experts, usually consisting of internal resources, plus an outside accounting firm and legal counsel. They instruct their outside accountants to perform a quality of earnings report. This is where the abuse comes in. In its purest form, the quality of earnings report is a check and validation that the information they based their purchase offer upon is accurate and correct. At its most unsavory, it is the buyer instructing the accounting firm to render opinions that are designed to attack the value and terms originally set forth in the letter of intent. Deep into this exhaustive process where the competitive bidders are long gone and the seller is experiencing deal fatigue, the buyer will use these "expert opinions" to require price adjustments to the deal.

On top of that, they play brinkmanship: If you don't agree, we walk away. These professional buyers are emotionally detached from this transaction, unlike the sellers. They will just move on to the next one if they don't get what they want. The seller can either cave in and take a haircut or walk away from a deal they have invested six months of emotion and effort into.

The Buyer's "Experts"

One quality of earnings report we experienced was an opinion that the benefits package for the employees was below market. To get it up to market would cost $100,000 and, since our purchase price was based on a 5 X EBITDA multiple, we are dropping the purchase price by $500K. It was completely arbitrary and not accurate to compare our small market client with the Boston market compensation package. Our client's benefits package was reasonable and customary for their current market. On another transaction, the quality of earnings opinion was that last year's growth was unusual so we are just going to normalize EBITDA over the last 3 years to take a $750 K adjustment to our current purchase offer. Forgive my French, but total arbitrary BS.

The Power of Options

Back to our apartment lease comparison. Why this behavior? The landlord has plenty of other renters waiting in line for the apartment. The buyers typically have multiple acquisition interests in process at any one time. If you don't like our terms…. Next!

Counter Offer With Precise Language

Much of this balance of power trouble for the business seller can be avoided with an intelligently worded letter of intent negotiated prior to agreeing to dual signing it and taking your company off the market. Once the LOI is signed, the price and terms never improve for the seller — they only go in one direction that favors the buyer. So, oftentimes during due diligence, the performance of the business will suffer because the owner and CFO are distracted by all of the demands of the deal. The experienced buyer will often demand a change in purchase price based on this drop in performance.
If they are going to operate this way, why not turn the tables around? You could counter offer the language in the letter of intent with, "The purchase price is based on a multiple of EBITDA of 5.34 times. Based on the September 30th trailing twelve months that reference purchase value based on $1.0 million of EBITDA is $5.34 million. For the final purchase price, we will use the trailing twelve months to the closing date EBITDA X 5.34.” The buyer should not be able to reasonably disagree with this. It is like a mutual NDA: What is good for one is good for both.

Net Working Capital Is a Key Buyer Target

Another poorly worded clause (in favor of the buyer and to the detriment of the seller) in the letter of intent is about setting the level of net working capital. The typical LOI clause prepared by the buyer's experts is: This proposal assumes a cash free, debt free balance sheet and a normalized level of working capital at closing. And, of course, they try to leave this open so that they have huge wiggle room for their quality of earnings report opinion which may set the level arbitrarily at $600,000 late in the due diligence process.

Being a savvy seller, you’re going to enter competitive negotiations and give a counter proposal of $200,000, for example, and define how you will calculate it. Tips and tricks like this can be learned (over time and with some cost) or can be hired out in the form of an advisor; either way, the seller has more options than the buyer wants you to think!

Be Careful With Earn Outs

Another area where the sellers potentially get their pockets picked is clever expert language. It has to do with earnouts. Often the buyers will put an all-or-nothing earnout condition that says, for example, the seller must grow revenues by 10% per year to get the earnout and if the seller falls short, she receives nothing. A better way for the seller is to calculate a factor to multiply each year's revenues by in order to arrive at the earnout payment for that year. For example, total revenues X 0.11.
One additional earnout trap is the multiple conditions earnout. You have to achieve a specific revenue growth target plus a profit goal in order to receive the earnout. This is terrible for the seller because, first, a multiple condition earnout is very hard to consistently hit and, second, once you sell your company, controlling the profitability is much more difficult due to such factors as corporate overhead allocation.

Final Thoughts

So if you are negotiating the sale of your company, try to change the dynamic from that of an apartment renter to one of a commercial real estate lessee. You can balance the power by seeking several competitive bids, employing experts who know the industry norms and the market, and through the use of counter offers that add clarity and precision to the terms and conditions written into the original letter of intent by the buyer's team of experts. 

Dave Kauppi is a Merger and Acquisition Advisor and President of MidMarket Capital, providing business broker and investment banking services to owners in the sale of information technology, software, and other technology based companies. Dave is also the editor of the Exit Strategist Newsletter and author of the Book Selling your Software Company - An Insider's Guide to Achieving Strategic Value

Wednesday, October 24, 2018

The Art of Getting Strategic Value for Software Companies

Takeaway: If you want to get top dollar for your software company, you need to think strategically and entice the right buyer with the right information. Below is our latest published article on Divestopedia.

One of the most challenging aspects of selling a software or information technology company is coming up with a business valuation. Sometimes the selling prices of these technology companies are far higher in terms of valuation metrics (i.e., EBITDA multiple or price to sales) than those for a manufacturing company, for example. This article discusses how information technology business sellers can properly position their company to the right buyers in order to achieve a strategic transaction value.

Why are some of these software company valuations so high?

It is because of the profitability leverage a technology company can generate. Here's a simple example to illustrate. What is Microsoft's incremental cost to produce the next copy of Office Professional? It is probably $1.20 for three CDs and 80 cents for packaging. Let's say the license cost is $400. The gross margin is north of 99%. The same goes for Google with their Ad Words platform that is "self service" for the businesses buying the paid search placement. The majority of content on Facebook is provided by users, making that business model very profitable. That does not happen in manufacturing or services or retail or most other industries.

Fill the Valuation Gap

One problem in selling a small technology company is that they are a relatively unproven commodity compared to their large, brand name competitors. So, on their own, they cannot create this profitability leverage. The acquiring company, however, does not want to compensate the small seller for the post-acquisition results that are directly attributable to the buyer's market presence. This is what we refer to as the valuation gap. The potential is there, but the battle is about what percentage of future results gets allocated to the seller and what percentage gets allocated to the buyer.

The business seller wants to artfully help the buyer justify paying a much higher price than a pre-acquisition financial valuation of the target company. In other words, the seller wants to get strategic value from the buyer. An important thing to keep in mind is that the effectiveness of this strategy goes up exponentially based on the number of qualified buyers that are vying for the acquisition when it is time to submit letters of intent. The reason for this is that some of the acquisition benefits we present will resonate with some and not with others. The more buyers involved, the greater the chances of one or more of the benefits creating a favorable impression of post-acquisition business value creation.

Tips on Positioning Your Software Business for Maximum Price:

Cost for the buyer to write the code internally — Many years ago, Barry Boehm, in his book, Software Engineering Economics, developed a constructive cost model for projecting the programming costs for writing computer code. He called it the COCOMO model. It was quite detailed and complex, but I have boiled it down and simplified it for our purposes. We have the advantage of estimating the "projects" retrospectively because we already know the number of lines of code comprising our client's products. This information is designed to help us understand what it might cost the buyer to develop it internally so that he starts his own build versus buy analysis.

Most acquirers could write the code themselves, but we suggest they analyze the cost of their time-to-market delay. Believe me, with first-mover advantage from a competitor or, worse, customer defections, there is a very real cost of not having your product today. We were able to convince one buyer that they would be able to justify our seller's entire purchase price based on the number of client defections their acquisition would prevent. Think of the difference today between first-mover Gatorade and the distant number two, Powerade.

Restate historical financials using the pricing power of the brand name acquirer. We had one client that was a small IT company that had developed a fine piece of software that compared favorably with a large, publicly traded company's solution. Our product had the same functionality, ease of use and open systems platform, but there was one very important difference: The end-user customer's perception of risk was far greater with the little IT company that could be "out of business tomorrow."

We were able to double the financial performance of our client on paper and present a compelling argument to the big company buyer that those economics would be immediately available to him post-acquisition. It certainly was not GAAP accounting, but it was effective as a tool to drive transaction value.

Financials are important so we have to acknowledge this aspect of buyer valuation as well. We generally like to build in a baseline value (before we start adding the strategic value components) of 2 X contractually recurring revenue during the current year. So, for example, if the company has monthly maintenance contracts of $100,000 times 12 months = $1.2 million X 2 = $2.4 million as a baseline company value component. Again, this financial analysis is to establish a baseline, before we pile on the strategic value components.

We try to assign values for miscellaneous assets that the seller is providing to the buyer. Don't overlook the strategic value of Blue Chip Accounts. Those accounts become a platform for the buyer's entire product suite being sold post-acquisition into an "installed account." It is far easier to sell add-on applications and products into an existing account than it is to open up that new account. These strategic accounts can have huge value to a buyer. Value that can be created for the buyer is important when the selling company has developed a superior sales system or highly effective business model that could be implemented in the buying company.

Finally, we use a customer acquisition cost model to drive value in the eyes of a potential buyer. Let's say that your sales person at 100% of quota earns total salary and commissions of $125,000 and sells five net new accounts. That would mean that your base customer acquisition cost per account was $25,000. Add a 20% company overhead for the 85 accounts, for example, and the company value using this methodology would be $2,550,000.

You think this is a little far-fetched. However, these components do have real value — that value is just open to a broad interpretation by the marketplace. We are attempting to assign metrics to a very subjective set of components. The buyers are smart and experienced in the M&A process. They'll try to deflect these artistic approaches to driving up their financial outlay.

The best leverage point we have is that those buyers know that we are presenting the same analysis to their competitors and they don't know which component or components of value will resonate with their competition. You need to provide the buyers some reasonable explanation for their board of directors to justify paying far more than a financial multiple for our client's company.

Dave Kauppi is a Merger and Acquisition Advisor and President of MidMarket Capital, providing business broker and investment banking services to owners in the sale of information technology, software, and other technology based companies. Dave is also the editor of the Exit Strategist Newsletter and author of the Book Selling your Software Company - An Insider's Guide to Achieving Strategic Value

Wednesday, October 17, 2018

Letting the Market Bridge the Valuation Gap in Your Business Sale

Below is our latest Article Dave Kauppi Article on Divestopedia

Takeaway: Using fair market value to help business owners bridge the gap between the valuation they feel they deserve and that which they're likely to receive increases the likelihood of a transaction.

Statistics show that a surprisingly low percentage of businesses for sale actually sell on the first attempt. The major reason for the lack of sales is the valuation gapbetween the buyers and the seller. This article discusses how that gap can be breached, resulting in completed business sale transactions.
In a survey that we conducted with business brokers and merger and acquisition professionals, 68.9% of respondents felt that their top challenge was dealing with their seller client's valuation expectations. This is the number one reason that, as one national investment banking firm estimates, only 10% of businesses that are for sale will actually close within three years of going to market. That is a 90% failure rate!

Setting Value Expectations for Business Owners

As we look to improve the performance of our practice, we looked for ways to judge the valuation expectations and reasonableness of our potential client. An M&A firm that fails to complete the sale of a client, even if they charged an up-front or monthly fee, suffers a financial loss along with their client. Those fees are not enough to cover the amount of work devoted to these projects. We determined that having clients with reasonable value expectations was a key success factor.

To give our clients an idea of the kind of offers they would receive for their business as-is, we prepared a mock letter of intent for them after analyzing their business. This mock LOI included not only transaction value, but also the amount of cash at closingearnoutsseller notes and other factors we felt would be components of a real market offer.

If you can believe it, that mock LOI was generally not well received! Clients couldn't believe the value they gave their company wasn't reflected in our analysis. For example, one client was a service business and had no recurring revenue contracts in place — in other words, their next year's revenues had to be sold and delivered next year. Their assets were their people, and their people walked out the door every night. Our mock LOI included a deal structure that proposed 70% of transaction value would be based on a percentage of the next four years of revenue performance as an earnout payment. Our client was adamant that this structure would be a non-starter. Fast forward nine months and 30 buyers that had signed confidentiality agreementsand reviewed the confidential information memorandum withdrew from the buying process. It was only after that level of market feedback was the client was willing to consider the message of the market.
We decided to eliminate this approach because it put us sideways with our client early in the M&A process. The clients viewed our attempted dose of reality as not being on their side. No one likes to hear that you have an ugly baby. We found the reaction from our clients almost that pronounced.
We tried probing into our clients' rationale for their valuation expectations and we would hear such comments as, "This is how much we need in order to retire and maintain our lifestyle," or "I heard that Acme Consulting sold for 1x revenues" or "We invested $3 million in developing this product, so we should get at least $4.5 million."
Unfortunately, the market doesn't care what you need to retire. It doesn't care how much you invested in the product. The market does care about valuation multiples, but timing, company characteristics and circumstances are all unique and different. We often hear examples like "IBM bought XYZ Software Company for 2X revenues so we should get 2X revenues." However, it is simply not appropriate to draw a conclusion about your value when compared to an IBM-acquired company. You have revenues of $6 million; they had $300 million in revenue, were in business for 28 years, had 2,000 installed customers, were cash flowing $85 million annually and are a recognized brand name. Larger companies carry a valuation premium compared to smaller companies.

The Price and Terms of a Sale Are Based On Several Key Business Characteristics

1. Contractually Recurring Revenue — by far the most powerful factor for driving favorable price and terms. You just need to look at Microsoft's stock price since the new CEO changed their business model from a one-time software license sale to a subscription model. Revenues went down short-term, but over the longer term, revenues have accelerated and the stock price has responded beautifully.
This characteristic is why all of the major software firms are converting to the SaaS (Software as a Service) Model.
For a business buyer, this significantly de-risks the transaction. The longer the contracts, the better. It is predictable revenue and the risk of large customer defections post-acquisition is greatly reduced. This is much more highly valued than a business that is driven by having to sell new business as the bulk of their revenue. So, the greater the percentage of revenue that is contractually recurring revenue, the higher the selling price for your business. The greater the contractually recurring revenue, the greater percentage of transaction value that will be payable in cash at closing. The lower the contractually recurring revenue, the greater the transaction value that will be shifted to a seller earnout, seller financing or both.

Also, the greater the percentage of contractually recurring revenue, generally the term of owner involvement in the business will be reduced. So if you have very little recurring revenue and you want to exit shortly after sale, good luck. The new owners will want you around to help transition the business and the customers.
2. Durable Competitive Advantage — There is a reason Warren Buffett is such a successful investor. He looks for businesses that have a competitive moat around them and that are not commodities. They have pricing power. This is a powerful driver of selling price and a meaningful factor in risk reduction.
3. Growth Rate — This is an area where the current EBITDA valuation model falls short. A firm growing revenue at 30% per year should be valued far higher than another firm with the same EBITDA growing at only 10% per year. Wall Street has accounted for this with their price/earnings/growth multiple. Growth rate is valued by business buyers, but they will try to use the EBITDA model to justify their price if you let them.
4. Customer Concentration — This is a value killer and a terms killer. If you have 40% of your business with one client and that client goes away, you do not have a business. That is exactly how a buyer looks at it and it normally scares them away. But if there is a transaction, it will be characterized with a very large percentage of the deal as an earnout and a much smaller percentage in cash at closing. The buyer will want the owner be involved for a long period of time to ensure these necessary customers stay.

The Valuation Challenge of Intellectual Property and Software Businesses

This issue becomes even more difficult when the business is heavily based on intellectual property, such as a software or information technology firm. These companies face a much broader interpretation by the market than more traditional brick-and-mortar firms. With asset-based businesses we can present comparables that provide us and our clients a range of possibilities. If a business is to sell outside of the usual parameters, there must be some compelling value creator like a coveted customer list, proprietary intellectual property, unusual profitability, rapid growth, significant barriers to entry or something that is not easily duplicated.

For an information technology, computer technology or healthcare company, comparables are helpful and are appropriate for gift and estate valuations, key man insurance and for a starting point for a company sale. However, because the market often values these kinds of companies very generously in a competitive bid process, we recommend just that when trying to determine value in a company sale. The value is significantly impacted by the professional M&A process. In these companies where there can be broad interpretation of value by the market, it is essential to conduct the right process to unlock all of the value.

Letting the Market Decide Value

How do we handle value expectations in these technology based company situations? M&A professionals are not the right authority on our client’s value, the market is. If the client feels like his broker or investment banker is just trying to get him to accept the first deal so that the representative can earn his success fee, there will be no trust and probably no deal.
If the client sees his representatives bring multiple qualified buyers to the table, present the opportunity intelligently and strategically, fight for value creation, and provide buyer feedback, that process creates credibility and trust. The client may not be totally satisfied with the value the market is communicating, but he or she can see the reality of the situation. The likelihood of a completed transaction increases dramatically after this.
The client is now faced with a very difficult decision and a test of reasonableness. Can he or she interpret the market feedback, balance that against the potential disappointment resulting from his or her preconceived value expectations and complete a transaction?
Dave Kauppi is a Merger and Acquisition Advisor and President of MidMarket Capital, providing business broker and investment banking services to owners in the sale of information technology, software, and other technology based companies. Dave is also the editor of the Exit Strategist Newsletter and author of the Book Selling your Software Company - An Insider's Guide to Achieving Strategic Value

Monday, March 19, 2018

BizCast Video Announcing our New Approach to the Unsolicited Offer

We are really excited that BizCast interviewed us about our new product offering for Business Owners that have been approached by a buyer with an unsolicited offer. Please check out the brief interview.

BizCast Interview with MidMarket Capital President Dave Kauppi

Dave Kauppi is a Merger and Acquisition Advisor and President of MidMarket Capital, providing business broker and investment banking services to owners in the sale of information technology, software, and other technology based companies. Dave is also the editor of the Exit Strategist Newsletter and author of the Book Selling your Software Company - An Insider's Guide to Achieving Strategic Value

Saturday, March 10, 2018

Announcing Letter of Intent Consulting - an M&A Service Offering from MidMarket Capital

Since publishing our Book, Selling your Software Company - An Insider's Guide to Achieving Strategic Value Click Here For Our New Book on Amazon our volume of inbound inquiries has more than doubled. What has surprised us is the number of calls we are receiving where the business owner either has a Letter of Intent (LOI) or is about to receive a letter of intent from the buyer.  Their emotions go from giddy anticipation to anxiety as they look at a document that is complex and technical and contains several terms that the business owner is not familiar with. Such thoughts as, "Am I getting a fair deal?"  What is a subordinated seller note?  What does a cash free, debt free transaction mean? How is a net working capital surplus calculated and what are the implications for what I receive at closing. What are all of these reps and warranties? Is a non-compete standard procedure? 

Mistakes in negotiating this very important document can cause the seller to lose $ hundreds of thousands, to $millions depending on the size of the transaction. The other result is that after three months of grueling due diligence, the buyer interprets loose wording in the LOI, intentionally in their favor, and then calls in their very expensive CPA firm and Law Firm to support their claim. The business owner faces a big haircut as these interpretations are captured in the purchase agreement. What very often happens, however, is the owner walks away from the deal. This is a big loss for everybody.

Our hourly consulting service is based on 20 years of experience in negotiating deals with the toughest buyers in the world, Private Equity Buyers. We help to balance the deal experience scale between the buyer's team and the seller's team. Our approach is to negotiate the LOI so that there are no unexpected surprises or haircuts at the end of due diligence. We incorporate very specific wording with formulas and examples that cannot be interpreted in the buyer's favor no matter what big 5 accounting firm or major law firm they bring in. This results in the terms and conditions negotiated in the Letter of Intent become the terms and conditions translated into the purchase agreement. We help get good deals across the finish line.

If this sounds familiar to your situation, please email me at, or call me at my direct office number (630) 325-0123 or on my cell at (630) 215-3994 

Dave Kauppi is a Merger and Acquisition Advisor and President of MidMarket Capital, providing business broker and investment banking services to owners in the sale of information technology, software, and other technology based companies. Dave is also the editor of the Exit Strategist Newsletter and author of the Book Selling your Software Company - An Insider's Guide to Achieving Strategic Value

Monday, January 29, 2018

Traditional Valuation Techniques May not Apply for an Information Technology Company

Our latest article published in Divestopedia

Takeaway: Learn why more traditional valuation methods may not be the best for your IT company.

Business valuations of software companies use proven methodologies to arrive at an indication of value. If the technology is one in demand, however, the valuations provided by the markets can be off the charts. This article discusses how the pros value software companies and the limitations to their approach.

The Influence of High-Profile Tech Deals

Software company owners looking to sell their companies are often inspired to start the process after reading about the latest high profile, stratospheric acquisition price paid by a large tech bell weather company. The transaction metrics (i.e., transaction value to sales or transaction value to EBIT) sometimes defy all logic.

The new, would-be seller applies these metrics to his company's sales and EBIT and determines that IBM, Microsoft, Google, Oracle, Cisco, etc. should be ready to get into a bidding war over his $5 million in revenue, game changing, best-in-breed software company for a value of 8X revenue.
Let's break down the methodology that professional business valuation firms use as their standard in arriving at a company's indicated value. Their approach calls for a triangulation of three valuation methodologies.

Public Company Comps

The first is a comparison to publicly traded companies in the same category. It is very interesting to look at the lists that the valuators come up with. Technically they are all software companies with SIC Code 5734-01, but they are as alike as apples, coconuts, watermelons and blueberries. True, they are all fruit; but that is where the similarity ends.
Next, they take the valuation metrics of these publicly traded companies. The most commonly used are sales to enterprise value and EBIT to enterprise value. Next they come up with the median value (one half of the companies are above the value and one half are below). They then apply what is best described as an arbitrary discount factor to account for the value differential between public companies and small, closely-held companies. They come up with their adjusted metrics then apply them to the target company and voila: you have one of the valuation legs completed.

Completed Private Company Transactions

The valuation analyst next applies the same approach to actual completed transactions. If the buyer was a public company, then the metrics are publicly available. If the transaction is between two privately held companies, the metrics are only available on a voluntary basis. Maybe 10% of these participants release information about these transactions. These unreported deals are probably the best fit in terms of comparables, unfortunately.
In order to get a meaningful number of transactions, the analyst often is forced to use transactions from a 5-10 year period. Do you know how to say tech bubble or tech meltdown? This is not a simple process.

The Old Reliable — Discounted Cash Flow

Wait, maybe we can add some much-needed precision with the third valuation technique, the discounted cash flow method. First, calculate a risk-adjusted discount rate. After three pages of explanation, you'll usually arrive at a discount rate of between 24–30%. Next, project the after-tax cash flow for the next five years and discount it to present value.
They then calculate the terminal value of the company (five years of year five cash flow discounted by the risk-adjusted rate less the projected growth rate). They discount that number to present value and add that to the discounted cash flow to create the third leg of the valuation stool.
How many software companies are not projecting hockey stick growth during the valuation period in question? Not only are these projections very aggressive, but cash flow margins are projected to improve by a factor of three times during this same period.

The Seller's Research Helps Set Valuation Expectations

Now our seller is armed and dangerous with his company's value. That becomes his minimal acceptable offer and it must all be in cash at closing. To use a Wall Street saying, this company is priced for perfection. We often discover during a sell-side engagement that these projections are not just missed, but they are missed by a large margin. In spite of this, the seller's valuation expectations remain the same.
All is not lost, however. One of the unique aspects of selling a software company is that if the technology is fresh (think SaaS, mobile apps, virtualization, cloud computing), financial multiples are often not the driving force in the buyer's valuation equation.

For Some Tech Companies, the Market Exceeds Expectations

One thing that we have learned in the representation of software companies for sale is that the value is subject to broad interpretation by the market. We find that strategic buyers in this space are driven by such considerations as first mover advantagetime to market, development costs, customer acquisition costs, customer defections and enhancing an existing product suite.
The better the target company addresses these issues, the greater the post acquisition value creation potential. If the right buyer is located and recognizes the seller's potential when integrated with the new owner's distribution channel and customer base, we may find an even bigger hockey stick then our very optimistic sellers. If two or three buyers recognize a similar dynamic, then the valuations can become very exciting.

Dave Kauppi is a Merger and Acquisition Advisor and President of MidMarket Capital, providing business broker and investment banking services to owners in the sale of information technology, software, and other technology based companies. Dave is also the editor of the Exit Strategist Newsletter and author of the Book Selling your Software Company - An Insider's Guide to Achieving Strategic Value