- July 30, 2023
- Posted by: CBGabriel
- Category: Business
In a recent survey conducted by Consumer Reports, it was revealed that among home buyers, an “updated/modern kitchen” continues to reign as the most desirable feature in an ideal home. Similarly, for tech, software, and online business shoppers, recurring revenue stands out as the most appealing incentive.
Just as various actions can be taken to enhance the value of a house, such as finishing a basement or repainting high-traffic areas, there are strategic steps you can implement to boost the value of your tech, software, or online business. These strategic steps are commonly referred to as “value drivers.”
In this article, we will delve into the theory and significance of value drivers, while outlining the key drivers that can significantly influence the value of your tech, software, SaaS, or online business. Moreover, we will provide you with specific actionable measures to enhance the value of your business.
So, what are you waiting for? Let’s unlock the full potential of your enterprise!
Unleashing the Power of Value Drivers: A Gateway to Enhanced Business Value
When it comes to maximizing the worth of your tech, software, and online business before a sale, understanding and optimizing the value drivers take center stage.
So, What Exactly is a Value Driver?
In simple terms, a value driver is a strategic action that has the potential to significantly enhance the value of your business.
For instance, recurring revenue emerges as the pinnacle value driver for technology, software, and online enterprises. Armed with this knowledge, you can channel your efforts into fortifying this key driver of value.
Where Value Drivers Converge: The Tech & Software Connection
Value drivers often intertwine, exerting a positive influence on various aspects of your business.
Consider this: elevating recurring revenue can reverberate across multiple value drivers. Likewise, augmenting the LTV (lifetime value) of your customers can dynamically reshape your business assumptions, ultimately impacting multiple value drivers in sync.
Why Prioritization is Crucial in Value Optimization
The value of your business may vary in the eyes of different buyers, with each attaching varying importance to specific value drivers.
In this realm, the counsel of an experienced M&A advisor proves indispensable. Their expertise helps pinpoint the most promising value drivers, poised to yield superior returns with minimized risks.
As you explore the value drivers enumerated below, bear in mind that the landscape is not rigid; overlaps can exist within and across these drivers. Nevertheless, delving into the realm of potential value drivers remains a pivotal stride towards catapulting the overall value of your business.
Unlocking the Spectrum of Business Values
When it comes to the value of your business, there is no one-size-fits-all approach. The valuation can vary significantly based on the type of buyer involved:
Financial buyers adhere to valuing a company using its Fair Market Value (FMV), typically by considering a multiple of the company’s earnings (EBITDA). However, they may see strategic value potential in their portfolio companies.
On the other hand, strategic buyers are more inclined to offer a higher price, factoring in the strategic value. Their willingness to pay hinges on the potential synergies that the combined entities can achieve, along with your negotiation to receive a share of those synergies.
The divergence between the prices set by financial and strategic buyers can be substantial. Each buyer interprets your value drivers differently, whether individually or collectively, leading to subjective valuations that vary from buyer to buyer.
For large businesses with exponential technology or those possessing products that a buyer can leverage—like IBM rolling out a product through its national salesforce—the potential value range can be broad. Nevertheless, there exists a common set of value drivers that hold paramount importance for most buyers within a specific industry.
At the heart of it all lies the knowledge that your business holds a spectrum of possible values, and navigating this landscape with confidence can unlock remarkable opportunities.
A Note on General Preparedness for Technology Businesses
Achieving Unwavering Preparedness: A Key to Success
Before we embark on exploring the value drivers, let me stress the utmost importance of being confidently prepared. The message may be straightforward, but its significance cannot be overstated.
Maintain a state of readiness to sell at any given moment. Allow me to reiterate: Be ready to sell at all times. And to drive the point home — be ready to sell . . . at all times.
In the dynamic tech industry, unsolicited offers are a norm. Hence, perpetual preparedness is your best defense.
Picture woking up on a Monday morning to find an email from a competitor expressing keen interest in a ‘potential strategic relationship.’ Such spontaneous approaches leave little room for crafting a strategic response.
Every word you choose will be dissected by your competitor. Even the slightest hint of vulnerability could cost you millions in potential transaction value.
Consider the case of a former client who received such an invitation from a much larger, well-capitalized rival — a dominant industry player, backed by a PE-firm on an acquisition spree.
Regrettably, our client’s overly eager response may have been perceived by the potential acquirer as a sign of desperation. This misstep could have resulted in a substantial financial setback. However, through a series of skillful calls, we managed to reverse the situation.
During these conversations, we confidently reaffirmed our strategic position and outlined alternative options our client was exploring, such as joint ventures and fundraising. Preparedness is the shield against such pitfalls, and lack of it is perhaps one of the major reasons why businesses miss opportunities to sell.
While my emphasis on preparedness aligns with the execution of your company’s value drivers, as outlined below, it deserves special attention. Therefore, let me succinctly highlight the key elements of preparedness:
Financials: Your financials should radiate impeccable accuracy. Engage a different CPA firm (not the one handling your routine books) to independently review your financials, ensuring they meet the stringent due diligence standards of potential buyers.
Documentation: Comprehensive documentation is a must for all aspects of your business, including legal, operational, human resources, and beyond.
Management: Foster a management team capable of independently running the business and bind them with robust employment, confidentiality, non-solicitation, and invention assignment contracts.
Staff: Implement retention plans for vital employees and address any issues arising from employee concentration.
Business Plan: Create a compelling business plan with well-documented key assumptions and showcase metrics on a positive upward trajectory.
Contracted Revenue: Validate that your contracted revenue can seamlessly transfer to a new buyer. Engage an attorney to review customer contracts, ensuring their assignability in the event of an acquisition.
While your company’s value drivers aid in preparing you for various scenarios, there is always a possibility of overlooking an aspect of preparedness that may not be directly addressed by those drivers. For this reason, seeking guidance from an M&A advisor to review your company and conduct pre-sale due diligence is a prudent step.
Ensuring that all facets of your business are finely tuned before entering the market will ultimately empower you to extract maximum value from your company, regardless of when the sale occurs or whether it’s the result of a carefully strategized plan or an unsolicited offer from a competitor.
Now, let’s delve into the top five value drivers that can impact the value of your company.
Value Driver #1: Unleash the Power of Recurring Revenue
In the realm of software and tech businesses, there’s one value driver that reigns supreme – recurring revenue. Contractually secured, recurring revenue holds an elevated position, surpassing the value generated from new sales. As a result, buyers are more than willing to invest substantially in a business that boasts a steady stream of recurring revenue.
Take a look at some prime examples of companies basking in the realm of recurring revenue:
- Netflix – Thrives on monthly subscription fees.
- Spotify – Flourishes with its monthly subscription model.
- Apple – Rakes in recurring subscription fees through Apple Music, iCloud, and more.
- Accounting Software – Flourishes with subscription fees from users of QuickBooks, Xero, and others.
- Web Hosting – Booms with subscription fees from loyal clients of GoDaddy, Bluehost, and similar services.
- Microsoft – Soars high with recurring subscription fees from Office 365 and more.
Now, contrast these with companies that lack the advantage of recurring revenue, such as Uber, Lyft, and Airbnb.
It’s essential to distinguish between recurring and repeat revenue. While repeat revenue is undoubtedly valuable, it can be somewhat unpredictable as an income source.
On the other hand, recurring revenue, automatically debited from users’ credit or debit cards on a regular schedule, offers stability and predictability. This model is evident in various services, like cell phone bills, gym memberships, and popular platforms like Netflix and Spotify.
Recurring revenue not only boasts predictability but also contributes to a higher customer lifetime value (LTV) compared to non-recurring revenue. The higher the LTV, the more a company can invest in customer acquisition cost (CAC), paving the way for a more scalable business.
While focusing on bolstering recurring revenue is crucial, never overlook the significance of customer retention. High attrition, which signifies low retention or excessive customer churn, can hinder your business’s scaling potential. Poor retention can stem from various issues, including product features and overall user experience.
Before you scale your business, patch any leaks in your metrics, and ensure your retention game is strong. Perfect your value proposition before taking on the scaling challenge. Confidence in your foundations is the key to confident scaling.
In the eyes of acquirers, recurring revenue shines with confidence, unlike forecasted revenue based on new product sales, which often faces heavy skepticism and discounts. The allure of contracted recurring revenue lies in its stability, shielding the business from potential risks.
Acquiring businesses without contracted revenue can be a risky proposition. Owners might depart, taking their valuable relationships with them, or customers may flee during the transition phase, unsettled by the uncertainties that accompany an acquisition. Hence, contractually recurring revenue stands tall as the gold standard for any astute buyer.
The B2B landscape echoes a similar sentiment, as uncertainty can cast a shadow on potential sales in the pipeline. In contrast, contracts foster customer retention, offering ample time for the acquirer to build trust and solidify relationships post-closing. As a result, businesses boasting contractually recurring revenue command higher multiples, elevating their appeal in the eyes of potential acquirers.
With certainty and confidence woven into the fabric of recurring revenue, it emerges as a strategic advantage that promises stability and growth, a cornerstone of successful business acquisitions.
Strategies for Enhancing Recurring Revenue
Optimize Pricing: Assess the elasticity of your pricing method. A price increase has a direct impact on the bottom line, considering direct costs such as sales commissions. Boosting profitability can significantly enhance the overall value of your business. Let’s explore an example illustrating the potential effects of a 10% price increase:
Before Price Increase:
- $10 Million in Revenue
- $2 Million in EBITDA
- 5.0 Multiple
- Valuation: $2 Million EBITDA x 5.0 = $10 Million
After Price Increase:
- $10 Million x 10% Price Increase = $1 Million in additional Revenue & EBITDA
- $11 Million in Revenue
- $3 Million in EBITDA
- 5.0 Multiple
- Valuation: $3 Million EBITDA x 5.0 = $15 Million
In this case, a 10% price increase resulted in a 50%, or $5 million increase, in the value of the company.
- Offer Maintenance Contracts: Convert customers to annual or long-term contracts. Increase pricing and grandfather legacy customers into existing pricing with long-term commitments.
- Create Add-On Modules: Provide discounted prices for add-on modules and inform customers about upcoming price changes. Offer grandfathering into previous pricing with a contract commitment.
- Implement Sales Incentives: Reward salespeople based on revenue types, prioritizing contractually recurring revenue over one-time transactions.
- Track Vital Metrics: Create a dashboard with key metrics like customer retention, churn rate, LTV, CAC, months to recover CAC, customer engagement, and leads by lifecycle. Swiftly spot funnel leaks and take corrective action.
- Enhance Retention: Elevate customer retention through product improvements.
Bonus Tip: Read “The Lean Startup” and shortcut the feedback loop. Employ weekly sprints with your team to create incremental or dramatic changes using minimal viable products (MVPs). Gather early customer feedback and iterate for a solid value proposition. Scale confidently once achieved.
Value Driver #2: Document Comparable Transactions
Comparing your business to industry giants like Amazon, Facebook, or Google may seem unrealistic unless your company is valued in the same league. Focus on relevant comparisons within your industry, considering companies of similar size and market potential to your own.
Finding comparable transactions can be challenging, especially for small and tech companies. Parties involved in the sale often keep price and terms confidential to avoid potential implications on future acquisitions.
Reporting transaction data is not mandatory for privately held companies, and even public companies disclose acquisitions only if they are deemed ‘material’ based on certain thresholds.
For tech companies in the lower middle market, billion-dollar transactions may not be relevant, and comparable transactions must be similar in size to the target for meaningful insights.
While transaction databases exist, the information is limited and may not include identifying details, making it less valuable for buyers.
In summary, documenting relevant comparable transactions is crucial for informed negotiations and ensuring a realistic valuation for your business.
Tips for Documenting Comparable Transactions:
- Obtain Information Directly from Industry Sources: Your strongest approach is to directly gather information from within your industry. Having detailed transaction data strengthens your case, and information from reputable publications adds credibility. Note that sellers and advisors are more likely to share information than buyers, who prefer to keep it private to avoid potential implications.
- Use Google Alerts: Set up Google Alerts with relevant keywords like industry terms, size categories, and acquisition-related phrases to receive timely notifications on industry acquisitions.
- Attend Industry Events: Network at industry events and connect with influential individuals who might have insights into recent acquisitions.
- Engage in Meetup Groups: Participate in tech-related meetup groups to form new connections that could lead to valuable transaction information.
- Connect with Professionals: Network with angel investors, attorneys, accountants, investment bankers, M&A advisors, private equity firms, and other professionals who can provide transaction insights. Consider compensating professionals for their time and expertise.
By following these straightforward strategies, you can gather comprehensive data on comparable transactions, enhancing your understanding of the market and strengthening your negotiation position.
Value Driver #3: Prepare a Buyer List
Creating a buyer list is a highly valuable yet time-efficient activity. Simply set up a spreadsheet with potential buyers who may be interested in acquiring your company. Sources like industry directories, publications, and events can aid in compiling this list.
Importance of a Buyer List:
When you enlist an investment banker or M&A advisor to sell your company, one of their initial tasks is to prepare a list of potential acquirers. Ideally, this list should consist of 50-200 potential buyers.
Maximizing Your Price:
Having a comprehensive list of buyers is essential to maximize your company’s value. Many business owners struggle to identify suitable acquirers, leading to limited options and reduced leverage during negotiations.
Conducting a Private Auction:
To achieve the best price for your company, a private auction is often employed. For this, a list of 100-200 buyers becomes crucial to initiate multiple conversations and generate competitive bidding through letters of intent.
Through this strategic approach, you can drive up the price and maintain a strong negotiating position, avoiding vulnerability during due diligence. A well-prepared buyer list significantly impacts the success of the sale process.
Achieve Better Results with a Substantial Buyer List
In the process of selling your business, maximizing your chances of success is crucial due to the many potential challenges. For most companies, having a list of at least 50 well-targeted buyers is essential, with 100-150 being even better.
Targeted Buyers for a Good Fit
A sizable list is important, but equally crucial is ensuring that the buyers on the list are well-targeted. They should align with your company in terms of size, services, and acquisition potential.
The Right Size Matters
The ideal buyer should be larger than your company but not excessively so. Ideally, their revenue should be at least five times that of your company. For instance, if your company generates $10 million annually, the buyer’s revenue should be at least $50 million per year. A buyer too similar in size may be overly risk-averse, making the transaction less attractive to them. Larger buyers, on the other hand, are more likely to find the transaction less risky and act more decisively.
Consider the Risk Factor
The ownership concentration of the buyer matters as well. Imagining yourself as a buyer for a company of similar size allows you to understand the risk involved. Lowering the check amount makes you more open to risk-taking.
Diversify Your Options
Avoid being exclusively tied to one buyer, especially if they are the sole owner of a similar-sized company. This situation may lead to challenges in negotiations and could impact the price. Diversifying your buyer list with appropriately-sized companies helps you attain the highest possible price for your business.
When considering the size of an acquisition, there’s no one-size-fits-all magic number. However, it’s essential for the acquisition to have a meaningful impact on the buyer’s business. If your company generates $1 million in revenue, approaching companies with $500 million in revenue might not be the best fit, though exceptions like Facebook’s acquisition of Instagram do exist.
Acquiring a business, whether it’s worth $1 million or $500 million, demands a significant investment of time, energy, and resources. As a result, most buyers tend to focus on acquisitions that are 5% to 20% of their own company’s size. If the acquisition won’t significantly influence their business, it’s less likely to be considered. While exceptions can occur, relying on exceptions for a critical transaction like this is not advisable.
The same principle generally applies to technology companies. Acquirers, be they strategic or financial buyers like private equity groups, often seek customer validation in the form of revenue. If a business lacks sufficient revenue, the buyer may perceive it as too risky for acquisition.
Financial Buyers: A Similar Perspective
This truth extends to financial buyers, including private equity groups. These groups operate several funds concurrently, with each fund having a lifespan of around ten years. While the timing may vary, launching a new fund every two to three years is not uncommon.
Capturing Contact Information: Unlocking Your Business Potential
In the realm of larger companies, the surefire approach to seize the attention of a potential acquirer is by directly engaging the manager of a division that stands to benefit from a product complementary to yours. This esteemed individual is what we proudly call an ‘internal champion.’
But hold on, it’s not just about the company being motivated to seal the deal; it’s equally vital that the key players involved in the transaction share that same drive. That’s why, when crafting your list of potential buyers, it’s essential to include the names and contact information of decision-makers within these companies. These are the individuals with the power to drive the deal forward and personally gain from its success.
Now, let’s delve into the intriguing aspect of how the buyer list can impact your business’s value.
The Power of Strategic Value
First things first, let’s be clear: the ‘Fair Market Value‘ (FMV) of your business remains unaffected by the buyer list. However, where things get fascinating is in the realm of strategic value.
Picture this: if you own a software company, who do you think would be willing to pay a premium for your venture? Is it another software giant that boasts a $200 million yearly revenue, has garnered seven rounds of venture capital financing, and envisions harnessing your technology to enhance their existing suite of products? Or is it merely Bob the Builder?
Indeed, the potential value of your company varies considerably based on the identity of the buyer. That’s why evaluating the most likely acquirer and their driving motivations is paramount. If a financial buyer is on the horizon, the value prediction becomes more accurate. However, when strategic value comes into play, the potential value range becomes wonderfully diverse. Let’s note here that unless the financial buyer owns a portfolio company in your industry, there’s no need to include them in your list.
Understanding Acquisition Dynamics
As we navigate through this captivating journey, we must also consider the acquisition appetite and track record of the potential buyers on your list. How many successful acquisitions have they made in the past? Are there any available insights into the prices they paid for these ventures? Additionally, gaining insights into the frequency of acquisitions in your industry is a smart move.
The Ideal Buyer: A Master of Deals
To secure the brightest future for your company, it’s crucial to seek an ideal buyer. One who possesses a proven track record of acquiring multiple companies and, most importantly, has the capacity to turn discussions into fruitful transactions. A buyer’s ability to execute deals is a game-changer. Choosing a buyer with no prior experience in acquiring companies poses inherent risks and diminishes the likelihood of a successful outcome.
So, let’s put these tips into action as you document comparable transactions:
- Prepare a spreadsheet with two tabs: one for potential buyers and another for potential sources of buyers. The buyer list should encompass essential details such as the company name, contact name, website, contact information, number of employees, revenue, completed acquisitions, and potential synergies.
- Aim to have a robust list of at least 50 buyers, with an ideal goal of 200 potential suitors.
- Focus on companies that are 5-20 times the size of your own, as they are prime candidates for fruitful collaborations.
- Ensure that the companies on your list offer products or services that beautifully complement your own, creating a perfect synergy.
- Take note of any recent acquisitions made by the company, jotting down relevant details like the company’s name, size, and other pertinent information.
With these insights at your disposal, you’re well-equipped to embark on a confident journey towards unlocking the true potential of your business. So, let’s seize the day and pave the way for a future that exceeds all expectations!
Value Driver #4: Increase Total Revenue & EBITDA
When it comes to enhancing the value of your company, there’s one paramount factor that stands above the rest: boosting your total revenue and, even more crucially, your EBITDA. Now, you might wonder how this differs from Value Driver #1, which emphasizes increasing recurring revenue. The key distinction lies in the effort and resources required. While ramping up total revenue and EBITDA demands substantial time, energy, and investment, increasing recurring revenue offers the quickest impact on your bottom line.
Once you’ve examined these options, it’s time to explore the other value drivers and strategize your next moves. Prioritizing these drivers is best achieved by considering the potential return and risk, as well as the time and investment needed for their implementation. In essence, this calls for employing the RVD Model to make informed decisions.
Let’s delve into some of the essential aspects that drive value for your company:
Revenue and Recurring Revenue:
As we explored in Value Driver #1, the baseline value for most software companies’ contractually recurring revenue is set at an impressive 200%. In simple terms, if your company generates $2 million in contractually recurring revenue, most potential buyers will be inclined to offer a baseline value of $4 million as the starting point for negotiations.
One of the most straightforward ways to boost your EBITDA is by raising prices. Every incremental increase in price (minus any direct costs like sales commissions) directly contributes to elevating your EBITDA.
For instance, if your business presently generates $10 million in revenue and $2 million in EBITDA, and it’s valued at a multiple of 5.0 (totaling $10 million), a 10% price hike would elevate your EBITDA to $3 million, effectively raising the value of your business to $15 million ($3 million EBITDA x 5.0 = $15 million). Thus, a mere 10% price increase can result in a substantial 50% ($5 million) surge in your company’s value.
In the realm of valuing tech companies, acquirers often establish a baseline value based on a multiple of EBITDA. EBITDA serves as the crucial starting point for negotiations, especially in the middle market. In most industries, EBITDA multiples tend to follow fairly predictable patterns, with acquirers rarely straying from prevailing industry norms.
For example, if your company generates $3 million in EBITDA, it’s reasonable to expect most potential buyers to value your business within a range of 4.0 to 6.0 times your EBITDA, equating to a valuation of $12 million to $18 million.
By confidently leveraging these value drivers and understanding their implications, you’re well-equipped to unlock the true potential of your company and embark on a journey of unprecedented growth and success. Let’s set the wheels in motion and watch your company’s value soar to new heights!
Determining Your Position in the Value Range
The process is quite straightforward. Buyers take into account factors beyond EBITDA to assess where you stand in the range. Initially, nearly every buyer establishes a baseline value by applying a multiple to your EBITDA. From there, they adjust the price within the range (typically 4.0 to 6.0 multiple) based on various other considerations. Essentially, the higher your EBITDA, the higher the baseline value of your company.
Let’s explore the impact of increasing your EBITDA by 50% (from $2 million to $3 million). Such an increase will also elevate the value of your company by 50%, ranging from $12 million to $18 million (based on a 4.0 to 6.0 multiple). This translates to not just an additional $1 million in your pocket annually but also an extra $4 million to $6 million at the closing table.
Driving Value by Reducing Expenses
The most effective way to boost your EBITDA is by cutting expenses. Prioritize prudent spending for two to three years leading up to your planned exit. For each dollar you save in expenses, you’ll not only retain that dollar but also gain an additional four to six dollars at the closing table.
For instance, if you trim expenses by $200,000 over two years before the sale, and the sale process takes a year (totaling three years), you’ll put an extra $1.4 million to $1.8 million in your pocket — $200,000 (Year 1) + $200,000 (Year 2) + $200,000 (Year 3) + $800,000 to $1.2 million (Increased Purchase Price).
Calculating ‘Adjusted EBITDA’ with Prudence
Adjusted EBITDA incorporates various adjustments, such as your salary, perks, professional fees, and rent. To maintain a solid position, it’s crucial to be conservative with these adjustments. Buyers may not explicitly raise concerns, but they might discount the purchase price to mitigate potential risks from unverified adjustments. It’s vital to uphold credibility, as aggressive adjustments could increase perceived risk for them.
In such scenarios, buyers might be less inclined to retain you post-closing and may take measures to mitigate their risk, such as negotiating a lower price, conducting more rigorous due diligence, expanding the scope of representations and warranties, increasing holdback amounts, or raising the value of seller notes (subject to the right of offset in case of fraud).
By understanding and implementing these strategies, you can confidently position your company within the value range, ensuring a successful and rewarding journey toward your desired exit.
The Significance of Establishing Credibility
One of your primary objectives should revolve around enhancing your credibility. It is vital to be perceived as possessing robust management acumen, sound judgment, and unwavering ethics. By accomplishing this, you position yourself to secure a more lucrative post-closing salary if the buyers decide to retain you, and you also reduce the need for purchase-price mechanisms aimed at mitigating their perceived risks.
Minimizing Adjustments for Maximum Impact
Now, let’s explore how to achieve this goal. The approach is simple — strive to minimize the number of adjustments you make during the two to three years leading up to the sale of your company. Fewer adjustments translate to reduced perceived risk for the potential buyers, increasing the likelihood of selling at a higher multiple of EBITDA. While this may result in some additional tax expenses, the returns in the form of an elevated purchase price can significantly outweigh those costs.
Essential Tips to Elevate Revenue and EBITDA:
- Increase Pricing: Delve into the elasticity of pricing to determine if your business can withstand price adjustments. Experimenting with price increases can prove instrumental in boosting your overall revenue.
- Reduce Expenses: Exercise prudence in cutting unnecessary or discretionary expenses in the two to three years leading up to the sale. Streamlining your expenditure will contribute to bolstering your EBITDA.
- Adjusted EBITDA: When dealing with adjustments to EBITDA, focus on reducing their overall number in the two to three years before the sale. Ensure that any adjustments you do make are well-documented and supported by clear backup documentation.
By adopting these professional strategies, you lay a solid foundation for enhancing your credibility and maximizing the value of your company during the sale process. Your astute approach will undoubtedly position you for success and yield fruitful results in the long run.
Value Driver #5: Strengthen Customer Base & Metrics
Establishing a critical mass of customers holds significant importance for larger companies. It showcases the development of a higher-quality product, thereby reducing the perceived risk for potential acquirers. A broad and diverse customer base enhances the likelihood of a high user experience, especially when retention and engagement metrics are robust for your product.
Embracing Diversity in Adoption Lifecycle
The strength of your customer base directly impacts the purchase price you can command. Aim to cultivate a customer base that comprises not only early adopters but also late adopters. While early adopters contribute to initial progress, relying solely on them may lead to stagnation once their pool is exhausted. Strive to strike a balance between early adopters, the early majority, the late majority, and a select few laggards.
While smaller innovative companies may initially cater primarily to early adopters and the early majority, pursuing diversity in your customer base yields substantial benefits. A diverse adoption lifecycle signals to potential buyers that you have gained strong traction with your customers and have successfully aligned your product to meet their needs.
The Value of Blue Chip Customers
For B2B companies, having relationships with Fortune 500 and blue-chip customers is highly prized by acquirers. Such prestigious clientele indicate the viability of your product in meeting the needs of prominent organizations. Acquirers perceive scaling a business through sales and marketing efforts as less risky than building an engaging product.
National or Fortune 500 customers possess strategic value for certain buyers as these relationships open doors to cross-selling their entire product line to these companies. Furthermore, upselling to existing blue-chip accounts proves easier than acquiring new ones, making them immensely valuable.
Take, for example, Intuit’s acquisition of Credit Karma for $7 billion in 2020. By acquiring Credit Karma, Intuit gained access to Credit Karma’s 100 million registered users, enabling them to cross-market their other products. Upselling to existing customers with established relationships presents a powerful growth opportunity.
In some cases, potential acquirers may seek to acquire your company solely for the existing relationships with well-established customers. These relationships can significantly impact the value of your company, given the high cost of acquiring blue-chip accounts.
By recognizing the significance of achieving critical mass and fostering relationships with blue-chip customers, you elevate the appeal of your company to potential acquirers and set the stage for a successful and lucrative journey forward.
The Significance of Customer Diversity
For potential buyers, customer diversity holds immense importance. Ideally, no single customer should account for more than 3% to 5% of your total revenue. Higher concentration on any one customer raises perceived risks for buyers. However, a robust management team can mitigate these risks. If the customer maintains strong relationships with employees who will remain with the company after the sale, the transition process becomes less susceptible to disruptions.
Mitigating Risks: Pre-Sale Actions and Deal Structure Mechanisms
To address this concern, proactive measures can be taken prior to the sale. Long-term agreements with customers and ‘institutionalizing’ client relationships, by reducing personal connections, are effective risk-reduction strategies.
Additionally, deal structure mechanisms come into play, involving risk assessment through customer surveys and interviews during the due diligence process. Contingent payment mechanisms like earnouts and holdbacks can be designed to mitigate risk in case of customer loss.
Contracts: A Crucial Consideration
Another vital aspect is the assignability or transferability of contracts in the event of a sale. This applies not only to customer contracts but also to third-party contracts such as leases with landlords or vendor agreements. Contracts lacking explicit assignability clauses pose risk factors in asset sales.
While structuring transactions as stock sales is a common solution, some buyers might hesitate due to potential contingent liabilities. Change of control provisions in many third-party contracts necessitate approval for stock sales, posing a challenge. Advanced solutions like ‘reverse-triangular mergers’ are reserved for larger transactions and go beyond the scope of this discussion.
The Power of Long-Term Contracts
An essential concern regarding customer contracts lies in their existence. In many cases, businesses lack formal contracts with customers, granting customers the freedom to come and go at will. Long-term contracts are highly favorable to buyers and serve as significant value drivers. If opting to introduce customer contracts, it’s essential to include a clause addressing assignability.
By confidently understanding and addressing these critical aspects, you elevate the appeal of your company to potential buyers and pave the way for a successful sale process. A thoughtful and strategic approach ensures you maximize the value of your business and create an attractive proposition for prospective acquirers.
The Value of Customer Database
A customer database, like a CRM, holds significant value for buyers for various reasons. One key advantage is the acquirer’s ability to market their products to your existing customer base. As mentioned earlier, upselling to existing customers is more straightforward than acquiring new ones.
A robust CRM empowers the buyer to implement scalable methods for introducing their product suite to your customer base. The more comprehensive the information in your database, the better. Demographics and targeted data enable the acquirer to develop precise, focused campaigns.
Take Credit Karma, for example; Intuit could benefit from knowing which Credit Karma customers own businesses. This knowledge would enable targeted email campaigns, offering those customers a free trial of QuickBooks or other small business solutions. Furthermore, campaigns based on the user’s credit score could be developed, tailoring offers to individual needs.
Customer Acquisition Cost (CAC) & Other Metrics
CAC plays a dual role. A high CAC indicates more valuable customer relationships. For instance, if the industry’s average CAC is $5,000, and you have 1,000 customers, your customer base would be valued at $5 million ($5,000 x 1,000 = $5 million) to replicate its worth without overlapping with theirs.
In cases where there’s a strong product fit between your customer base and the acquirer’s offerings, purchasing your company solely for its customer base could be a prudent investment, especially when time and opportunity costs are critical in your industry.
On the flip side, a high CAC may limit scalability. The scalability of a business is linked to its CAC relative to the lifetime value (LTV) of each customer. The higher the CAC compared to the LTV, the more challenging it becomes to scale the business.
For instance, a business with a CAC of $50 and an LTV of $10,000 is considered highly scalable, while a business with a CAC of $1,000 and an LTV of $2,000 would not be regarded as highly scalable. The ratio between CAC and LTV is what truly matters, not just the absolute numbers.
In summary, a robust customer database is a valuable asset for potential buyers, enabling targeted marketing and offering insights into your customer base’s true worth. Understanding CAC and its implications allows for better evaluation of scalability and potential growth opportunities.
Consideration of Key Factors
In the pursuit of maximizing your company’s value, there are essential factors to take into account. A significant aspect to keep in mind is your cash flow cycle, representing the time it takes for your firm to convert a sale into cash. For most tech companies with short cash flow cycles, scalability is readily achievable. However, if your business model involves online operations, substantial inventory levels, customized products, or extended customer terms, your sales cycle may be lengthy, hindering scalability and necessitating significant working-capital injections for future growth. These factors, in turn, can impact the purchase price.
Taking Charge of Your Metrics
To drive improvement and enhance value, maintain a centralized dashboard of key metrics, and consistently monitor their performance. Keep a close eye on customer acquisition cost, customer retention, lifetime value, and other vital metrics. Through weekly sprints with your deal team, steadily enhance these metrics over time. Maintaining meticulous records in a spreadsheet allows you to incorporate improved metrics into your projections, forming a solid basis for the value of your company, rooted in up-to-date data.
Defending Your Asking Price
Documenting the assumptions behind your projections empowers you to confidently defend your asking price based on your pro forma. Your projections are built on key metrics, and tracking and documenting them provide a robust foundation for your financial forecasts.
Summary of Valuable Tips
To improve your customer base and metrics, consider the following strategies:
- Customer Diversity: Cultivate a diverse customer base spanning various adoption stages of your business.
- Blue Chip Customers: Establish a strong sales infrastructure and team capable of acquiring larger customers.
- Customer Concentration: Mitigate customer concentration by institutionalizing relationships and reducing personal involvement in revenue-generating customer accounts.
- Contracts: Ensure customer contracts are transferable in the event of a sale and offer incentives for long-term contracts.
- Customer Database: Develop a comprehensive customer database with detailed information to enable scalable and targeted campaigns by potential buyers.
- Key Metrics: Utilize a centralized dashboard to monitor key metrics and collaborate with your deal team on projects aimed at continuous improvement.
Mastering the Value Drivers
In the tech, software, and online business domains, comprehending and leveraging value drivers are essential to enhancing your company’s worth. By understanding and effectively utilizing these top value drivers, you can strategically improve your company’s value before entering the market, setting the stage for a successful and lucrative transaction.