Business valuation is hardly connected to reality and sales prices can wildly swing depending on whether the industry is growing, if the technology is truly unique or it’s hard to find talent. Sadly, most companies look for a seller out of necessity not out of opportunity and are typically gutted of both valuable items and opportunities by the time they are forced into sell-or-fold. Recently we got a chance to review the offer sheet of one of our competitors as they put themselves on the market and I think it offers a valuable lesson for anyone building a business towards the valuable exit.
The Valuation Math
The key to valuation is knowing that bankers can smell the valuation padding. Mostly because the same guys that advise the seller to manipulate their financials are also unwinding it on the other side for the buyer.
When a company doubles in the last year, after barely breaking even for nearly a decade, all through one or two partners – through which it’s selling stuff at cost – it doesn’t paint a wildly successful company with growth potential, it paints a desperate one on the way out.
If a company is growing while it’s margins are imploding, that is not a growing business. It’s the very definition of churn.
If you look at your revenue/margin year over year and your profit margin is dwindling you either have to make a hard decision to chop off the golden anchor business that’s sinking you or come to terms that the profitless revenues won’t get it done. P.S. This is also a trick companies play on outside investors and banks – though it never works – they make it seem like they are growing where they are literally just giving it away. The excuse is “well, one day we’ll just raise prices” but if that was in the cards company wouldn’t be on sale.
The IP/Tech
Every software company I have ever looked at pretends to be Apple. Just because you run your office on a homebrew firmware on dd-wrt does not make you the next Cisco.
When a company derives most of it’s profits from licensing third party software and solutions.. it has no discernable value towards it’s tech. Maybe over time most hardware will qualify as vintage and will be highly valued on eBay or electronics clubs.. by someone..
If you are sitting on a ton of hardware, licensing, third party solution stacks and integration projects the core value of your company is significantly lower than what you think it is.
The People
Finally, the monkey circus.
“Our people are geniuses and are highly respected in our field.”
Oh yeah? If they were so smart why are they working for you while you’re here trying to sell a box of fleas?
If the later part of that line is true, they have likely been sitting on the fence waiting for a major “buyout” so they can cash out and get the hell out of dodge for a long time. I’m sure they are fantastic but this isn’t Bell Labs with Nobel laureates – and they are itching to get away from this business as bad as you are.
The Client Base
The client base can tell you how the company is really doing.
Did most business come aboard recently? If so, at what profit margin?
Did the company retain any truly long term clients? How big are they and have they been growing?
Most companies, after they get redrawn for sale, make a mistake of scraping their legacy business for new business and in the process get a ton of new clients that aren’t very profitable and will likely switch as fast as humanly possible as soon as a more cost friendly solution came around anyhow.
Further complicating things is that the change in management often opens up the likelyhood that the clients will bolt under new management for something else. When you look at what you are buying and consider raising prices on the existing client base, what are the odds the clients stay on board? If both the price and management shift (and along with it the staff) then anything you added recently might be heading for the exit as well.
The Summary of Despair
People have emotional attachment to the things they built and feel that the value far exceeds what the company is currently worth. So instead of proving that, they are offended when they take it to a third party that has to do the hard work.
When you buy a software business, and an antispam company qualifies as that, you are essentially buying clients and contracts. And when the company is obviously struggling and brings in a lot of money that it’s making slim to nothing on – that’s not an opportunity, that’s a liability waiting to explode. Thinking that such a nightmare is worth millions isn’t even viable from the standpoint of basic arithmetic of just multiplying the profit numbers considering how much of it comes from few large resellers and distributors. Any one of whom can dip at any time.
MSPs need to do the exact opposite of what is “logical” when prepping for a business sale. Money needs to come from a lot of different areas, the staff has to be disposable, the liabilities and debt need to be damn near none and your profit margin needs to be climbing not disappearing.
But then again, if you ran your business like that in the first place you wouldn’t be the one being shopped around.
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