As HostingCon approaches, hosting industry executives are shaping up to meet with industry contacts, possible partners and even a probable buyer of their business. Hosting business valuation is a hot subject at the moment ( this issue of the Buzz mag is focussed on it ) and a business has a large amount of preparation to do before an offer is put on the table. In his show “How to Structure Your Company Now to Sell Later,” Larry Donahue will explain how corporations can build more price into their companies in preparation for that day when it leaves their hands.
An solicitor and Web technologist with over twenty years of expertise, Donahue devotes his time to helping little, hi-tech start ups in the Net and e-commerce sector. Unlike standard web searches that drag their nets across the skin of the sea, deep web searches cast their lines far down, finding online info buried on dynamically generated sites.
Before FatCow, he spent just about 10 years as a technology specialist and Internet solicitor, working with setups as various as GE Capital and the US military. The Buzz : How has the recession and the liquidity crisis modified the way companies make their fusion and purchase decisions? Larry Donahue : I believe there are 2 aspects to this query : What are the valuations and parameters of MA deals during these hard industrial times, and how does today’s recession impact how folks look at MA as a workable exit system.
In my session ( Mon. , 11am to 12pm, Business Development Track ), I’m going to target the latter aspect of that question. I’ve found that many ISP’s and hosting firms have always had a tough time keeping their heads above water. Plenty of the entrepreneurs I chat to, feel like they are on a hamster wheel, and truly haven’t any idea how to get off.
They are facing tougher competition from the local bells and / or the more entrenched state or world players. Many have seen a decline ( or at least reduced expansion ) in signups in this recession, and they look to a potential sale as a method to “get out while they continue to can. The issue, naturally, is that it’s not a great time to sell a business. It’s a buyer’s market out there.
The recession has pushed plenty of debatable corporations over the edge. So, unless you’re disinterested about maxing out your valuation, it’s potentially not a wonderful time to sell. I also see cutbacks in staff, to help trim expenditures. This often leads to compromises in business processes. I inspire companies to actually understand what their strategic strengths are, and to not compromise.
For instance, if your business is truly famous for great consumer service, it’s probably not a smart idea to reduce hours or cut back staff in the purchaser service office. Presuming a company has made price which has sparked interest in buyers,the company might have a bright future. How does a company identify the right time to sell when it is increasingly appealing to keep ownership?
My advice, and something I am going to discuss at the session on Mon. , is to actually maintain a record of those key metrics that immediately correlate to valuation, conduct a pragmatic evaluation of how those key metrics will change over time, and then identify when the right numbers are reached, to get the number you’re attempting to find in an exit.
This should be better explained in an example. First, let’s presume we’ve chatted to a number of brokers and suitors, and have a fair belief that our business can get 1.0x of yearly cash. Note that depending on the business, this is often different. As an example, managed services related companies may look at a multiple of profits.
SaaS based companies appear to be a multiple ( 2x to 8x, often more ) of annual cash. 2nd , let’s think I own half of the business, and that it generated $2M in income in 2008, and I’ve constantly grown the business 100% every year, for the past five years. 3rd , let’s say that we understand our business design, operations, sales and selling, and have each confidence that we will continue our superb growth for the obvious future.
All I must do is add servers, thus I don’t need to procure a new datacenter or anything out of the ordinary. Forth, let’s presume that I love my business, but that I might be ready to stroll off with $10M in my pocket. My half of the business would yield $16M, right? No First, each business usually has some kind of liabilities. You want to take away the liabilities from the final sales cost. Let’s think $2M in liabilities in this example. At half of the equity of the business, I should subtract $1M from the $16M. We’re now down to roughly $12M that I will pocket.
Note that pretty much all scenarios are way more complicated than this, and it’s extraordinarily unusual to find an enterprise that maintains fantastic ( and steady ) expansion traits. Also, do you like those “pay in advance” and / or “yearly plans,” because they help your cash flow? Sadly , they can truly come to haunt you in a sale, because all that money is really a guilt on your books.
The point here is, a real date can be figured out, presuming you know enough of your business metrics, and what the variables are that inspect when thinking about a valuation. Is it safe to say that a company’s worth is approximately 1x yearly revenue? And, what other things impact a company’s value?
LD : Sadly , I’m not the best one to consult on the “going rate” for valuation. My experience is in the general factors, and I usually, always, always talk to the brokers experienced in the particular companies I either run or consult for.
While acknowledging that, 1x of yearly money is what I’m hearing at streetlevel for your everyday, vanilla, run-of-the-mill ISP and hosting company, though there are exceptions for companies with unique business models or striking metrics.
Also, each once-and-a-while a business is the fortunate beneficiary of a strategic purchase ( i.e. A purchase by an entity that is not now in the particular industry, and is purchasing your business to either move into the industry or get your technology ).
These strategic buys are awfully rare, and usually shouldn’t be counted on. Before I touch on some of those, we must not forget the final goal of a successful exit : cash in your pocket. Keep as much equity in your business as possible. Don’t be fast to give up equity for tiny, particularly silent, partners. Property, if you can afford it, frequently makes an incredible difference for successful exits. Capital gains are taxed at a lower rate than standard earnings.
If you’re asked to sacrifice on the money paid for your business, for a long term consulting project or work contract, don’t forget to think about ( 1 ) the differing tax levels, and ( two ) the incontrovertible fact that money paid today is worth a bit more than cash paid to you over a period of time. So, the factors I’ve seen impact valuation fall into many major classes, with specific key metrics beneath every one.
Acquirers of your business wish to see steady, predicted, proved expansion in cash. If valuation relies on profits, you better have a constantly growing EBITDA at least during the last three years, ideally at least 5 years. This includes CAR ( client signup Rate ), churn, signup expansion, ARPU ( Average Cash Per Unit of sales ). Does your brand have a powerful and identifiable meaning in the marketplace? Consider Nordstrom, and what that name means with respect to purchaser service? Do you own key patents or otherwise have troublesome technologies or processes nailed? Does your business do something that is tricky to replicate?
Is the success of your business tied to some superheroes, including yourself? If this is the case what happens to the business when the key workers get loaded on the exit? An acquirer has 2 options : ( 1 ) decrease the price to what they think the business may do, when the key staff leave ; or ( two ) established some type of “golden-handcuffs” to keep those staff around. 1 is far more inexpensive, from an acquirer’s viewpoint, than 2. Glaringly , if you excel at a number of of these, it’ll have a robust result on your final valuation.
These factors should be matched to potential suitors. For instance, if an acquirer is just inquisitive about ditching your brand, and sucking in your accounts into their platform, they can not price a great brand nor value any strategic advantages.
In reality, strategic advantages ( like a top-end offering ) may scale back the price in this suitor’s eyes, as it means they’re going to lose some of your clients in a transition. On the other hand, if a suitor actually appreciates your brand, and wants to enlarge your brand with their technology, they are going to place a much stronger stress on the value of your brand and your key business metrics.
Little web hosting firms are frequently run by tech experts rather than business specialists – what can these firms do to make certain they’re not getting a raw deal when it comes to selling? LD : often, there are 3 stages to selling a business : ( 1 ) building the business years before it is sold, ( two ) pre-sales, and ( three ) talks, due diligence and closing.
My session will often concentrate on 1, which is where a business has years to target growing into a valued asset for a successful exit. My reply relies on the stage : In building the business, keep detailed, consistent and correct financials and key business metrics. If you don’t, a potential acquirer can use it to their advantage.
For instance, suppose you don’t have a correct way to maintain a tally of churn? An procure would be all too pleased to presume a number — a big number. If you sold present certificates, and didn’t keep an eye on your redemptions, an acquirer is all too pleased to presume you’ve got more present certificates out there than you do ( i.e. Imagine you just lately learned the easy way to keep correct track of monthly signups.
An get might need to discount your expansion, since you can’t prove it over the long-term. Besides, if you look messy in the way to manage your business, keep your financials or track your key business metrics, it creates FUD ( Fear, Doubt and Doubt ) for potential acquirers. The natural, and all-too-human disposition would be to devalue such a business.
It also creates nervousness in trusting all of the nice things you are saying about your business. In the presales stage, this is where you’re actively hunting for acquirers. My idea here is to start to find competent illustration. This industry is in possession of some really smart, able and truthful lawyers and brokers. Seek their viewpoints and advocate, and work to form a trusting relationship with somebody that may represent and barter for you, as a sellers agent. In the final stage, it is fundamental to have a competent, experience transactional lawyer and a sellers agent working for you.
They’ve done this before, and will help you thru the method. The “dirty small secret” in selling your business is : The acquirer will produce a term sheet or offer letter for your business. You will enter into a “due diligence” period, and this is where the acquirer has a legitimized interest to ( 1 ) not get burned, and ( two ) discount or devalue sides of your business deemed not desirable or valuable by the acquirer. Competent delegates will help you navigate thru this very difficult period, helping you to appreciate what you must give or stand your ground on.
What should firms do to prepare staff for the potential sale of the business? LD : First, I usually counsel being fair and upfront about an exit. I really like to tell my staff what the time horizon looks like, and what they can expect. 2nd , I’m employed to provide some “skin-in-the-game” for workers, so they can forecast an exit, as opposed view it with fear. If they fear an exit ( real or perceived ), they will work against it.
In a similar fashion , if they could benefit — and understand precisely how it benefits them — they’re going to work to help the business maximise its price, 3rd, I suspect it’s necessary to help staff understand precisely where the business wants to go, and what should be done to maximise worth. I like to provide both a goal and stretch goal. “If the company sells for $10M, it means each option is worth $X.” This helps staff work out precisely how much they can earn in an exit.
For lower-paid support staff, $10k to $20k on an exit is awfully appealing. On the other hand, a high-paid company endorse may need $250k or more, to find an exit appealing.
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