Should I Sell My Business?
Your rollup post was timely. We just received an acquisition offer. We have some other projects we think are higher value and this product is fairly steady state with some minor upgrades, which is why we are even considering the deal. What factors should we consider in deciding whether to take it? Numbers and term sheet attached.
This is a terrible deal. I will summarize the key facts from the attached documents:
- The company last year had annual recurring (subscription) revenue of $1.1 million (doubled from the year before), projected to go to $1.8 million this year and $2.7 million next year. The company has negative churn, in that cancellation losses are more than offset by revenue from users upgrading to premium services.
- The company has two shareholders who own 50% each and no investors to repay.
- The total costs to operate the business are approximately $700,000 a year and the owners distributed $400,000 last year. Costs are not projected to increase and may in fact go down given lower development costs.
- The acquisition offer is $7 million, payable as follows: $1 million now with a $250,000 holdback of two years. The balance is split $2.5 million and $3.5 million each of the next two years if the business achieves 160% of the revenue targets. If the business merely achieves current projections, the payouts will be $1.25 million and $1.75 million, for a total purchase price of $4,000,000, minus retained holdback.
- The founders will be required to work for two years for the acquirer or forfeit the additional payments.
- The acquirer has no particular advantage in sales or technology to add to the products or sales efforts. It is primarily buying the cashflow.
There are a number of factors to consider here.
First, what is the company fairly worth? I do not know the valuation multiples in your space, but a generic software subscription business with your growth rates and stable cost structure should at least be commanding a 10-15x multiple of revenue, and probably higher because of your gaudy profit numbers. A strategic buyer with serious sales and marketing muscle might even pay a large premium. You have created a serious ATM machine if you can maintain it.
Second, what are you really being offered? You are being hired to work for the buyer in exchange for an upfront payment and future payments derived upon your own revenue (one of the great things about a rollup strategy from the buyer’s side!)
Economically, it is misleading to call it a $7 million deal. It is really a $4 million deal, minus up to $250,000, as holdbacks are almost never paid back in full — assume maybe you see at most half of the holdback returned. Then you have the potential to earn $3 million more based upon sales increases beyond your projections. Understand that you have no control over revenue targets. What if the buyer bundles your products for “free” with its other products, depriving you of the extra revenue? What if they fail to put any extra marketing or sales efforts into the process? You no longer control the company.
Third, what does the world look like if you do nothing except what you are doing? You are projected to distribute approximately $3.1 million the next two years (and somewhere between $5-$5.5 million if you hit the highest earnout targets). These numbers are less than what you are being offered, but if you do not sell you get to keep the business and the recurring revenue stream. You have, in effect, an annual annuity so long as you maintain the business.
In other words, the buyer is mostly just giving you the money you would have earned otherwise and then taking your annuity for itself at the end.
Sometimes the ability to step back and establish financial independence or turn to other projects are compelling reasons to sell at a lower price, especially if you think your revenue will erode over time. The offered amounts will not give you retirement money and you will be working the next two years anyway, as it is required for the earnout. Plus, you are not getting the money now. You are getting your own generated future revenue in the future, so you are not receiving any benefit from having the funds now, which is often a reason to sell.
What are your options? If you definitely want to sell, create a competitive controlled auction process. We will cover how to do that in the future classes on acquisitions. I might suggest you groom suitors throughout the year and begin the formal process next year early, after you close a year with over $1 million in profit. I would also invest in serious additional marketing, as every extra sale now is effectively 100% margin and will drive your multiples and final sales price higher.
But I have a better idea: why not transition the business to professionalized management while you and your co-founder step back to pursue your other ideas? Wean the business from your daily involvement. The test for success is simple: if you are both hit by buses, would the business survive? Even if you overpay for competent management (as you should), you will have stable and increasing cashflow for years to come and the free time for other projects. Selling to this buyer will not help you accomplish your other goals, as you will be locked up by the buyer for two years, which both takes your working time and may also contaminate intellectual property ownership for the new businesses.
If you need significant capital to finance the other higher value businesses, borrow against your future cash flow in this business then pay it back over 4-6 years. You will get a lump sum today and will still own your business, and the annuity, in the end. Think of it as rolling up your own business by buying your own cash flow through low interest debt.