Source: David Gardner (Founder of Cofounders Capital), originally published by WRAL TechWire.
Albert Einstein is credited with saying that compounded interest was the greatest invention of the twentieth century. I would like to think that if he were alive today, he might argue that software (SaaS) exit multiples have taken that spot. It still amazes me how these companies with only minimal profitability regularly sell for six to fifteen times their recurring revenue.
That is the good news but what happens to the companies that do not breakout and only achieve low revenue and very slow growth?
The Rule of Thirds
Most early-stage investors know the law of thirds. A third of your investments will be a 100% loss and about a third of them will be your big winners. It is the middle third I would like to discuss today. These are the companies in your portfolio that do not fail but neither do they take off. Some call them the walking dead. As a founder or an investor, you try like hell to figure out what is wrong but after many pivots, a management team change and a couple of recapitalizations, it is just not working and you need to exit it and recoup whatever you can.
Putting On Your M&A Hat
Selling your low-revenue/low-growth portfolio company can be very challenging. Brokers tend to not want to take on these less lucrative opportunities and even if they do, their fees on a small deal can turn your small loss into a much bigger one. If you are the founder, it is time for you to put on your M&A hat and do right by your investors helping them to recoup as much of their capital as possible. If you are the venture capitalist, it is time for you to roll up your sleeves and earn your management fee.
Framing your Pitch
In this situation you obviously do not want to center an acquisition discussion around a multiple of revenue so you will need to focus on the more intangible benefits of your company. Following are a few positioning approaches that may help you achieve this. Every buyer’s situation and goals are different so you initially will not know which of these approaches will resonate the best. Probing questions are your best friend early on in these conversations. Until you understand your acquirer’s metrics, strategy, competitors, problems, and goals, it will be very difficult for you to determine the best positioning to maximize the sale price for your company.
Without a lot of revenue, the focus may be on the value of your technology. In trying to establish a value for your technology, it may be useful to point to the amount of money that went into building it. Startups tend to be super-efficient and they can typically build things faster and for far less money than a large corporation. If the acquirer has already decided that they want to enter your space then it is just a build vs buy decision. IT departments tend to view big internal projects as job security and will often argue to management that they can build your tech quickly and cost effectively. You will need to politely discredit them by pointing out challenges they have not yet thought about. This will give management pause especially when they recall how over budget their last internal project was. You also probably have R&D tax credits that a profitable acquirer could utilize representing real cash savings. Any patents you can point to or trade secrets you can allude to will help bolster your claim that it is almost always cheaper for large acquirers to buy rather than build innovation.
Shortened Time to Market
Another more subtle and often forgotten value proposition that low-revenue companies can offer an acquirer is a faster time-to-market. Even if you fail to win the cheaper-to-buy debate, you can always win the time-to-market debate. Just as nine women cannot have a baby in one month, no matter how big an IT team may be, it still cannot spec, write, and test a product overnight. You will need to punctuate how much profit or market share the acquirer may forfeit waiting for a product to be developed from scratch. You most likely have at least some referenceable customers. These are worth their weight in gold to an acquirer trying to enter a market.
Team and Tribal Knowledge
Just as important as your technology, and often even more so, is your team. If a company wants to enter a market or add a product to their lineup, what you have learned can keep an acquirer from making some big and expensive mistakes. You already know what value props resonate the best with clients and what typical prospect objections will need to be overcome. You have gathered information to formulate an informed product roadmap, possible channel partners, what APIs are most important and how competitors are positioning against your offering. It will take a lot of time for any potential acquirer to gather these learnings and more than likely a lot more money than it cost your startup to figure out.
Do not undervalue your team. Big companies crave the energy, passion and innovation found in startup teams. The value of such people often goes well beyond the monetary value of the technology being discussed.
The main thing to remember is that when you are soft-landing a low-revenue portfolio company you are probably holding a lot more cards than you think. Acquirers may want you to think that your technology is just one more feature in their already feature-rich flagship platform but remember that there is a reason why they are talking to you. Your product feature might be a key differentiator that will empower their sales people to close tens of millions in highly competitive product shootouts. It may enable them to check an RFP box that was costing them dozens of major deals each year. Big companies have a difficult time innovating, attracting true innovators and quickly doing anything. They need you so do not sell short just because your company’s revenue is low.
About BELAY Financial LLC
BELAY Financial LLC (www.belayfinancial.com) provides flexible contract CFO & Controller services to entrepreneurial companies. The firm specializes in cost-effective financial reporting, budgeting & forecasting, implementing controls, complex modeling, valuing businesses, and other financial management. Most of the firm’s clients are growing technology, healthcare, business services, consumer, and industrial companies at various stages of development from start-up to tens of millions in annual revenue. BELAY Financial has a team of more than 45 professionals serving more than 120 companies, and is part of BELAY Solutions, a national firm providing virtual assistants, social media management, and accounting services to small companies.