Business Exits: Selling a High-Growth Tech Company

by Neill Whitehead  B.Com., M.B.A., C.A., F.Fin.

 

So you are thinking of selling your fast-growing technology company, what should you do next?

 

If you are the owner of a high-growth tech company, the odds are that you have given more thought to your business exit than most business owners, but the question still remains - how do you sell it for a high valuation?

 

 

 

There are plenty of articles which explain the trade sale or IPO process.  There is also no shortage of people ranging from M&A experts to those with personal transaction experience who will venture an opinion.  Some people will even impress you with their jargon, list of industry contacts and track record of similar sales deals.  However, none of this necessarily translates into a high valuation on exit - which is of course what you will want to happen if you do decide to sell.

 

Part of the problem lies in the way that people have been taught over the years to value businesses.  Accountants and valuers have learned to use techniques such as:

  • Discounted cash flow,
  • Capitalisation of future maintainable earnings, and
  • Net assets.

These methods value a business based on its historic or forecast financials, its net assets or some other established industry multiple.  Whilst these techniques all have a role to play with many businesses, they may not be appropriate to a high-growth technology company for a number of reasons:

  • High-growth companies typically invest heavily in their business (i.e. their products, services, infrastructure or marketing) to create future revenue and grow market share,
  • A buyer is likely to change the management team, use new sales channels or markets and inject funds into the new business, and
  • The buyer may be able to add value to the high growth company, or create synergistic value, by combining it with its other lines of business and this is not reflected in a traditional valuation.

As the owner of a high-growth tech business, you owe it to yourself and your family to extract the maximum value on exit.  To do this, you need to know how it is done - and there is a complete lack of information about the process to follow in the lead-up to a sale.  Let me give you some tips on how to achieve a strategic business exit for high multiples based on my experience of more than 20 years dealing with a range of technology companies.

 

Financial versus Strategic Sale

 

First, you need to understand the difference between a ‘financial’ sale of a business and a ‘strategic’ sale.

 

1. Financial Sale of Business

A financial sale typically involves the buyer and the seller of a business negotiating the purchase/sale based broadly on the financials of a business and its projections.  The most common way to value a technology business and negotiate a transaction is based on a multiple of revenue or profit (typically EBIT, EBITDA or NPAT).  The valuation multiple will take into account comparable sales in the industry, specifics around the business and its growth trajectory.  Understanding this process provides a useful insight into how professional investors make money in such businesses: they buy in at low multiples, make improvements and grow the business then they sell at higher multiples, resulting in a large overall gain.  See chart 1 for an illustration of this.

 

Chart 1. Financial gain

 

If you know what you are doing, this can be a great way to make money.  But it doesn’t necessarily translate into an extremely high valuation on exit.

 

2. Strategic Sale of Business

 

This brings us to strategic transactions, which are can result in the sale of a business for well above what could possibly be justified by a financial buyer.  At its most extreme and in a competitive environment, a strategic sale has absolutely nothing to do with the financials of the selling organisation – it is all about the value of the business to the buyer. For example, the buyer can take the existing product, service or assets and make a lot more money by putting the product or services through the buyer's existing sales channels.  Alternatively, there may be some other compelling reason why the purchased business adds disproportionately to the value of the buyer's enlarged group.  See chart 2 for an illustration of further gains that may be achieved through a strategic sale.

 

Chart 2. Strategic gain

  

Achieving a Strategic Sale

 

So selling your business to a strategic buyer makes a lot of sense and is the Holy Grail in doing a transaction.  It can’t be hard – right?

 

Wrong.  Very few people really understand how to plan for a strategic sale and then achieve it.  Most M&A experts will talk about a strategic sale, but when it boils down to it, very few people will be able to give you a game plan to achieve such a transaction and then execute on it.  It can be a case of "all talk and little action."

 

Let’s consider for a moment the following technology businesses which have achieved extremely high valuations.  These were both young companies yet the sale or investment price had nothing to do with the usual financials of the selling business, so how did they achieve this? 

  • The start-up messaging company WhatsApp had been in business for just over four years and had revenues of US$20m per annum before it was sold to Facebook in 2014 for US$19bn.
  • On a much smaller scale now – Scan was founded in 2011 and made apps to scan QR codes and barcodes.  In 2014, it was acquired by SnapChat for US$54m.

 You probably know or have guessed the answer to this question already – the high valuation is all about the value of the business in the hands of the buyer or that there is something else extremely valuable about the business which you would not normally see in a set of financial statements.

 

Your Game Plan

 

Let’s now bring discussions back to your technology company.  You may not be able to emulate the extremely high valuations in the examples above, but you can at least give yourself a good chance of achieving a strategic sale if you follow the rules we developed when selling PC Tools.  Some of what I am about to say will be obvious, but other bits will not be self-evident, so you really need to pay attention now!

 

1. Allow Enough Time to Exit

 

The first thing you need up your sleeve is time, ideally 12 months or more, because there is potentially a lot of work required to prepare for a strategic sale.

 

2. Undertake the "Buyer Discovery" Process

 

The next task is to identify potential buyers of your business or similar businesses and then flesh out their compelling reasons for purchase.  This is way easier said than done and  it involves a deep understanding of their operations and potential reasons for purchase.  Unfortunately, people turning their mind to this task will often only do so in a cursory way, but this is one way in which they are short-changing themselves. 

 

Ask yourself whether you really have a thorough knowledge of each of the potential purchasers you have identified – their size and the location of their operation, their product range, business strategy, key products and services, decision makers, business gaps and weaknesses.  Failing to fully understand these things could lead to a missed opportunity to create something super-attractive in your business over the coming 12 months in the lead-up to a sale.

 

3. Rank Your List of Potential Buyers

 

Having come up with a list of names, each potential purchaser should be placed into an A, B or C list based on things like:

  • strategic fit,
  • size of operation,
  • capacity to purchase, and
  • acquisition history. 

You should also clearly spell out the top six or more detailed reasons for acquisition by each purchaser, because they will vary from company to company.  You might even find it useful to break this list of potential purchasers down into strategic groups such as industry vertical or type of operation.  Once you have this information, store it somewhere central and regularly update it.  Keep a watching brief on these companies by downloading information, monitoring the media and using tools like Google alerts.

 

If you have done a good job of identifying potential purchasers and their possible reasons for acquisition, then it makes the next task much easier.

 

4. Look at Your Company through the Lens of the Potential Buyers

 

Start with a company in your ‘A’ list and consider the fit between their list of possible reasons for purchase and your business as it stands today.  Put yourself in their shoes – if they were looking at your business now, would they say “They have a great product but I wish it had this extra functionality”, or “If only their development team was located closer to us” or “Wouldn’t it be great if their website did the following…”.  Uncovering this information is easier said than done, but there are ways to find it out.

 

This information feeds into your planning discussions over the coming 12 months and may even lead to changes in sales and marketing activities, product road map, operations, IT systems and procedures, locations and/or staffing.  Notice that I used the word ‘may’ here: you don’t necessarily make all changes identified through this process because some just won’t make sense taking into account everything else that is going on in your business right now.  But if you knew now that one company on your ‘A’ list would be especially interested if your deployed software solution had strong internal messaging capabilities which the buyer could use to cross-sell and up-sell its other products or services or help it to break into another segment of the market, then it is worth considering adding this functionality into your product road map now.

 

5. Get on the Buyer's Radar

 

It’s one thing to expand your business, products or services with potential buyers in mind.  They also need to know about your capabilities as well (because it’s hard to sell a secret).  The trick here is to be on the potential buyer’s radar for at least 12 months out and have some sort of connection with them and there are ways to do this without obviously putting out the ‘For sale’ shingle.  For example, you might: 

  • Arrange to be at the same industry conference and mention in private discussions or explain as a speaker some new development you have implemented which is sadly lacking in the potential buyer’s own business. 
  • Issue a press release which highlights something you have built and draws attention to unnamed competitors which can’t do the same thing. 
  • Share useful industry insights or ideas with a connection, or ensure that the development teams of both companies somehow get closer together under the guise of a completely different purpose. 

There are lots of practical ways to get close to the right people in a company which gets you on the radar and then maintain the connection with them in such a way that they have a good understanding of your capabilities and potential and will act as an internal ‘sponsor’ when it comes time down the track to negotiate a deal.

 

6. Create Your Internal Business Exit Team 

 

To do this right and to give yourself the best possible opportunity for a strategic exit, you need to do all these things in a structured way.  This means you need a core, small group of internal and external trusted advisors getting together regularly and discussing each potential buyer of your business almost as if they were a project in themselves (just be careful who you involve in this exercise though as you don’t want employees to be distracted from their core duties or have word leak out about the process without you controlling the message).  The process doesn’t need to be all time-consuming, think about this as working smart not hard to achieve a premium on sale of your business. 

 

Conclusion

 

There is a lot more that can be said about this end-to-end process of building buyer value.  This includes further practical examples about strategic buyer identification, the project plan around each party and how to deal with each them, but I will save that for another article.

 

 

Neill Whitehead was one of the first employees at the Australian software company PC Tools and has been involved with many other technology companies since.  As PC Tools' CFO, he helped grow the business rapidly and organically from just a few staff to 250 employees spread across eight countries before it was sold to Symantec for US$262m.  Neill is an advisor at Saxon Klein specialising in building high-growth tech companies to sell to strategic buyers.  Contact Neill on 1300 898 898 or at neill.whitehead@saxonklein.com.au.

 

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