To Grow or Sell Your IT Company - A Crossroads Decision
Often the biggest decision an IT entrepreneur has to make is figuring out if I can grow and scale this business myself, or if it is time to sell to a strategic acquirer.
Owners of software companies with a great new product are often frustrated by their inability to gain broader market acceptance. The problem isn't the product, the issue is risk-averse buyers. This article explores how a business sale may be the best way to unlock your product's potential.
Software — If You Build it, They Will Come… Not
In our investment banking practice, we are often approached by software companies that have a leading edge, brand new software product that is not producing the desired sales results. Many times, they are what we affectionately term 'accidental software companies' — an Information Technology consulting firm that has developed a solid application in conjunction with their demanding blue-chip client. They strike a deal with the client to reduce their development fees in return for ownership of the intellectual property.
Just like that, they become a software company. Not so fast, Mr. Optimist. You can't just say you are a software company and expect the product to garner mass market acceptance. These companies generally do not have a sales force that can transition from selling projects to selling a software product. Many go down the path of hiring a salesperson who has an impressively large company sales resume. He promises to bring his large client database with him and achieve impressive sales levels. He is going to take this small company to the next level.
An Expensive Mistake
Nine months later, with a substantial base and draw, the sales star is far below quota and is either fired or quits to find a much easier sale. It is one thing to sell with Oracle, SAP, Microsoft or IBM on your business card. It is an entirely different proposition representing Acme Software Products. It is a rare sales person that can make that transition and achieve success for the new company.
The primary deterrent to sales success is that the perceived risk for the large company software purchaser is far greater with the unproven newcomer than with the established software giant. This dramatically lengthens the sales cycle with much more testing, software code escrow requirements, references, proof steps, trials, etc.
How Do I Take My Software Company to the Next Level?
So how does this small company scale? How about the value-added reseller (VAR) channel? Again, the inexperience can be costly. You can't just recruit some VARs and expect sales to multiply. It is a big commitment of resources to manage the channel. You are competing for mind share with many other strong products and services. The revenue split with a VAR is generally about 50%.
Strategic alliances have been employed successfully in earlier times. This approach has been tried by a large percentage of emerging software companies to the point where this channel is extremely crowded and diminishing in its effectiveness. Larger companies are becoming very selective and demanding in lending their brand, sales resources, and mind share to anything but their own products. If they do agree to partner, the terms are not favorable for the small guy and often there is some ownership equity requirement.
Maybe a Company Sale Is the Best Alternative
Step back from the ledge. All is not lost. Often the best approach is to seek to be acquired by a larger software or information technology company that has the client base and sales resources to leverage with your hot new product. It is important that you manage your expectations, however. If you are below $50 million in revenue, Microsoft, Google, IBM, Oracle and the other multibillion dollar software firms are not going to buy you. There is the occasional outlier that defies this rule, but large corporate development people do not even blink unless you are big enough to move their needle. So if you are a $3 to $25 million in revenue firm, your buyer is most likely a $25 million to $300 million software or IT services firm.
Buyers Delay Payment for Market Potential
I must include one final reality check. Buyers of software companies are reluctant to pay for potential, projections, pipelines or any other seller-perceived hockey stick revenue explosions with cash at closing. They have heard it all before and will not be persuaded to part with their cash until those orders actually come in. The good news is that if they are convinced that there is potential and this product is a good fit with their sales team and clients, they often will make a generous earnout offer based on future revenues or profits.
This can be very attractive to the seller because now his effective sales force, installed base of customers, brand name recognition and marketing budgets have all been expanded exponentially. The risk in the marketplace has been reduced and the sales cycle compresses. So if the selling company with 2 sales people and 30 installed accounts gets acquired by a larger company with 1,000 installed accounts and 30 sales people and gets a 15% of revenues earnout deal over four years, the seller can recognize considerably more value when compared to slugging it out on their own over the next 15 years.
Written by Dave Kauppi
Dave Kauppi is a Merger and Acquisition Advisor with MidMarket Capital, Inc. Dave is based out of the greater Chicago area and specializes in Technology, Information Technology, Healthcare and intellectual property focused companies. Dave is also the author of the Exit Strategist Newsletter.