Building Your SaaS to be Acquired
By Katie Burns
Aug 01 2018
As the CEO of ion interactive, I began building to be acquired a full five years prior to being acquired. We were in the highly competitive enterprise martech space and needed to:
- differentiate the company strategically;
- align the product with the right partners through integrations;
- audit financials for accuracy and accountability;
- and evolve operations with scalable systems and processes.
Long before there were any potential buyers, we had to position ourselves for success and to be attractive to larger organizations. Like many a SaaS, we aspired to liquidity and scale via a strategic acquisition. We were preparing to be bought by a strategic, and that had a lot of far-ranging implications.
A significant driver of building to be acquired is who you see as your buyer. A strategic buyer is different than a financial buyer and revenue valuations are different than EBITDA valuations. Who’s buying and how they’re valuing has everything to do with how you prepare.
To clarify, this is not about preparation for a specific buyer within a specific, near-term process. By then, a lot of these ships have sailed and you are who you are. This is about crafting the company and who it appeals to through readiness.
Implications of Building to be Acquired
Market and Model
Your sandbox dictates your playmates. If you choose a space that’s too narrow, you’re limiting your total addressable market (TAM) along with your buyer list and valuation. And, if you go too wide, you could be perceived as too general — competing with everyone (or no one) and again limiting your buyers and hurting your valuation.
ion pivoted a few years before its acquisition. The pivot served to broaden TAM; improve price elasticity; and widen the future array of potential strategic buyers. Of course, all of that also meant we were more attractive to financial buyers, but they were not the focus. The pivot had downside risk in lost time and revenue growth momentum as a result of the transition. We accepted that risk in exchange for the strategic upsides. We made that choice years before we wanted to exit, so that was partially why it made sense.
Following a transition, like a pivot, buyers need enough history in the new model to de-risk the deal. If you’re considering significant discretionary changes, watch your timeline. If you’re less than three years away from your target exit — and you’re not a unicorn — it will be challenging to justify fundamental changes in the business. In this case, fundamental means:
- who your buyers are (Ideal Customer Profile (ICP) — role/level);
- what your market/space is (TAM);
- what your product is;
- and how you market and sell (big picture).
Discretionary is the keyword. If you have changes you must make to the business, obviously, you’re going to make them. But, in that case, you’re probably more than three years out from liquidity anyway.
Partnerships and Alliances
Often in SaaS, partnerships and alliances begin with technical integrations and/or co-marketing. The relationships built at those levels sometimes evolve into business development discussions. This is obvious, but remember, these relationships cut both ways. You could be on or off a potential buyers list based on who you did or did not partner with. If you get cozy with your best buyer’s sworn enemy, it could help you or it could also get you crossed off the list. Again, perhaps obvious, but look at board composition and investors too. Connections are everywhere and they can help or hinder.
Your market, model and alliance decisions dictate who you compete with; who you can partner with; and who could find you attractive in M&A. If you already have a short list of specific strategics, be sure you make the right choices to stay on the right lists.
Somehow I feel compelled at this point to caution against expecting billion dollar strategics to beat down your $10M ARR door. The likelihood of outsized buyer interest is very low and reserved for only the most meteoric sub-scale performers. Possible? Yes. Likely? No. And one more buyer point — I’m focusing on strategic buyers because that’s the stereotypical SaaS ideal. But, financial buyers are paying more than they used to, so don’t necessarily shut down that lane.
Operational Implications of Building to be Acquired
There’s no quantifying the value of audited financials for a $10-$20M ARR company. You’re punching way above your weight class when you’re audited and ion made that commitment five years prior to its acquisition. I believe that having audited financials kept us on buyers’ lists that we otherwise wouldn’t have been on. I also believe they shortened our diligence process and set and preserved a higher valuation. No, I can’t firmly quantify those claims. But, after being on hundreds of calls, I can confidently say the ROI on those audits had to be a lot.
Audited financials were not the first way be began to operationally prepare to be acquired. We started by hiring bigger, better accountants. That led to more professional systems and processes (including rigorous revenue recognition). And that led to annual audited financials. Over the course of a year, we went from QuickBooks and spreadsheets to Intacct and audits. Not only did we have more accurate and timely financials, but we also net lowered our expense with less laborious billing and reconciliation.
Revenue Accuracy as Leverage
Plan on your buyer looking at and finding everything in diligence. If you get lucky and they don’t find everything, great. But plan on it. If you are financially loose, you will pay. The way you will pay is in either a lost buyer who thinks you’re too much work (or can’t de-risk you enough); or a reduced valuation.
As you’re building to be acquired, keep in mind that your revenue is likely to be one of the most scrutinized facets of your business. The overarching question being if your buyer has confidence that your revenue has been accurately and properly booked (likely to GAAP standards). If your revenue recognition isn’t spot on, you will likely see a discount taken on your valuation (especially if your valuation is a revenue multiple). In the worst cases, your buyer will re-trade the whole deal and make you a new offer based on perceived risk their assessment of your actual revenue. Without a systematic, defensible foundation to fall back on, you will have little recourse and leverage to get back to your higher valuation.
Another cautionary note… less scrupulous buyers will smell a loose financial seller and make an outsized offer they plan on re-trading down. If you are loose and you know it, either fix it or talk about it openly before you burn massive resources on a diligence process. Better to know the real number up front than fall in love with a myth.
Systems and Processes
I recently wrote an article on the Value of Process, so I won’t rewrite that one here. But, I do want to get into some of the more critical areas as you’re building to be acquired.
Contracts on Parade
We got organized several years before our acquisition and systemized our filing and identification of customer contracts. If it was non-standard, we knew about it. We applied similar rigor to vendor and employee contracts and agreements. Your contracts will likely be reviewed and risk will likely be assigned to them during diligence. Your purchase agreement will then likely contain reps and warranties that tie back to your contracts. So, if you’ve made a thousand special contractual exceptions, now’s the time to identify and document them. Better yet, don’t make a thousand special exceptions and save yourself the reps and warranties headaches.
Security and Risk
Buyers hate risk. If you become risky, your value goes down or your deal gets killed. Access to your source code and any private information (PI) must be strictly controlled and rigorously managed. Unfettered access to code undermines the value of your intellectual property (reducing valuation). Loose access to PI increases your liability and/or compliance risk (adding massive carve-outs to your reps and warranties). Loose security practices point to lax policies or enforcement, which implies poor management. Nothing says ‘you’re an idiot’ like giving an intern in the Philippines access to your code base. Try to limit that impression.
Positioning and De-Risking
Think about positioning for opportunities and de-risking for valuation as you’re building to be acquired. The majority of what I’ve discussed here is long-term. It will be hard to fix many of these issues a few months before you go to market. The most defensible position is one based on three-plus years of solid, audited performance in these key areas. Are you doomed if you don’t have this stuff together? No. You’re probably not doomed. But, your process is likely to be more challenging, your valuation less solid, and your purchase agreement longer with more stringent reps and warranties. If you have the choice, build for acquisition now, and make your life easier when it’s time to go to market.