Institutional Readiness Begins with Process
By Justin Talerico
Aug 27 2018
Diligence is grueling and putting much higher demands on the institutional readiness of SaaS companies. Investors, buyers, and bankers want more validation, more interviews, more data, more backup and more assurances that their money is being allocated wisely. Risk mitigation impacts everything. SaaS business processes are more valuable than ever.
SaaS Institutional Readiness
And that’s just the M&A side of process and documentation. Even if raising a round or getting liquid isn’t on your roadmap, process has tremendous value in running a predictable, profitable and sustainable SaaS company. It’s also a sure way to sleep more soundly and feel more prepared and professional. But, we’ll write those off as soft benefits and focus more on the hard ones.
Performance, Momentum, and Risk
Documentation and process are the keys to institutional readiness — proving performance, maintaining deal momentum and mitigating risk. Claims made in a book or business plan become the basis of valuation, conditional bank approval or terms. If claims are unsupported by documentation, deals may be re-traded or rescinded.
I look at the value of documentation and process the same way I look at a home inspection. Homebuyers typically make offers based on cursory tours and facts provided by sellers. Offers are often subject to an inspection where a qualified professional takes a closer look to make sure that the buyer is getting what’s expected and that post-purchase risk is mitigated. When inspections uncover material problems, deals are renegotiated and sometimes canceled. For sellers, inspection problems found by one buyer will likely be found by others. Real problems don’t just go away with the buyer who found them.
This is true of business and process as well. If there are real problems, diligence will uncover them. And, if they are found by one buyer or banker, odds are they’ll be found by all. The only solution is to fix the house. And the best solution is to fix the house before its ever on the market — to get the best ‘real’ price that is confident to stick through even the most demanding and detailed examination.
Making the Business and Proving Its Value
Many entrepreneurs view the process of institutional readiness as distracting and of less value than focusing on the business. Good systemized processes maximize business value but don’t make business value. So in that regard, the entrepreneurial skepticism is founded. My personal view is that both are needed — the entrepreneurial making of the business and the process-driven maximization and justification of its value.
This point meanders a bit, but stay with me… Back on the M&A perspective… Many smaller tech companies think that they’re more attractive to large strategics than they actually are. Many believe they can leverage higher valuations than they actually can. The common understanding of this is that large strategics can expend the same M&A effort to add $100M in ARR as they can to add $10M in ARR. But another part of this is that the $10M in ARR is actually a lot more effort and dollar-for-dollar more risk than the larger company. Why? Because most $10M ARR companies are run like $1M ARR companies. They have low institutional readiness. They have little documentation. They underinvest in operations, professional services, and audits. They are small businesses in practice even if not in revenue — higher risk, more work, less upside. That’s not a super attractive profile for a buyer.
It’s Not About the Toilet Handle
There are two kinds of problems uncovered by home inspections — minor ones that might each adjust the price a few dollars and major ones that blow the deal out of the water. The value of institutional readiness is not in avoiding the broken toilet handle, it’s in avoiding the termites in the foundation. Yes, defined processes will reduce random mistakes, but their greatest value is in surfacing awareness and focusing attention to avoid massive valuation issues like over-reporting revenue, overstating gross profit, or misrepresenting customer or revenue retention.
Revenue recognition is a great example of a highly documented process. Only with detailed documentation can a SaaS defend consistent, accurate and potentially GAAP compliant earned revenue. Since revenue growth and trajectory are the foundation of many valuations, validation of how that revenue is booked will be the subject of many a diligence review. If there’s a SaaS revenue recognition skeleton in the closet, it will be found.
De-risking and Deal Velocity
There’s another, often less appreciated value in institutional readiness — deal velocity. A banker friend utters one phrase more than any other — “time kills deals”. Even if your toilet handles are tight and you have no termites in the foundation, a lack of process and documentation can slow or even halt your deal. Read that another way — even if you’re squeaky clean, your lack of proof can scare a buyer into thinking that they can’t de-risk your deal. The truth is they can de-risk it, but they would have to create all of your missing documentation to do it. And they don’t want to do that.
Process Driven to Decide and Document
For more than two decades I’ve invested in SaaS business processes and documentation while growing profitable, fundamentally sound companies. I’d characterize that culture as process-driven. It’s not an arduous layer of bureaucracy, it’s a simple commitment to intentionally decide and document. Employees love it as it’s accountable, predictable, transparent and consistent. When it’s time to go to a bank, raise a round or exit, banks, investors, and buyers love it for all the same reasons. I sum up institutional readiness as de-risking the business both internally and externally. The earlier you get on the process bandwagon, the easier it is to maintain. If your experience is at all like mine, you’ll look back on that effort and say it was so worth it.