With the economy shutting down due to the coronavirus, small businesses still need to figure a way to operate. Payroll, rent and other expenses still need to be met. A review of a firm’s technology may provide some quick solutions to help manage through the current environment.
E-Signature – Companies that rely on contracts to trigger revenue, still need to have contracts executed during a time of social distancing. Lowering the contract execution standards can create legal issues, possibly years down the road.
E-signature solutions including Docusign and Adobe enable digital contract execution. Contract execution can be faster. Faster contract execution translates into faster billing and receipt of cash.
Cloud storage for Remote Access – Firms already using cloud storage for documents enable their employees access to documents remotely. This is critical to maintain operations when most staff are working from home. Good solutions exist from Box, Dropbox and Microsoft’s Onedrive. Office 365, includes Onedrive. Cloud storage solutions can have limitations on collaborating on documents, which can create conflicting files.
Collaboration Apps – Employees working from home still need to collaborate on projects and initiatives. Email and text messaging are poor solutions and can fill an employee’s email box. Today there are low cost/free collaboration applications that work on desktops and mobile devices. Slack and Microsoft Teams are two robust solutions.
Most Office 365 subscriptions includes Teams. The collaboration app enables employees to group discussions into topics. Multiple users can view or edit the same document at the same time. When employees are working from home, the need to collaborate on documents without corrupting the documents is higher than ever.
Review Subscriptions – Reviewing technology subscriptions can free up cash. Cancelling unnecessary monthly subscriptions will conserve cash.
It is a good time to do a complete inventory of all subscriptions, the cost and term. If a required subscription is up for renewal, can the number of users be reduced? The renewal date is often when you can reduce the number of users. Your vendor may allow your firm to reduce the number of users required on a good will basis. Many vendors that want a long-term relationship will work with their customers in a time like this
Cloud Applications – Most companies have moved to the Cloud for their applications. Review desktop applications that require a user to be at their desk in the office to perform the function.
In the past 20 years, we have gone through 3 major shocks to the economy. There was 9/11, the financial collapse in 2008 and now the economy is freezing up due to the coronavirus. At Salentica (my former company) we worked through the first two events and learned some important lessons.
For B2B software companies with a product revenue base of annual recurring revenue, it is likely clients will continue with their subscriptions as the costs are already paid or in the budget, so don’t require approval. In the short term, discretionary consulting projects are the first ones that are cancelled or postponed by clients. Business owners need to anticipate that their services/consulting business will slow down and manage accordingly.
In the 2008/2009 slowdown, we found that our software product sales impact lagged the worst of the financial crisis. One theory I have is that large software acquisitions that can take 6-12 months were underway and continued even when the economy did a rapid slowdown in late 2008. Buyers had the approvals and budgets in place and senior management is likely looking past the downturn, unless the company needed to preserve cash.
It was well into 2009 when the markets had started to recover that we saw a slowdown in our product sales. It was likely because new software acquisition projects that were in the planning stages in the fall of 2008 were not approved for 2009. So while the worst of the recession was over, there was no budget or approval in place for new software capital projects. Small and mid sized consulting projects were brought back sooner as they could be funded with from the operational budget.
The lesson learned for a B2B software company was that while there may be short term cut backs when there is a shock to the economy, the full impact may not be felt until after the economy has started to recover. When the initial shock hits, it is still possible to close new business for software acquisitions that are well underway. It also means that even when the economy is well into recovery, software product acquisitions may be postponed if they were cut from budgets while management was still dealing with the economic slowdown.
Acquiring companies go through a due diligence exercise to help ensure there are no surprises after the deal closes. The due diligence typically takes place once an offer has been accepted by the acquiring company, pursuant to number of conditions being fulfilled, one of which would be the completion of the due diligence.
Many companies require organizations to provide assertions, which become part of the purchase agreement. These declarations provide a framework that allows the acquiring company to take legal action against the owner if it is not consistent with the business practices. For example, the purchase agreement might state that all client contracts do not have an exit clause on ownership transfer. If subsequent to the close of the deal, it is determined there were a number of contracts that did have exit clauses, it could provide grounds for litigation against the owner.
The acquiring company may deploy a team onsite, or provide the owner with a list of information they want to inspect. This will become a time consuming exercise, if the information requested is not readily available. There are 7 main areas of due diligence where companies will focus on. Below is a summary of each area, along with a brief description of some of the activities that will take place.
Sales and Marketing
Activities that would be included here would be focused on the sales and marketing process along with the methodology relating to the forecasting approach that will feed into budget. As any valuation of the company would look at the future forecasted revenue streams, the acquiring company would want to be comfortable with how the forecast is put together. Furthermore, understanding the sales and marketing group will help the acquiring company in determining the areas of overlap within their organization and help assess the quality of the team.
Understanding the operations of the company will assist the acquiring company assess the overall day to day operations of the acquired company. The steps related to client on-boarding would be reviewed, along with the ongoing activities with the client. The project management approach relating to client on-boarding is reviewed here, to determine the risks associated to implementing new clients. Other activities such as account management, support levels and client turnover are reviewed.
An analysis of the financial statements is performed to understand the assets/liabilities, along with the types of revenue and expense. As the financials tie in directly to many areas of the business, there is often overlap between this area, and that of the other review teams. A properly structured due diligence team will manage this in an efficient manner. For example, the pricing of products is normally a marketing function, but the profitability of products has a direct relationship to the profitability of the company.
Depending on the size and type of organization, this level of effort here can vary significantly. If the company is a public organization or has activities in multi-jurisdictions, the review here would include a number of activities. A review of SOX Compliancy would often be a topic for this section. Transfer pricing would be reviewed in the case of multi-national organizations. Tax filings compliance would be covered here as well, and would include both corporate and State/VAT taxes.
Understanding the company’s infrastructure is important. Items like real estate, corporate networks, both network and physical security and others would be discussed to understand incompatibilities and identify areas of vulnerability.
The people in a company is a key component of any acquisition. It is critical for an acquiring company to understand the employee policies and procedures that are in place. Furthermore, key resources are identified and the plans in place to reduce turnover of those individuals are reviewed here. Turnover statistics are analyzed as well to help identify any potential staffing risks.
This is another critical area of review and covers many areas. Most of the key client/supplier contracts are reviewed, along with the letters of incorporation, board meeting minutes and employment agreements. Any outstanding litigation or recently settled litigation is reviewed as well.
Once an agreement in principle has been reached, both parties will want to bring the deal to conclusion as soon as possible. As a result, the due diligence phase will be on a tight timeline. It is important that the acquiring company is organized and is prepared for this phase. The inability to provide information to the acquiring company on a timely basis can cause the deal to collapse.
As a result, companies wanting to sell their business should ensure they are prepared internally for this step, well in advance of the sale. As part of the annual planning process, companies should perform a readiness assessment and determine if there are areas that need to be addressed. While a company can not anticipate everything that may arise during the due diligence process, most of the potential issues can be alleviated.
When the time comes to sell your software product business, proper preparation, which can take several years, can affect the value buyers will assign to your company and help ensure a successful transaction. The video below goes through 8 factors to consider and work on when preparing the exit strategy for your software business.
Owners of a software company need to be thinking about how to grow the value of their company. Understanding some of the factors can help with strategic decisions to drive maximum shareholder value.
A software company will typically be valued by a buyer or investor on factors beyond the financial projections and future cashflows. Financial buyers that are making their decisions primarily on a cashflow basis, will often offer low valuations, compared to a strategic buyer. The factors will often be unique to each possible buyer, which makes it important for the seller of a software company to try to understand a buyer’s motivation.
Some of the factors beyond financials include:
Client Base: A software firm’s client base can have a significant impact on a valuation. For a buyer, if a target firm’s client base can expand their market or provide a complimentary solution for their IP to increase the revenue from their client base, this has value to the buyer. In some cases a buyer will be looking to diversify out of their core market and will use an acquisition to buy entry into new markets for their existing products.
Intellectual Property: How unique is your firm’s IP and what would be the cost to replicate? Ideally your firm has IP that would be expensive and difficult to replicate, which creates a barrier to entry for competitors and allow for a higher license fee. A software firm must have clear ownership of their IP. Where contractors or offshore development is used, legal agreements must be in place to clearly define that ownership of the software resides with the software company.
People: How depended is the business on key individuals, especially if they are founders/large shareholders? It is common after an acquisition for founders and large shareholders to move on after a period of time (see blog on Why Do Owners Leave after Selling Their Companies). The buyer needs to know the organization will continue to operate and grow without the founders. High turnover, or a heavy reliance on contractors that may not be committed to the firm would be factors negatively affecting the value of a software company.
Strategic Relationships: If a software firm can provide a buyer with strategic relationships that they do not already have and would be difficult to get, this will have value for the buyer. When negotiating strategic relationships and partnerships, it is important to try to limit clauses that may limit assignment of the agreement in the event the software company is sold.
Revenue Sources: Buyers love recurring software revenue. From a buyer’s perspective, a question can be: “what am I left with if everyone quits after the purchase is completed”. Contractual recurring revenue provides a predictable revenue stream and will be given a higher value when it is included with the buyer’s financials. Software companies should look for opportunities to make non contractual revenue that recurs into contractual recurring revenue. In many cases a client may prefer an annual predictable commitment that can be budgeted.