Successfully Selling a Medium-Sized IT Services Company

Why Should You Sell Your IT Company Now?

The IT consulting and software market is booming, with the high demand for tech products and software leading to a scarcity of qualified and experienced IT resources.

Since the market tends to roll back towards a downward trend, now is the best time to make the most of the ongoing upward trend. As an owner of an IT company, you have the chance to take advantage of the current IT-boom.

As early as 2019, we determined from sales mandates that there is a brisk demand for small and medium-sized IT companies. Many bidders submit high bids in the bidding process, resulting in bid wars.

Why Should You Sell Your IT Company at All?

Selling an IT company is a profit-making proposition in today’s world. When selling the company, shareholders profit from high purchase prices and may invest the funds afterward in other businesses. The company’s founders earn a profit before the market turns, purchase prices fall, employees and customers drop out, or prices drop, making the business a poor investment.

When the company is sold, the founders may have the opportunity to continue working in the company for several years and perhaps realize projects on a larger scale with a significant shareholder that they have not yet won or could not implement due to its size. With the financial resources from the company sale, you can foment further growth of the company in a more relaxed manner.

Which Software and IT Companies Interest Buyers?

The more stable the business model of a software or IT company, the more interesting it is for strategists and investment companies. Stable implies a high proportion of recurring revenues, such as monthly subscription fees from software rental (e.g., SaaS, cloud). If such customer contracts then have a term of more than 12 months and the contracts are automatically extended, then the enterprise value of the software company increases when a company is sold.

The absolute driver for a high number of prospective buyers and high purchase prices is so-called “stickiness,” that is, how easily a customer can replace the installed software with a solution from a competitor. Suppose such an exchange of the software solution is excruciating for a customer–in terms of both time and money–because it is difficult to replace. In that case, such a software company is rated highly. A share of over 50 percent in recurring sales characterizes a software company that interests buyers. The broadest possible distribution of sales across a large number of customers also increases value.

Characteristics that appeal to buyers of software companies include:

  • Critical company size of more than 30 employees with first and second management levels that do not depend on the founder or founders.
  • Implementation of meaningful and up-to-date financial reporting.
  • Documented processes in software development and the software itself and all rights to the software solutions lying within the company–no spaghetti code and no open-source code.
  • Scalable business model (international) with low implementation costs for the customer or an extensive network of implementation partners. In the absence of this, sales cannot grow exponentially.
  • Upselling potential with existing customers.
  • Low price sensitivity among customers allows price increases, especially if the increases are already contractually regulated.
  • Interesting reference customers.
  • High customer satisfaction and low “churn rate” (terminations) from existing customers.
  • Low employee turnover, especially in software development and sales.

How Are Software Companies Rated?

Which factors increase value and which factors reduce company value? Every buyer of a software company is interested in its business model and its organizational stability in addition to its employees and customers. The higher the strategic fit from the buyer’s perspective, the higher the company’s value will be. Deal killers either prevent the company from being sold or significantly reduce the purchase price. They can, in principle, include high employee turnover, high customer churn rate, a business model that cannot be scaled, employees and customers who depend on the founder, and no comprehensive management no second management level.

The company valuation of software companies: Serious and professional M&A consultants have access to appropriate databases from which they can see a list of the M&A transactions that have taken place in the last 24 months and their parameters (e.g., EBITDA multiples, sales multiples, etc.). On this basis, they compile lists of evaluations of comparable transactions (“peer groups”). Using that information plus an additional company valuation based on the internationally recognized discounted cash flow method (DCF method), the M&A consultant can quickly show his customers a valuation range.

The Process of a Company Sale (M&A Process)

A successful M&A process prepares the company for sale and incorporates the professional implementation of each step in the transaction. These include:

  • Creation of an information memorandum that answers all important questions from the perspective of a software company buyer. Furthermore, a comprehensible financial plan (income statement, balance sheet, cash flow statement) based on historical and current data must be drawn up for the next five to 10 years.
  • Elaboration of an extensive list of potential buyers (strategists and financial investors). As M&A consultants, we create the “long list” based on many years of M&A experience in the software industry. After discussion with the customer, the long list is reduced to a manageable number of potential buyers (approx. 30 to 50), creating an “A-list candidates” is also called the “shortlist.”
  • Promotion to potential buyers. In addition to the informational memo, the M&A advisor creates the teaser. The teaser is a one-page document that presents the information relevant in anonymous form to potential buyers.
  • Sharing information and establishing deadlines. After the customer approves the teaser, the M&A advisor sends it to the A-list candidates with a confidentiality agreement (NDA or non-disclosure agreement). After signing the NDA, the interested A-list candidates receive the memo with a so-called procedure letter. The procedure letter describes the schedule and content of the M&A process.
  • Seller presentation. Interested buyers now have the option to hold a teleconference or a management presentation with the seller.
  • Submission of offers. Interested buyers now submit non-binding offers. The bidding process begins with the decisive factor being the number of interested parties who have submitted meaningful indicative offers. The M&A consultant, based on years of experience, recommends the most advantageous offers and helps begin negotiations for the transaction.
  • The following steps in the sales process are the letter of intent, due diligence, and contract negotiations.

Related: Exit Planning for Software Start-Ups. 

Preparing for a Company Sale

Professional preparation increases the chances of a high purchase price when selling the IT company. Every company sale is complex and should be professionally prepared and implemented with an experienced M&A consultant. As a shareholder, you shouldn’t make the mistake of selling the company on your own in addition to managing its day-to-day business. Doing so causes the business to suffer and, as a result, sales and profits and thus the company’s value to decrease.

A professional M&A consultant can assess the chances of a successful company sale before being hired. Furthermore, the consultant knows current valuations for IT companies and can provide a realistic range for the company value and the purchase price before accepting the contract. Years of similar experience ensure that all documents contain the information that potential buyers require, which accelerates the sales process.

With an M&A advisor, you can contact potential buyers anonymously and learn their interests–without the news getting around to customers and employees and negatively affecting business operations. The M&A consultant may also have many good international contacts with potential buyers, expanding the potential pool of A-list candidates. The M&A advisor expedites what is often a complex and stressful process.

Experienced M&A consultants control the process of a company sale to be completed quickly and require little time from the seller. The consultant moderates the entire process and coordinates all internal and external parties. This moderation function mitigates disagreements and renders informed opinions to guide the seller. This may entail the “bad buy” during negotiation to best serve the seller’s interests. Taking advantage of an experienced M&A advisor’s expertise circumvents or avoids errors that result in high costs, bring the process to a standstill, or have other adverse effects, significantly increasing the chance of successfully concluding a contract.

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Makalyn Feaster

Makalyn Feaster

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