Abstract: In this week’s article we will be exploring the decisions that influence the sale of a technology business. Whilst, this article is in keeping with our focus on Information Technology firms and is specifically targeted towards them, we think the broader principles would apply to sale of any business
Every year there are hundreds of technology entrepreneurs that after years (sometime decades) of hard work, time away from their families and after investing their own (and their family, friends and investors) funds finally decide to sell the business that they have created.
We briefly touch upon the factors that influence such a monumental decision for each and every one of these organizations.
Loss of Momentum
On the face of it most entrepreneurs would rather slog through a loss of morale (after all which business does not have its down days?) rather than take a decision to quit/sale. After all that’s what makes great organizations ‘great’. To differentiate between an entrepreneur’s zeal of implementing their vision through sheer will power and what we are referring to here let us illustrate what we mean
Challenges in Scaling up the Business:
Over 50% of the entrepreneurs and founding teams that we come across typically fail at recognizing that their businesses have started stagnating. Moreover, very few of them realize that it takes a completely different skill set to scaling up a business compared to starting it in the first place.
When confronted with managing a sales force and delegating responsibilities for customer management most entrepreneurs face the issue of lack of skilled manpower. The difficulty that a small/medium business faces in attracting smart managers is often understated. These could be due to lack of branding, not being able to effectively demonstrate a career path for the managers or several other such factors combine. The reality is that beyond a key revenue point/product roadmap almost every entrepreneur needs to empower a second line of managers that can grow the business exponentially.
If your business is unable to acquire and manage such talent no matter how hard you work the growth will slow.
The business press will have us believe that every great business (especially one with growing sales) gets funded. The reality is completely different.
Some businesses, typically Information technology services find it extremely hard to identify tangible competitive advantages, which preclude most of them from favorable equity financing. On the other hand, a medium sized business is neither a very attractive client for commercial banks given a lack of credible long-term business contracts and an ever-growing need of working capital.
Remember, if you have an IT Services business with a turnover of $10M and you expect to reach $15M in turnover the year after it would be impossible to fund the entire working capital requisite from your accruals alone (that is assuming you have EBIDTA margins north of 20%).
Lets also, not underestimate the need for ever larger balance sheets to attract and retain large clients (the very basis of exponential growth). Almost, every client above a certain size requires a dedicated manager and delivery platform along with certain infrastructure specifications. Whilst, most business are able to demonstrate the ability to execute the contracts on offer, where they most often stumble are on legalities which require them to have corporate governance measures like Executive/Directors/Commercial insurance. A lack of funds not only constraints your ability to grow it also, provides an unfair advantage to your larger peers.
Declining Business Metrics:
This is nothing but a fancy term for saying that you are losing business whether revenue, profitability or, people.
A business can lose customers for any number of reasons (customer going bust, customer changing product/service roadmap etc.). The important thing to remember is how long before you take the tough decision to let some of your people go. More often than not we have come across businesses with ruined financials (decent revenue, negligible or negative profits) largely because although, they lost customers they refused to cut costs proportionately in the ‘hope’ that another customer would fill the void.
Our advice, understand your sales cycle. No matter how close you think you are to signing that next customer revisit your past experiences with similar set of customers to make an educated guess on when those extra resources can be monetized.
In our experience a loss of more than 15% of revenues takes a minimum of 2 quarters to recover (assuming you are doing everything right and the market conditions are favorable). So take a hard look and decide whether you want to compromise your cash-flows and jeopardize the value of your business because you refuse to reckon with the hard luck that came your way.
Advising to sell a business during a recession is always a tricky one in the best of times. However, there are scenarios where it should be considered favorably. A downturn does not affect every player equally. Typically, it’s the small and medium businesses that are hit the hardest.
It is absolutely true that you will almost never get great value for your business if you sell it during a recession but at the same time it is also, a misnomer that the value offered would be the lowest you can expect. After all a declining business during a recession is easily palatable for most buyers; what is not is a declining business during the ‘boom times’.
So think hard about whether your business is positioned (cash flow and even on a personal/organizational level) well to not only survive but emerge stronger and larger during a deep recession. After all, if you survive the downturn only to come out as a skeletal clone of your former glory days neither your team nor you as an entrepreneur would realize terrific value for your business.
Changing Competitive Landscape:
Most savvy entrepreneurs realize when the macro economic trends in the industry start going against them. It could be evidenced in the form of customer preferences shifting from small niche vendors offering personalized service (something most small and medium businesses excel at) towards managing a smaller base of vendors and thus, necessitating a migration towards larger vendors being able to take on comprehensive delivery roles.
This could be evidenced in other ways as well. Example, most small product companies keep on believing that their niche product knowledge will lead to greater business from a nuanced set of customers. Whereas, the industry itself may have moved towards a more consolidated vendor base.
Recognizing this early would enable you to capitalize on your niche skill set and demand a valuation that is commensurate with your ‘current’ business value. Combining with a larger organization, helping them cross-sell to your customer base is one of the best ways to ensuring not only good valuations but also, a great road-map to future business integration.
Conclusion: In the second part of this article we will explore the role ‘numbers’ play in your decision to sell your business.