Introducing guest blogger Michael Schwerdtfeger, Principal at NewCap Partners, an advisory firm that specializes in middle market mergers and acquisitions. Over the course of his career, Michael has completed well over $2 billion in transactions, across a wide range of industries.
Do You Smell Smoke? Here are four ways that SaaS companies torch their own deals during mergers and acquisitions:
Neglecting to Institute Effective Revenue Recognition Policies
Changing your internal practices is easy when done early, but impossible to do late. So, make sure to put the right financial practices in place well before you are ready to sell your company.
Because of the difficulty many business owners have understanding revenue recognition rules, particularly in the context of a SaaS business model, failure to implement the right practices can (and does) kill deals. The complexity of the accounting rules around this topic means that many deals struggle to get through economic due diligence due to sellers’ lack of understanding of revenue recognition. The result is that often, after an external review, buyers’ accountants appropriately (but unexpectedly to sellers) restate the earnings of a selling company, significantly changing the valuation of the company.
I’ve personally been involved in a couple of transactions that suffered from a seller’s inability to understand and implement an appropriate revenue recognition policy. So, to avoid the revenue recognition land mine, you need to understand the concept in advance:
Revenue recognition is the accounting analysis of when to properly recognize revenues and expenses in a company’s profit and loss statement.
In essence, an appropriate revenue recognition policy matches up the costs and revenue associated with services or projects that take a long time to complete. In a SaaS business, it is particularly important that you recognize revenue ratably, as services are provided.
One of the ways to solve this problem is to go GAAP early. Otherwise, you’ll end up like one of my former clients, where the buyer worked hard (and spent a lot of money) to figure out what the company’s true profitability was (and when the profit should have been earned), but ultimately became frustrated enough to walk away from the transaction.
Self-Immolation is avoidable!
Believe it or not, many business owners put land mines in their own merger & acquisition transaction path and then jump onto them just to make sure everyone knows the mines are there.
You don’t have to suffer the same fate. Most of the explosions are avoidable simply by understanding problems in advance and taking simple steps to move out of the way.
Trying to Handle a Transaction Yourself
You can go it alone. But, just like you wouldn’t represent yourself in a lawsuit or prepare your company’s taxes, you’ll want help getting through an M&A transaction. An experienced advisor can make the process significantly easier and generate significant value.
Middle market M&A deals are difficult to complete. One of my colleagues once expressed wonder at how deals happen at all, since so many factors need to align for a deal to get done. Getting solid advice on marketing your company for sale is crucial, not just to maximize value, but also to complete the deal.
While advising companies on transactions, I’ve found that buyers and sellers often don’t speak the same language. Entrepreneurs who are also owners, run significantly valuable businesses without the infrastructure or institutional experience that strategic and/or financial buyers are used to seeing. A good M&A advisor will help you “speak their language.”
Additionally, completing a transaction takes time – a lot of it. Selling a company can take anywhere from six to 12 months or longer, and require countless hours of work and discussions with potential acquirers. The process will be exhausting and that distraction from your company’s success is a dangerous risk to take. Hiring an advisor can help you stay focused on what you do best – creating value for your company.
Finally, hiring a competent M&A advisor will create leverage, that you can’t create yourself, in marketing your company. Studies show that competition in M&A transactions significantly affects price. If you want buyers to compete for your company, you’ll want to retain an advisor to make that happen.
Failing to Get the Right Lawyer on Your Team
While business owners typically like to hire lawyers almost as much as they like to get root canals, nothing can make a transaction smoother (or kill a transaction faster) than having the right (or wrong) lawyer on your transaction team.
Often, a business owner’s experience with lawyers falls under general corporate guidance, family law, estate planning, HR or some other unrelated area. Sellers sometimes want to use these lawyers on the deal because they’ve been helpful in the past. This is a mistake! These lawyers may have been good at what they did for you in the past, but they probably are not versed in selling companies. You’ll absolutely want someone on your team who is an expert in the M&A process and regularly handles deals for sellers like you.
Also, realize that buyers will come to a transaction fully armed and likewise, you’ll need competent counsel on your side. Whether the buyer is a private equity firm or a strategic buyer, you’ll quickly realize that they have a team of lawyers who are experts in every phase of the deal, including M&A, tax, HR and environmental issues. You’ll need counsel to converse and negotiate with them. It will be costly, but will be some of the best money you spend.
Of course, there are other land mines along the way, but getting your financial house in order and bringing a great team to the transaction will help you avoid many of them.Thanks to Michael for contributing this post. If you’d like to see more of his posts, visit him on LinkedIn.