Exit. Selling your SaaS

16 July 2022

This article is part of the series called Founders Guide which Iโ€™m writing currently to help early-stage founders tackle the problems they face during the first year of the startup.

You did it! You reached a level where people want to buy your business. Someone texts on Twitter asking you to spill the details and you're already thinking of sipping Mendis coconut brandy in Necker island. You ask around to finalize the deal and realize that selling a business is actually tricky!

And why wouldn't it be? You have poured your heart and soul into a project for 5 years and you're about to hand it over to someone elseโ€”big decisions like these require a lot of knowledge and stoicism.

Most startup founders are great at creating something, but to exit a business, you need to focus on the right numbers, the right people, and the right time. I have seen the entire drama unfolding from close quarters and what stands out for me each time is the number of things that can go wrong. 

I'll go over the process of successfully exiting a business and the things you should know and the changes you need to make for this to happen. 

But first, who are you going to sell your SaaS to?

Buyers you'll meet

If you have a solid SaaS at your hand, there won't be a shortage of buyers. But here's the thing: not every buyer is looking to buy your business. Some are just window shopping and some just want to waste your time. But there will be real gold hidden underneath the fool's gold. You just have to know which is which.

The time waster

The absolute worst. Time wasters are neither serious about buying a business, nor do they know to run one. But you can spot them from miles away. They usually give you a quote right away. Ideally, this is something sellers prefer but from real buyers. Time wasters give you a quote that's laughably low because they're noobs and don't know how stuff works. 

The other breed of time wasters is simply there to waste time. They're employees in megacorps and have to fill out their calendars to look busy. They know about exits, acquisitions, and everything in between, but they just don't want to transact. The quickest way to spot them: see how they dodge meetings. 

In both cases, you're wasting your time entertaining them.  

The spy

This is something you probably wouldn't have expected but spies exist. They pretend to be interested in your business, take every data you feed them, and vanish into thin air. 

Due diligence is part of the selling process where you share sensitive information such as customer acquisition channels, cost, and revenue numbers. Competitors want to get their hands on this document to see how you're doing. Competitive intelligence is worth its weight in gold and you do all the hard work to hand it over. 

So how do you avoid this type of buyer? Add a backout fee. This is sort of a cancellation charge that can be anything between 1-10% of the valuation. Only serious buyers will ignore this. 

In a strictly general term, 90% of buyers come with these red flags. Only a few show genuine interest and even fewer make the process a delight. 

The bureaucratic buyer

The serious buyer who wants to buy your business. But they don't spark joy. Typically they're from big enterprises and come with all kinds of bureaucratic red tape. They're all about boring talks, NDAs, contracts, and legalities. You might get a good deal out of them but be prepared to really see through their overly boring process. 

The ideal buyer 

This is the kind of buyer every founder wants to meet. They are informal but honest, show real interest and knowledge about the business and if they really want it, they'll make the process as smooth as possible. I won't tell you how to can spot the ideal buyer, you'll just know when you see one. Statistically, you might get 3-5 ideal buyers out of 100 inquiries. 

The curious case of brokers

Buyers bring us to brokers. Brokers are experts at what they do and save your time and energy by handling the complexities of sales. Sounds like a win-win situation, right? 

But the real picture is slightly different. You see, brokers charge a flat fee. It can be anything between 2-5%, depending on the contract. But they often charge a selling fee as well. If a broker charges 10%, you're shelling out $100,000 from a $1 million buyout. That should sting any founder. 

Brokers are also about efficiency. The faster they sell, the quicker they can move to the next project. You, on the other hand, can take as much time as you need to evaluate offers and get the best deal.

If youโ€™re completely hopeless in selling and negotiation, brokers, despite their fees, aren't really a bad idea. But it completely depends on how you strike a deal with the broker. 

Negotiating a deal

This brings us to the proverbial negotiation table where the action happens. A lot of SaaS exits go wrong because the variables are limitless. Market standards, economic trends, and negotiation tactics โ€” everything contributes to the final deal.

Have the bargaining power

The best way to sell a SaaS on the negotiation table is to not sell your business. If a buyer asks for your quote, send them an outrageous one. Too many founders price their businesses conservatively because of their fear of scaring buyers away. That rarely happens. 

What happens more is founders pricing their business too low. This gives off the idea that you're not confident and sort of desperate, which is a huge red flag for buyers. Quote high with confidence and be mentally prepared to walk away if it doesn't work out โ€” only then will you sell your SaaS at a crazy valuation. 

Price smart

Remember when I said you should quote high with confidence just a couple of sentences back? Well, you still have to back the number with other numbers. Here are the things you need to consider: are your annual recurring revenue (ARR) and monthly recurring revenue (MRR) at solid figures and growing? Do you have a negative churn rate? Is your cost per acquisition low? These numbers will eventually come out later so why not save everyone's time and focus on the right buyer?

Valuation strategies 

Now, when you're putting a price tag on your business, there are a few ways you can go about it. I have seen all of these methods being used, some are reasonable and the others make little sense.

Revenue multipliers

The most straightforward valuation approach for SaaS businesses is revenue multiples. You take the YoY growth rate and multiply it by 5x-10x. How much you multiply depends on a couple of factors. 

Let's say, your valuation shoots up to $500,000 for a 5x multiple of 30% YoY growth. But if you don't sell the business and keep the YoY growth rate for 4-5 more years, you'll not only reach the same figures, you'll still have your company. At that time you can sell it in millions! 

This is an oversimplified analogy. This assumes you can maintain that same growth rate year in, year out and everything goes according to plan. But that's unusual. If you exit right away, you get a lump sum amount. 

That being said, the moment you sell a business, you essentially stop earning from it. Even if you put the amount in an ETF or stock, it will not grow at the rate of your business. You have to decide whether it's better to continue with your high-risk/high-reward business to get a bigger valuation in the future or accept a stable return right now. 

Seller's discretionary earnings

This is one of those factors that you as a business seller wouldn't enjoy but can't avoid as well. When you're starting out, you tend to gloss over a lot of expenses because this is your passion project. You can work 15 hours a day handling all the coding and designs and not take a salary for yourself. You might find a cousin who can do your sales and marketing for his portfolio or a high school friend who lets you host on his server. Or you can boast about making $100,000 a month but the thing is: the cost of running the show is extremely low. 

But when you sell it, the buyer needs to look at the ways to run the business. They'd need to hire full-time developers and marketers, get a hosting solution, or even an office space. This completely changes how much the business actually makes when you subtract the costs. This is the seller's discretionary earnings (SDE).

Obviously, I haven't seen a founder who's a fan of SDE because it takes away the bargaining power. But buyers love to discuss this so you should be aware of this while negotiating. 

Earnouts

My least favorite type of negotiation.

An earnout is a contractual provision stating that the seller of a business is to obtain future compensation if the business achieves certain financial goals - Investopedia

Earnout practically chains you to your business. You're free to quote a higher price but you have to reach specific targets within a specific timeframe to get the money. The worst part is, the buyer will have people in the company who'll make it hard for you to reach the goals because they don't want to pay you. 

Consequently, you'll end up working in a company that isn't yours, with people that don't want you to succeed, and for money that might never come. Stay away from this one. 

Industry trends

Valuations can also be based on industry trends. If a similar business in your industry was sold a couple of months back, the buyer will look into the numbers to gauge an industry standard. If you're not sure how to price your business, you can do the same. This is a great starting point for both parties. 

Fine prints 

Selling is less about the big number and more about the fine prints. You'll not only have to take care of a lot of boring stuff but also learn a few new things. 

Cash vs stock 

The first thing: do you want to be paid in cash or stock? Buyer will say stock, I say go all in on the cash. Here's why: selling stocks of private companies is extremely difficult. But if it's Google or Microsoft buying your business, you'd love to have their stocks.  

Non-compete agreement 

No buyer would want you to poach their market share by founding another company. That's why they have a non-compete agreement in place. 

Before you sign the agreement, make sure the scope is not too wide. If you're selling an innovative chatbot business, the buyer can ask you to not make another one a month later. But they cannot ask you to not build anything in the CRM space. 

Know about indemnity

Indemnification is something everyone wants by their side. It basically makes sure you're not held liable for any business fiasco or loss in the future. If you, as the seller, have indemnity from liability, you're essentially shifting the entire onus of what happens to the business to the buyer. 

Everyone wants to protect themselves from sudden lawsuits so this is an important conversation. I'd suggest hiring a good lawyer to go through this process the right way. 

Letter of intent 

A letter of intent is like a term sheet but in the format of a letter. This gives a general overview of the deal, the numbers, the scope, and the dates. But, a letter of intent is NOT legally binding. It cannot be used in court, unless it's used as a contract, with clearly worded legal value with signatures. 

Preparing the business to hand over

You have fixed the deal, weeded out the redundancies, and have the timelines fixed. Now it's time to sort your business. 

Iron out taxes

Taxes are a pain for startup founders and you cannot avoid them, especially when selling the business. If you own the company, you'll be hit with a personal tax. One way you can mitigate this is by locating the company in a startup-friendly region. The UK, Singapore, Switzerland, and Ireland globally, and New Hampshire, Florida, Texas, and Delaware stateside offer great options. 

It's important to talk to a lawyer in your country and region to find the best course of action. 

Spruce up the books

Bookkeeping is another boring yet necessary process that you should leave to an expert. You cannot risk the buyer finding out something odd in your books, which will have a domino effect on the entire business relationship.

Hire a good accountant, work with them and tidy up the books. 

Audit

You have to do financial and business operation audits and provide the report to the buyer. This is sort of due diligence that makes sure everything is exactly as they're described and the parties are not fighting over a lawsuit 5 years later. 

Handing over

Most of the acquisitions happen through escrow and it's important to use this platform. Escrow acts as a third party that receives the money and only disburses it when predefined conditions are met. 

Escrow is secure, and protects both parties. It looks for irregularities and only approves the transaction when everything's verified. 

You have sold the business. Now what?

Escrow has just notified they've released the money to you, which effectively means you no longer own a business that you created from scratch. You are about to get sad thinking about all the memories but your eyes catch the number of zeros in your balance. And that's when it hits: you're financially free, finally!

Emotional high

Selling a business is a major event in life. Don't rob yourself of the victory lap. Be proud of what you did and for once, in probably a long time, celebrate. Celebration helps you reconnect with people and life and it also keeps you mentally in a good space. You need to be thriving mentally for what's about to come next. 

Emotional low

After days, weeks, and even months of fun, a rush of emotions will come back to you. Or in the worst case, you'll feelโ€ฆnothing. 

You've worked so hard for 5-10 years on a project and now you've achieved everything. You have a crazy bank balance and you can do anything you want, only to realize you already did what you wanted to. 

Call it an existential crisis or ennui, but you'll be in a vastly different emotional state at this stage. And that's okay. Seriously, you have no idea how common this is and how many founders go through this. Give yourself more time, talk to people close to your life, and most importantly, reach out to a psychologist. It's better if you start consultations before you sell rather than later.

Early retirement vs investment vs starting over

A lot of entrepreneurs vouch for early retirement by investing smartly. I reckon you're the creator kind who'd love to get back to the grind. 

A lot of founders become angel investors to bet on startups shunted by big VCs. You can slowly grow into the investor role and make a name for yourself as a business influencer, philanthropist, and changemaker. A few decide to stay in their own company as a high-level employee but I don't feel great about that. Having said that, I do respect people having different levels of emotional attachment to their businesses.

If none of these seem fun to you, you can just start over. You've done it once, you can do it again. You must have learned a lot the first time which should make the 2.0 a wild ride. Many founders fear doing this because they let the pressure of outperforming the previous project get to them. 

But if you look at the second idea as a journey, rather than a valuation target you need to hit in a few years, all you have to do is boot up that computer. 

Here's to new beginnings. ๐Ÿพ