In the hosting and ISP worlds, we hear a lot about the multiples of revenue or EBITDA that companies are being sold for. One thing that buyers and sellers should be aware of however, is that the non-price terms of a deal can have a major impact on the price paid. There are two general rules of thumb that we use when evaluating terms;
(1) The more risk a party bears the more compensation they should get for taking those risks; and
(2) Money today is worth more than money tomorrow.
Here are some of the terms in a smaller hosting company purchase/sale that typically make the biggest impact on price (and how they tie to our rules of thumb);
Payment timing (1 & 2). It is easy to understand how this could affect a purchase price. A buyer that is willing to pay 100% of the purchase price on closing would likely pay a lower price (all other things being the same) than a buyer that paid only 20% of the purchase price on closing and the remainder over time. By paying everything upfront the buyer is taking on both more risk and they are paying with money that is worth more (today's money) than the other buyers money (tomorrow's money).
Payment and transaction certainty (1). If there were two buyers with similar offers, the one that offered the greater certainty of being able to make the payments or complete the transaction would likely have an advantage and be able to pay a relatively lower price. This is one reason why we encourage buyers to establish a solid track record of completing acquisitions as it reduce their costs in future acquisitions.
Churn protection (1). Another common term that can affect purchase price is the existence of buyer churn protection. Churn protection is when some or all of the purchase price is tied to the rate of customer retention or loss. A buyer would typically pay more for a company if a portion of the purchase price was tied to the rate of customer retention as it would reduce their risk. For a seller, this may or may not be a good term to agree to depending on the amount of the increase in purchase price and non-renewals, the amount of risk the seller felt they were taking on. The amount of effect this term can have of the purchase price would likely vary with the age and historic stability of the customer base.
Other legal issues. There are a variety of legal issues in most deals that can affect the risk to either party, and as a result, the price. One example - what happens if the buyer of your company is sued after closing, for an event that happened while you still owned it? Is that something the new buyer is on the hook for or is that something you are obligated to reimburse them for?
We've tried to highlight an issue you should think about as you go into a buy or sell process. For more details, please see the slides from a talk at Hostingcon 2008 with Hillary Stiff of Cheval and Joe Bardenheier of The Endurance International Group that addressed a number of these issues.
As always, if you have any questions please don't hesitate to contact us.
BE AWARE THAT THE PURCHASE OF ASSETS OR BUSINESSES MAY BE RISKY. SMALL BUSINESSES ARE OFTEN DEVELOPMENT STAGE OPPORTUNITIES WITH SIGNIFICANT FINANCIAL, TECHNOLOGICAL AND OPERATING HURDLES TO OVERCOME AND PURCHASERS HAVE A MEANINGFUL RISK OF LOSS OF THEIR ENTIRE PURCHASE PRICE.
Disclaimer: This post is for general information purposes and is not meant to be taken as financial advice or a comprehensive discussion of this issues discussed. Please be sure to consult your financial advisors when valuing your company, considering the sale of your business or making other financial decisions.