Boopos Capital – Financing Review for Online Business Purchases

September 17, 2022 by Michael Frew

One of the most frustrating things about online investing is finding the perfect business, but not having the money to buy it.

When you’re trying to acquire $100k – $5 million dollar online software businesses, there just aren’t many lenders that work with individual investors purchasing companies with no hard assets to repossess.

Traditional banks are not incentivized to invest in this space and usually can’t even understand what you’re describing. Personally, I have zero interest in trying to ELI5 how an online business cashflows to a bureaucrat that has never owned a business.

SBA loans are too slow, require a personal guarantee, exclude any type of creative financing, etc.

Private Equity firms are dipping down into our market now, but they aren’t interested in financing operators, just scooping up the businesses themselves.

Groups of successful online investors pool their money together for equity buys, but then you’re stuck with partners. I appreciate partnering solutions, but my primary focus is on being an active investor in my own operations.

At this point in my career, I’m still enjoying the life of a solo operator. I’m not interested in any outside, passive investor asking me “how’s it going” every few weeks. I work when I want, I vacation when I want, and I don’t have to explain it to anyone else that’s not also working directly on the project with me.

With those personal parameters, getting capital to purchase a business isn’t easy…simply because I’m not interested in the terms or lifestyle associated with those traditional types of financing relationships.

Acquisition Financing Firms

Fortunately, a few firms are starting to cater to solo operators or solo teams, like PIPE and Boopos Capital.

In late 2021, I financed a portion of my 2021 online investment using funds from Boopos.

The money is expensive, let’s get that out of the way right away. This isn’t a 4% interest on a 30 year loan, but it is an option. It’s a slice of financing you can combine with other slices of cash to structure a deal.

But in the end, I owe Boopos credit for finding me the business, following through on every promise, and providing the cash exactly when required.

For anyone interested in the experience and process of working with a company like Boopos, I tried to recreate all the important aspects of the deal below.

Introduction to Boopos

I first learned about Boopos from both MicroAcquire and the Rhodium Online Business Buyers mastermind group.

I reached out to the founder, Juan, and we spoke briefly about what I was trying to acquire and established that first ‘loose connection‘ relationship.

Little did I know how important that quick introductory discussion would be just a few short months later while I was trying (unsuccessfully) to unplug and vacation.

Sourcing Deal – “Did You See This One?”

Roughly two days into my vacation, I got an email from Juan asking if I’d seen a business for sale from FE International. For someone who was on the front page of their website at that time, I was a bit embarrassed I didn’t see the listing already. Somehow it had slipped my radar.

Without Boopos, I would have completely missed this listed business because I was on vacation.

After a glance at the prospectus, I knew two things.

First, this was the perfect business for my team.

Second, I was going to become the owner of this business.

It was love at first sight.

Experience with Pre-LOI

One of the best features of a Boopos pre-approved business is they’ve already done a good amount of due diligence on the company.

Now…please don’t misunderstand me…you still need to do a ton more, but it’s nice that someone whose financial liability is potentially on the line gave it a review before you waste even a second on the prospect.

Typically, if Boopos already vetted a business, they will post a loan amount they are willing to put into the acquisition.

For example, Boopos may put $500,000 into a $1,000,000 business if the buyer puts in at least a certain percentage of their own money. (The rest can be financed in other ways, like seller loans, etc.)

At this point, Boopos will share with you their term sheet and pre-close checklist.

Working Out the Financing

The point I want to make very clear below is that Boopos loans are similar to a variable rate loan in an environment with raising interest rates. Except, at least in this case, we know the schedule of rate increases from the start.

I want to illustrate exactly how those increasing rates affect your ability to pay the loan back, so you can construct your acquisition financing to your advantage.

Let’s dig into the term sheet for an idea of what a typical loan might look like for a typical acquisition.

In my case, I was looking to borrow around $200-$300k for the acquisition. In the end, I borrowed less, but the numbers were all the same regardless of the amount borrowed.

Key Variables in Boopos Financing

* Facility is the amount borrowed.

Let’s do this example for $500,000.

* Revenue Redemption Amount is the percentage per month Boopos would be entitled to of the business monthly Revenue (not income).

– 28.0% / month

Boopos will hook into your payment processor(s) (Stripe, PayPal, etc.) and automatically withdraw that money from the business bank account starting on month two after the close of the acquisition.

So if your business made $100,000 in revenue in the first month, a few weeks into the second month, Boopos would withdraw $28,000. That $28,000 is applied to your loan balance.

Keep that in mind when you’re calculating the cash flow of the new business. For some businesses, that 28% revenue cut can be the entire monthly profit, so if you are also financing other debt, make sure you’re covered.

* Repayment Cap is the maximum amount to be repaid, based on a multiple of the Facility.

For example, the Repayment Cap might be 1.6x the size of the Facility. If you borrow $100,000, the maximum amount you would have to pay back is $160,000.

* Opening Fee is like an ‘origination‘ fee or ‘closing costs‘ from a mortgage lender.

Boopos will typically take a 2% opening fee, so if you borrow $100,000, they will send you $98,000 to close the business. Remember that small haircut when you look at the repayment plans below.

* Prepayment rules and corresponding differences in prepayment time frames.

This is where Boopos financing starts to get interesting. Typically, Boopos will reward earlier paybacks by keeping that interest rate lower in the earlier years vs. the later years.

It’s best to think of these numbers as the Interest Rate, not as a Prepayment Rate.

Prepayment – inclusive of Royalties collected to date – will typically look like the following table:

* Before the 1st anniversary: 1.15x
* Between the 1st and 2nd anniversary: 1.30x
* Between the 2nd and 3rd anniversary: 1.45x
* Thereafter: Repayment Cap

So what does this mean?

Let’s do a simple scenario: Assume you have a $100,000 Boopos loan and your new business earns $5,000 in revenue each month with 0% growth. The Boopos Revenue Redemption Amount is 30% of the Revenue per month.

It means that if you pay off the entire $100,000 loan in Year One, you’d have to pay $115,000. ($100,000 x 1.15).

If you wait until the second year to pay the loan off, you’d have to pay back $130,000 ($100,000 x 1.3x)

Remember, you are only required to pay the Revenue Redemption Amount each month, which is 30% of Revenue. Any amount over that required payment is up to you.

What would it look like to pay off the loan at the end of Year One vs. the end of Year Two?

Year 1:

Loan Balance Due Boopos: $115,000 ($100,000 x 1.15x)

Total Revenue Earned from the Business: $60,000 (12 mo. x $5,000/mo)

Auto-Pay Boopos: $18,000 (12 mo. x $1,500/mo)

Remaining Balance at EOY 1: $97,000 ($115,000 – $18,000)

To take advantage of the 15% interest rate, you would need to pay the remaining $97,000 before the end of year one.

Now, this is where it gets interesting, do NOT skip this part!!!

If you allow the loan to mature into the second year, your original balance owed – from day one – goes from $115,000 to $130,000.

Therefore, on the first day of that second year, your balance owed actually increases by $15,000.

On day one of year two, your new payback schedule looks like this:

Year 2:

Loan Balance Due Boopos: $130,000 ($100,000 x 1.3x)

Total Revenue Earned from the Business: $120,000 (24 mo. x $5,000/mo)

Revenue Auto-Pay to Boopos: $36,000 (24 mo. x $1,500/mo)

Remaining Balance at EOY 2: $94,000 ($130,000 – $36,000)

At the end of year one, your balance was $97,000. Now, after another year and $18,000 in additional payments, your balance is only down to $94,000.

See how this starts to snowball and you can’t get ahead of the increasing interest rates over time?

If you let the loan roll into the third year, you’re looking at:

Year 3:

Loan Balance Due Boopos: $145,000 ($100,000 x 1.45x)

Total Revenue Earned from the Business: $180,000 (36 x $5,000/mo)

Revenue Auto-Pay to Boopos: $54,000 (36 x $1,500/mo)

Remaining Balance at EOY 3: $91,000

Crap! We’re still above $90,000 after three years of payments on a $100,000 loan.

Let’s pull that out a bit to show the differences:

EOY 1 Balance : $97,000 (Paid Boopos $18,000)

EOY 2 Balance : $94,000 (Paid Boopos $36,000)

EOY 3 Balance : $91,000 (Paid Boopos $54,000)

If you wait until Year 4, you’re paying back the entire Repayment Cap of $160,000 ($100,000 x 1.6)

This right here is the key to a Boopos Loan. You must understand the increased cost if you don’t pay it all back in the first year.

Where Does Boopos Financing Help?

You’re probably thinking, “This isn’t for me, that’s a lot of money and a high interest rate” and that’s understandable. But, like any financial instrument, there’s a place for Boopos financing in your tool kit to build your portfolio.

Boopos loans are good for businesses where you need a tranche of money to bridge the gap between what you have and what you need.

It’s also good if you believe you can immediately increase the company’s profit and revenue. If you could 2x this business in one year, you’d have much more capital to pay Boopos off in that first year at the lowest rate of 15%.

15% is still a high interest rate, but remember, Boopos financing is a tool that enables you to purchase a business for the long term.

Paying 15% for a short-term loan that closes a substantial deal can be worth it.

In my case, Boopos made up around 8% of the total purchase price, but it helped get the deal done. I would have had to hunt somewhere else to find that cash or give up more equity to someone else. Neither of which I was interested in while trying to close this deal.

My Recommendation

Only borrow from Boopos an amount you know you can pay back in one year.

Full Stop.

That’s how I use them, I never, ever plan on letting that loan roll over into that second year.

Other Benefits – No Personal Guarantee

There are other benefits of using Boopos.

If you take money from the SBA via a bank, they’re going to make you sign a personal guarantee.

For me, that’s a non-starter. I have too many other assets to expose them all to the risk of one deal.

Even if it means a higher interest rate, the most that I can lose from a Boopos deal is the business itself. Nothing else.

Try that with your bank or the SBA.

Other Benefits – Humans – Not Banks

If you’ve ever tried to get money from a bank or the SBA, you know you’re talking to a wall most of the time. An urgent question from you is a suggestion written on a leaflet thrown over a cubicle wall to a full Inbox on the wrong person’s desk.

Compared to the service you would receive from a bank, you’ll love Boopos.

You can reach someone quickly via email and get an answer that day.

Their money arrived the day they said it would arrive.

Their terms were never fudged and they worked around the small challenges that always arise in closing an acquisition.

They do what they say they will do exactly when they say they will do it.

And you don’t find yourself wondering what new factor will scuttle the deal at the last minute and cause the bank or the SBA to hold up the close.

Conclusion and Recommendation

Personally, I will work with Boopos again for a loan to acquire a business that I can pay back in one year.

I thoroughly enjoyed working with their team and I’m excited to see their growth in the industry.

If you have any questions about my experience, feel free to sling me an email.

Photo by Alexander Grey on Unsplash

Online Business Acquisition Costs You Won’t Find In a Broker Prospectus

February 15, 2021 by Michael Frew

Whenever an online broker lists a business for sale, the prospectus will include the ongoing costs for the online business acquisition. These costs are what the current seller and broker believe the new owner will incur moving forward.

These costs typically represent the pure cash flow from the business. Yet, they do not tell the whole story. These numbers are sheltered from routine expenses in the real business world.

That doesn’t mean the broker or seller are trying to deceive you. They trying to remove all the costs that would be variable for different types of buyers. They are presenting a buyer-agnostic set of online business costs. It’s up to the buyer to add-back all the expenses that they would incur to know the true cost of running the business.

For example, business insurance is rarely included as an online business acquisition cost. Yet, most companies over a few thousand ARR a year need some level of business insurance. This is to protect the investment and shield the owner from some personal liability that you should keep in mind.

There is a healthy debate as to what expenses always should be included in an online business acquisition cost prospectus. My goal here isn’t to argue what should or should not be included. My goal is to highlight some types of costs that aren’t typically included.

The Red Flag Online Acquisition Non-Cost – Less than 10% Expenses

Before we go too deep into normal add-backs and costs you should consider, there is one flagrant red flag.

Removing every expense so that a business has almost no ongoing operational costs.

No names will be mentioned, but some very high profile and trusted brokers have started to list businesses that have less than 10% operational costs. 90% profit margins are attainable in some niches (advertising/content). But I doubt so many other niches can suddenly start coming to market with such low operational costs.

It is currently February 9, 2021 at 8:38pm PST. For fun, I’ll look at a few broker sites to see if I can find an example.

I easily found a business listed with revenue of $280,000 that claims their online business cost is $6,000 a year.

That means, for an ongoing expense of $500 a month, they make $22,833 in profit each month.

Of course, the owner claims to do nothing. That’s required, since this business must be ‘completely passive’ at $500/month. Yet, the business grew 50% in the last quarter without a penny in new cost. Does that pass the sniff test? If it does, why would the owner have an interest to sell a business growing 50% a quarter with zero effort?

I doubt both situations can be true at the same time.

I’m not saying the $500 is not true – even though they are omitting a lot of actual time and costs. I’m just saying that those numbers should immediately raise from a red flag warning when related to an online business acquisition cost structure.

Personally, I wouldn’t touch one of these businesses. If you want to purchase one, dig really, really deep into how the business operates. How much of that revenue is coming from legitimate, recurring, and sustainable traffic and customer sources?

Owner Compensation – Pay, Hours, and “Owner Time”

https://twitter.com/ariozick/status/1337035086152282112

I’m the first to admit, I love running my businesses. I work on them all the time. Not because they need me (heck, they would likely do better without me in there mucking things up) but because I love working on them, talking with my customers, and operating in the online business world in general. It took 12 minutes to write this paragraph because I am task switching between business items and writing.

If you asked me how many hours I spend to keep these businesses going, I honestly wouldn’t have an accurate answer. I’d have to think about what I do that’s an essential cost and what I do just because I enjoy it.

Essential costs are creating new marketing goals or filing legal paperwork. Delegated tasks – that some owners do themselves – include customer service, advertising campaigns, and subscription management.

It’s not just that the cost of the extra help would put less money in my pocket. I just love the work. If I get overloaded in the future, I can always pass along my Work the System SOP’s and delegate these tasks.

When a business is ready to sell, brokers do a good job of segregating those activities to determine the time required to run the business.

Despite that, always 2x the number of hours a prospectus claims a business needs from the owner. Just like software projects take 2x longer than expected, you should 2x the amount of time an owner says they work on a business. At a minimum. If they say the business is between 15-20 hours a week, don’t kid yourself, you’re buying a full time job.

Should Brokers Include Owner Compensation?

I appreciate that Owner’s Compensation is usually not included. My owner situation is different than your owner situation. By not including that cost, I can make an accurate judgement based on my own unique circumstances. I may hire someone, add the work to a current team, or do the work myself.

For a seller, if it’s included, it moves the price downward. This conditions the seller to be reluctant to accept any other reasonable price drops. For buyers, I don’t want it included because what I pay myself likely as little to do with the true value I add to the business. For example, the seller may pay themselves very little because they already pay themselves a solid salary in another business.

Personally, I want owner compensation removed. How the current owner pays himself has no bearing on how I will pay myself in the future.

The real issue is when brokers remove the salary of an employee based on the same reasoning. If you’re paying someone $250k a year to run the business, that’s a real expense. Changing it to $150k because you can likely run it with someone less expensive is not acceptable.

Overhead – Routine Online Business Acquisition Costs Not Included

There are a few routine online business acquisition costs that are not included on any financial prospectus. The reasoning is the same as the one for Owner Compensation. Mainly these costs are external to the business itself and completely dependent on the new owner.

An example list of these types of expenses, typically referred to as “overhead”:

Business Insurance (multiple policies likely for online businesses)
Office Expense (home or commercial location)
Internet Access
Computer and Technical Equipment for Owner and Employees
Office Supply Expenses (pens, paper, phone chargers, etc)
Payroll Tax
Payroll Expense
Preferred Software (for example, I use Baremetrics to easily monitor my SaaS metrics, but I wouldn’t consider it essential software to run the business.)

These expenses run into thousands of dollars a year. However, they can also be split up among multiple businesses. Your fixed costs per business decrease as your portfolio grows.

Investors handle these overhead expenses differently based on their own situations. Some skimp on business insurance or run their company out of their bedroom. Others have company cars and pay themselves very well. It’s entirely up to you, one of the benefits of running your own company.

Annual Plan Obligations

Many businesses offer annual plans to their customers. Those businesses may also operate on a cash-based accounting system. This means that when money is received or spent, it is recognized immediately for accounting purposes.

Many companies also offer a discount if you pay up front for an annual plan. By trading for less money today, companies use the upfront cash to gain more customers tomorrow.

When you sell your business, you’ve received the benefit of the annual plan – the money. But have an invisible liability within your company – the obligation to deliver the service.

Brokers do their best to adjust valuations if a business has a lot of annual plans. Yet, I’ve never seen a business listed at exactly 4x and then showing a subtraction in the purchase price for the ongoing obligation of servicing annual plans. I’ve heard “yes, we factor that into the sale price”, but can’t show where that was factored into the purchase price.

If you are buying a SaaS, it might be worthwhile to look at the number of annual plans. Then, adjust the value based on liabilities where you aren’t receiving the benefit.

Help is on the horizon, however. Stripe (and other payment processors) provide a Revenue Recognition feature. This can help illustrate ongoing pre-paid obligations for potential buyers.

State Business Fees, Taxes, and Other Incorporation Fees

A business does not exist without support from state and federal organizations. Think your local Secretary of State and the IRS.

Every business will require an entity for the assets, whether it’s an LLC, corporation, or partnership. (I don’t recommend a sole proprietor set up. It exposes the individual to 100% of the business risk).

Those entities cost money to set up and operate. You will have to pay state fees, state taxes in most states, and other taxes disguised as convenience fees.

Your state of business incorporation – many times the state you live in, but not always – will dictate the amount of paperwork and the costs involved.

There are also operational activities that each business must perform each month, quarter, and year. They can range from documenting an annual meeting with the managing partners (even if it’s just one person) and keeping track of operational documents. This demonstrates that the business is run “as a business” and not as a personal piggy bank.

If you’ve had an interest in owning a business for a while, you likely know most of the things you need to do to start your business. What most people forget is that you also have to operate the business correctly. I used the book Run Your Own Corporation as a starting point for what I needed to do to stay in compliance. I want to sleep easy at night knowing I can show any legal eagles that I’m operating my company professionally.

Discretionary Training, Certifications, and Conference Costs

I’m surprised at how many businesses leave out significant costs that aren’t operational costs, but are part of the “realm” the business operates in…for lack of a better way to say it.

Some scenarios I’ve seen:

Many companies have “must go to” conferences, events, and trainings each year. If leads come primarily from attending conferences, is that included in the ‘owners hours’ and expenses?
Does the business have ongoing compliance certification costs? For example, does the business need SOC-2 certifications? Those cost a lot of moolah and if an owner lets the certification lapse in the year prior to the sale – to lower costs and boost their sale price – is regaining the certification cost factored into the sale price?
What is the cost to replace an owner with multiple relevant certifications and is well known in the industry?
A company says they have “10,000 emails in their database” in the prospectus. Did the company recontact all email addresses collected prior to May 2018 to re-confirm the recipient accepts GDPR compliance and privacy restrictions? (I’ll save you the time, they did not.) Does the seller have GDPR record of consent for each email? If not, the emails are a liability, not an asset.

Under GDPR, email addresses are considered confidential and must be used and stored within strict privacy and security guidelines. Emails can only be collected through explicit opt-in, with a requirement to keep record of consent.

This section could go on for miles. I wanted to give you a little sample some of the more nuanced online business acquisition costs that don’t show up on the broker prospectus. I hope this helps you think through some of these online business operational costs next time you’re valuing a potential acquisition.

None Are Show Stoppers

None of these items are show stoppers by any means. They are just additional costs that don’t show up on the prospectus. It’s good to know about them before you invest rather than learning about them afterwards. Some companies may not look as exciting when you have to 2x the time it takes to run them, they have GDPR issues, and sell 95% of their subscriptions on annual plans. Maybe it will even keep you from ending up with a failed acquisition.

For more similar insights, please check my companion article 8 Buying SaaS Business Insights I Learned from David Newall’s SaaS Business Valuation Guide.

Affiliate Disclaimer: If you click on the Run Your Own Corporation or Work the System SOP’s Amazon links and purchase a book, I earn something like $0.13 – give or take a dime or two. So be forewarned, that’s an affiliate link and I will be compensated so handsomely that I may be able to retire.

Photo by Stephen Phillips – Hostreviews.co.uk on Unsplash

8 Buying SaaS Businesses Insights I Learned from David Newell’s SaaS Business Valuation Guide

October 8, 2020 by Michael Frew

David Newell from Quiet Light Brokerage is one of the most seasoned SaaS-oriented brokers in the online buying and selling community. He recently dropped a 13,000(!) word knowledge-bomb on the topic of How To Build, Value, and Sell A SaaS Business for 6, 7 or 8 Figures.

I’m fortunate enough to have bought a SaaS business from him in the past and he is truly one of the marquee brokers professionalizing our industry. His 60-page article is a must-read for anyone that is building, operating, or transacting in the sub $5M SaaS world.

Much of the article provides a solid background on buying SaaS businesses, but it does also have some intriguing nuggets even for more experienced SaaS operators and buyers that go beyond the beginner basics.

In this essay, I pull out what I thought were the eight most interesting takeaways that I learned from his article and sprinkle in some of my own opinions about our acquisition space.

1) Developers Can Unlock Tons of Additional Income

Let’s look at how brokers set up a business for sale:

“The key-man risk associated with the business is very high, presenting buyers with a major transferability issue (a key valuation pillar). This translates into a discounted multiple, an earnout offer structure (to de-risk the deal), or a very extended transition and training period. None of which is particularly ideal for the owner.”

“A smart, de-risked way to bring in a third-party developer (contractor or employee) is to have them learn the codebase and document it at the same time (code architecture map, annotations, etc).”

“In a best-case scenario, you want to demonstrate to a buyer that the developer has worked for you for a long period of time and had experience shipping major developments with the software.”

What does this all mean to developers and technically experienced professionals on the buy-side?

Brokers require sellers to set up their SaaS businesses to be sold to passive investors, not technically oriented operators like developers, engineers, and IT professionals.

Passive Investors vs. Developers / IT Investors

For a SaaS business seller that was founder run, brokers usually will want the selling founder to set up either a team before selling or have one ready to step in on day one.

This lowers the purchase price because that developer cost lowers the eventual SDE and sale price.

This can be a huge opportunity for developers, or people who have technical experience, or anyone who has managed technical teams before.

As a developer or technical oriented operator, you can purchase the business and either replace the team yourself or bring in a more competent, focused, and less expensive team that you already work with on other businesses.

Since technical help often is the most expensive part of your P&L (after the cost of taxes), this can immediately juice the returns of your business.

Unlocking Value with a SaaS Business Buying Example

When I bought the founder-run business Appointment Reminder, the broker made the seller spend six months training up a team of remote developers to be ready to go to assist me with the business.

Once I had bought the business, I dropped that contract and had my own team just absorb those tasks as another responsibility in their daily functions. (It really helps to always buy businesses in the same tech stack. I’m going to write an article on this concept soon.)

I earned back the equivalent of one year of expenses immediately from that move alone. Instead of taking four years to earn my money back, it would theoretically only take three.

2) The Differences Between Value and What You Get

“Your business’s worth is based on who is out there to buy it in the first place.”

“How much is my SaaS business worth?” is best answered as, “It depends on who you sell it to.”

The difference between value and what you get is:

Value is how much the business is worth using common valuation methods.
What You Get is what it can be sold for in the market.

And rarely the two shall meet.

Your business’ worth is based on who is out there to buy it in the first place and what they say it’s worth.

I run some esoteric businesses where there aren’t a lot of buyers that would pay what I believe is the true value for the business. My value and what I would earn on a sale may not match up.

I can live with that, but only because I don’t go to market assuming I can achieve a sale price that will match what I believe the business is truly worth.

3) Sellers: Understanding the Buying SaaS Business Landscape

Sub $3M Threshold

“…you can see that in the $100K to $3M exit landscape, the vast majority of exits (by volume and value) are made to individual, portfolio, or syndicated buyer types.”

Microfunds/Syndicates: They differ from private equity in that they do not have institutional financing and acquire 100% of the company at closing.

Under $3M, you’re likely only interested in a few types of buyers, and very likely not private equity and strategic parties.

“Private equity investors aim to incentivize the owner to stay on for at least 18 to 24 months post-sale to work towards pre-agreed revenue and/or development targets.”

At a certain revenue point and complexity of the business, it’s almost unavoidable that there’s going to be some post-sale work unless you’re willing to give up a lot of cash at closing.

But under that purchase price level, my recommendation is to get as much cash upfront as possible, with as little post-sale work as possible, and don’t settle for ‘holdbacks’. Holdbacks, which I cover below, are dependent on hitting revenue or development targets where the acquirer determines your “success” in the future. You never know when a pandemic of global proportions might show up and evaporate that hold back payoff.

Above $3M threshold

“Above the $3M threshold, the landscape shifts towards PE and strategic buyers. They focus on revenue-multiple and are willing to pay more, but often want the owner as a part of the deal, working for 18 to 24 months post-sale.”

Above $3M, your choices about selling, taking the cash and walking away get more limited.

There are many cases where getting money off the table is a good idea, even if you end up with a job from the old business you just sold for a year or two. Just be aware that if you’re a serial entrepreneur, you may want to conder selling before you reach that level and move on to buy your next business.

**4) Holdbacks (Sub $3M Range)**

If there is a substantial performance component to the deal, then there should be an emphasis on the skill and experience of the acquirer to ensure they can achieve those goals and future payments.

My opinion on holdbacks?

Pandemics…enough said.

Try and stay away from holdbacks as much as possible.

Remember, the acquirer is the entity that determines if the goals are reached in the future.

And let’s face it, business accounting can reclassify a lot of expenses, assets, revenues, and marketing efforts into other categories that can change key metrics in any direction an accountant would desire.

Holdbacks are standard for larger deals, but don’t let smaller sellers try and “pull-down” holdback standards from the upper echelons of PE firms and act like that’s acceptable under $3M.

5) SBA Eligibility for Buyers

“SBA eligibility significantly increases buyer demand. That’s because they only need a 10% to 20% down payment on an SBA loan to buy a business. If you’re selling for $3M, for example, there are a lot more buyers with $300K in cash than there are with $3M in cash. Because there’s more demand, you can qualify for a higher multiple.”

“SBA loan deals do not come with any earnouts or holdbacks either. As the seller, that means you’ll receive between 90% to 100% of the deal value in cash at closing. That’s definitely a strong incentive!”

As a SaaS business buyer, get pre-qualified before you start looking for deals. If you need help with this SBA qualification process, write to me.

As a SaaS business seller, go through the seller SBA process, it’s painful and annoying, but do it. You can get really qualified buyers that have less cash, but more experience, that can really take your business and run with it.

6) SBA and SDE Add-Backs

“The banks and SBA don’t participate in the adding back of expenses that we discussed in the SDE valuation section of this guide. Instead, they rely largely on the bottom-line net profit.”

This oddity of SBA sales changes how I look at my business in the 12-18 months prior to a potential sale.

If expenses like salary, health insurance, training, R&D, etc. aren’t added back in, then I’m not going to run those necessary expenses in the years prior to a sale. (This is why it’s helpful to have multiple businesses where one that you don’t care about selling can be your “overhead business”. Another article I have coming out soon, stay tuned.)

As a buyer, realize an SBA-backed business likely has some costs and expenses neglected that should have been in the business previously. Tasks that good businesses should be doing, like R&D, new customer acquisition, advertising, etc. may have been ignored for 12-18 months. This SBA rule encourages sellers to leave a well-running business on auto-pilot for a year or so and not invest in the business because it would lower the price of the eventual sale.

Just something to keep in mind when looking at SBA-approved businesses.

7) Buyer Beware of Broker Choice on What Is Really SDE

There are not many direct quotes from the article on this tactic…but between the lines there are hints of how brokers use a “massaging” of valuation periods to improve their asking price.

Here are a few things I always look out for:

Non-Standardized SDE Time Periods

Certain brokers use no standardization of SDE models, they just choose “Whatever trailing model looks best in the last 36 months“.

Sometimes it’s the last 3 months, sometimes it’s the last 18 months excepting the last 3 months.

Make sure you are comparing apples to apples when looking at buying SaaS businesses and using the previous performances of similar businesses for comparisons. Some brokers are more notorious for this practice, others don’t do it at all.

Annualizing Current MRR (“Run-Rate”):

However, in some cases, it makes more sense to use either the last six months (L6M), the last three months (L3M), or even the last month (L1M) and annualize that number instead. If you’re in a scenario where your SaaS is growing very quickly, it’s not appropriate to use the last 12 months. Growth over the last 12 months justifies the re-rating. Customer metrics (like churn and LTV) are stable or improving.

This is the most common method of inflating sales prices. It involves annualizing the most recent months of revenue instead of calculating the last 12-24 months. Those months are guaranteed to be juiced for maximum gains. The business likely had a drop in expenses and a mysterious increase in revenue.

Remember, to bring a business to market, a broker will spend months getting it prepared and looking good to potential buyers. They are basically “staging” the business, just like you stage a house for sale.

Then suddenly at the end of this process, the business has an incredible month or two and they decide to base the price on that purely happenstance great time period? Hmmmm….

High Paying Customers That Aren’t Real Customers

Possibly in conjunction with #2, verify in your due diligence that all high paying customers have been with the business a long time, are legitimate businesses, and not just the seller’s friends juicing up the bottom line that will slowly disappear after the sale.

Every single one of my businesses could easily add one or two fake accounts a month for half a year that would really increase my sale price.

Does that high-value subscription have usage? Is it a real business that’s verifiable? Those types of metrics are harder to fake. Could there exist a seller PBN-style of business that’s not spoken about that provides this type of service?

OK, now I’m getting a bit too paranoid…

One Time Gains Added into Sale Price Calculation

A fairly common way a sale price is inflated is a company that has a one-time product offering (software upgrade, etc.) that is factored into the sale price as if it’s a repeatable, normal revenue driver of the business.

One-time product offerings that required 12 months of work for that one month launch are not repeatable for a new buyer. A new buyer would have to spend all of that R&D money again on the next version but would never get the benefit of the one quoted in the prospectus.

Let’s take an example, a business that makes a net profit of $3k per month has a new product upgrade version come out in July that nets $30k that month. The valuation will take into account that $30k month, even though the buyer gets zero of that income, it is not repeatable, and does nothing but increase the sale price.

The seller gets the $30k and gets to bump up the sale price for what is really a one-time product sale.

Just pretend that this bump in revenue was actually a one-time expense? A broker would call that an “add-back” and subtract that one-time event from the expenses line. But since its profit, it’s left in there to boost the sale price.

Keep an eye out for those…

8) Brokers Protections

Enough bashing brokers! I actually do love brokers and they do a tremendous amount of great work under the hood so you don’t even have to realize how complex this business really is on a day to day basis.

Hiring an advisor means you get access to their list of vetted, pre-qualified buyers. These buyers trust that broker to bring good deals.

There is a discount on the sale price if I have to teach you how to sell your business.

Don’t bother looking for that last quote in the article, that one is mine. Brokers provide a ton of value for their cut of the sale.

If a seller doesn’t want to use a broker to sell the business, then I want a discount (roughly equal to what they would have paid the broker) because now I have to do all that work and it’s a real pain.

Many buyers will gladly do that grunt work for a possible sale, but that’s something I believe should be done by an expert and experts should always be paid well for their services.

Bonus, there are nine items!

9) Why Annual Plans Stink for Buying SaaS Businesses

Monthly to Annual Plan Ratio: As a rule of thumb, monthly recurring revenue is more valuable than annual recurring revenue (i.e., monthly plans vs. annual plans) because MRR is more predictable.

Thank you David for someone finally saying this about annual plans!

I’ve always believed annual plans were a terrible idea for many businesses. If I buy a business that has annual plans, I halt the sale of any new annual subscriptions moving forward.

Why are Annual Plans a Bad Idea?

Annual plans are a pain for accounting, a pain for getting the credit card to work the next year, and why do I need to give a 10-20% discount just because a customer wants to pay upfront now? If you want to pay upfront, that’s great, but it’s still going to be full price.

In many cases, businesses want the cash upfront at a 20% discount because they want to invest that cash immediately in finding new customers. Ok…that’s great if you’re running a business with no cash in the bank, but if that’s the case in our sub $5M world, you have other issues. You’re basically paying 20% interest on a one-year loan. That’s predatory loan interest levels.

Would you take out a one-year loan at 20% interest to buy Google Ads for your business? I sure hope not.

Enough of my opinion about the worthlessness of Google Ads and my opinions on selling annual plans, let’s dig into this a bit.

Free Labor for the Seller, Liability for the Buyer

For any business sale, each annual plan is a liability to the buyer. Each annual plan your buyer has to serve…but was never was paid to do the work. It’s free work for the SaaS business seller and a liability for the SaaS business buyer.

Bad Customers Might Only Be On Annual Plans

Many times I have seen customers are on annual plans because they are bad customers, not because they are good customers.

I primarily do annual plans for customers that I decide either need to be fired or can stay if they agree to pay in full a year in advance.

These are the type of customers that are such problems that only earning one or two months of revenue is not enough to keep them around, they must pay one year upfront for me to let them stay as a customer. I’m sure I’ll do an article about firing bad customers soon.

You may find that the annual plans you are counting on as revenue in eight months never pay again because they were all bad customers in the first place.

Factored into the Sale Price?

I know brokers say they factor annual plans into the sale price, but I’ve never seen any broker break it down and say “This business is worth $1,230,000 at 4x but we’ve lowered the price to $967,500 because of the annual plans.”

They list it at $1,230,000 and claim it was lowered to compensate for annual plans.

Sure…sure it was.

Summary

Hopefully, my thoughts above highlighted some of the things I’ve learned from David about buying SaaS businesses in the past.

Dave did an awesome job of really pulling out the details of many complex moving pieces both for sellers, operators, and buyers alike. Many thanks to him and I’m sure I’ll be coming back to his essay many times over the next few months.