Built to Sell – Jon Warrillow – Book Essay

October 27, 2021 by Michael Frew

This Built to Sell book essay is part of a series of essays highlighting key aspects that impacted my career as an online SaaS/software business acquirer and operator.

None of these book reviews are summaries. I am just highlighting items that spoke to me based on my experiences as an online business acquirer. There is a lot more to learn in these books than I cover here, but these are the main takeaways that helped me in my career.

The title of “Built to Sell” perfectly falls in line with my belief that buying businesses is the most reliable way to build and attain wealth. I wish I had thought of the phrase first!

Jon Warrillow is a household name…in the types of households that talk about acquiring companies. The book Built to Sell is a cornerstone of that conversation and has a ton of useful information, not only for online business buyers and sellers, but for any business acquirer or investor.

Although Jon’s book was written with the premise of selling an offline marketing and advertising agency, the overall philosophy closely follows what all online business owners need to keep in mind if they ever plan on selling their companies.

Because online businesses aren’t quite as complex, there are some pieces of advice in Built to Sell that aren’t quite as relevant or applicable to the online business community. Yet another reason online companies are so much more enjoyable to run than a stand-alone retail outlet.

The book is broken down into two parts – a story with some seller checklists – and told as a real life situation rather than a set of lecture chapters.

The story centers around a business owner (Alex) who wants to sell his ‘unsellable’ business and the wise business mentor (Ted) who helps advise him to recreate his business so that it is sellable in the future.

Personally, I find it a fresh and unique approach over the typical “7 things you MUST do to sell your business” style of books.

But let’s make this fun, shall we? In that same vein, here are the seven most interesting takeaways that I learned from this book.

Each is an aspect of keeping your business ready to sell at any time and should be in the back of your mind when you are making the typical day to day decisions with your company.

Seven Lessons from Built To Sell

“You should always run a company as if it will last

forever….and allow it to be sold at any moment.”

This is easily the most important lesson from the book, hands down.

You never know what might happen in your life where you either need to raise capital or divest your business assets in a hurry. Liquidity of your online business should be resident in your mind at all times with every decision you make.

Prior to 2020, I think many owners ignored this advice, but now that we’ve experienced the recent global pandemic, owners know that unexpected events could possibly require each of us to sell and sell quickly.

We also never know when those of us that operate as single-owners could be incapacitated or even pass away.

You want to run your business in such a manner that you could call David up at Quiet Light, turn over your SOP’s, financials, etc., and he could sell the business in 30 days. That’s a lot better than having to completely rearrange your business to make it palatable to buyers.

In Built to Sell, John refers to this as the “options strategy” instead of an “exit strategy”. Always run the business as if nothing will ever change. But keep in mind you may need to sell really, really fast. Try and keep that option open.

Might I add…with brick and mortar companies, selling really fast can mean selling in a year. With an online business, selling really fast can mean money in your pocket in 30 days. Yet another benefit to running an online business as a more liquid, wealth building asset.

The idea of running a business with the “option” to sell became even more relevant and important to me once I got married and people depended on me for their livelihood. Imagine something terrible happening to you and your significant other suddenly having to not only run the business, but try to sell it at the same time. You want to give them the best chance to succeed in either venture.

Consequently, operating your business as if you may sell also helps you run the business in a more organized and logical fashion too. It’s a win win.

Some of the Best Businesses Are Also Worthless

“You need to demonstrate that your business can run without you” *

I would add that you need to make sure you demonstrate the business can run without you and the people you contract or employ, as many times they leave upon a sale and a buyer can’t rely on them not to when negotiating.

When Alex first tells Ted he wants to sell the business, Ted quickly gets right to the point. “Alex, your business is virtually worthless today”.

This statement is very true for a lot of online businesses that are sold in the under $1M market. Many of these businesses are successful due predominantly to the skills, talent, connections, or hustle of the original owner. A new buyer likely won’t be able to replicate those exact skills that made the business successful in the first place. In many cases, without the original owner involved, the business is actually worth a lot less than quoted in the sale price.

Someone once told me that “Oprah’s talk show business was virtually worthless because Oprah is the business”. Sure, there are reruns you could sell as an asset, but who watches reruns of daytime TV from years ago? That’s the main reason she had to pivot to creating Harpo – as a way to remove herself as the main driver of the business value. Many online business owners need to do this too.

I’ve purchased a business where I didn’t realize that the owner was so integral to the success of the business. It didn’t work out so well.

Successful developers that create really strong software companies need to bring in a person or team to replace them before they try and sell the business. If not, it’s going to turn off a lot of buyers from exploring the idea of a purchase of the company.

Patio11 did this before selling Appointment Reminder and I found it to be very reassuring. In the end, I brought in my own dev team to run the business. But knowing there was a fail safe in case of emergency helped him get above his selling price.

If you’re selling, you need to “extract yourself from the epicenter of the operations” as John says in Built to Sell. This is the number #1 reason I shy away from many with SaaS/Ecom/Software businesses for sale. The owner is still integral to the success of the business and expects the buyer to pay top dollar, yet also find a way to replace the seller.

Process Over Charisma

In the same vein of not selling a business where the owner “is” the business, Ted tries to get Alex to come up with a predictable, recurring, repeatable, boring, routine, and understandable system for creating his work product (logos, in this case). Of course, those types of processes are soul crushing for the artists and creatives that make the graphics designs, but necessary to make the business sellable.

Remember…the people looking to buy your business likely aren’t driven by the same passion you had to start the business. In most cases, their passion is your cash flow. They don’t care very much about your original purpose. They just care that the business can continue to produce the cash flow they paid for.

So cast aside those romantic visions of your business and make it a cash flow machine for a potential buyer. That doesn’t mean you have to drop doing what you love in the business, it just means you need to be able to flip the switch and hand over a set of SOP’s and repeatable processes that someone without your talent, skills, and purpose can pick up and run with to the bank.

Not sexy or inspirational, but true.

Don’t Generalize – Specialize

I’ve seen quite a few businesses that show up at a broker’s doorstep that have a whole host of distractions and “other opportunities” tied into the business.

Many of them are half baked ideas the founder(s) had that they spec’ed out and then abandoned. They think that since they put time into it, someone should reward them when they sell, which is wrong.

Brokers usually cast aside these ideas and leave in a line or two in the prospectus indicating there are other things one could pick up and run with. But in most cases, if you’re selling your online business, it should do one thing really well over and over repetitively in a manner that can be reproduced by anyone.

Just focus on selling that one thing. Don’t try and tuck in all the abandoned domains you bought and did nothing with for the past four years.

How Do You Make Your Business Less of a Cash Suck?

“If you get an offer, the second most important number may be the working capital calculation”

New buyers are going to look at the operating capital required to run the business.

For many online companies, this really isn’t a large issue. When you’re sporting 50% profit margins, there’s more than enough cash flow to keep the business afloat, pay the new owners, and not cause wild fluctuations in cash on hand.

Amazon FBA and E-Commerce businesses, on the other hand, have inventory requirements and can eat up cash quickly. Especially in times of uncertain supply – as well as the usual uncertainty of demand – capital can be tied up for long periods of time.

New buyers are going to discount your business if it’s going to require a lot of capital just to keep it running.

The more you can make your business less of a cash suck, the less pushback you’ll get on your price when selling.

Resist One-Off’s, Custom Solutions, and Unique Payment Plans

“If you want your business to be profitable, enjoy fat margins, and thrive without you, you need to stop responding to RFPs and start carving out your own one-of-a-kind product or service”

This is a very important point in Built to Sell and I should have it higher in this essay.

Resist customized solutions like they are the devil who smites strong businesses all day long.

Take it from any business owner that’s ever said “Sure, you can run on this unique plan I’ll make for you”, it’s a nightmare to keep track of…even when you’re 100% on top of your game.

New buyers do not want to find out that 95% of your business runs like clockwork according to the SOP’s and procedures put in place, but that there’s 5% of customers that each have their own unique payment plan, custom code, or infrastructure setup that you now need to monitor separately and maintain.

Not only does that show a lack of discipline of the seller, it indicates that there are likely other misfit issues within the business, like more than one set of customers that always pay late or other users that expect a sit down meeting every time they have a question.

When I was running an e-commerce software solution, I made this mistake repeatedly. Accepting customer requests for 5% of the users ended up taking 50% of our time to keep those 5% happy.

It was a nightmare.

Did the money we made from those unique customer solutions make up for the lost time? Not even close.

I’d rather have 100 customers that all use my service in the exact same way than 500 customers where 50 have unique build outs and payment plans that I have to keep track of daily.

Trust me, buyers want those 100 solid, predictable, and reliable customers over the 500 where 10% of them are a hassle.

Honestly, what would likely happen is a buyer wouldn’t pay for those 10% of customers and then immediately tell those users to go back to using the service as designed or leave. At least, that’s what I’d do.

If your software business has a component that builds out customized solutions, that’s fine. But it’s got to be financially viable and worth it for a buyer to inherit that aspect of your business.

Think hard about this one before you set up a one-off payment plan for a customer. It might bite you down the road – not only when you’re running the business – but also when you try to sell the company.

Is the Seller Running To or Away from Something?

A question you see a lot on Reddit is “why would someone sell a successful business”. Especially something like a successful SaaS business.

It’s a really, really good question.

A lot of online business owners will tell you that they’ve got too many irons in the fire and need to concentrate on the ‘new, new’ thing they got going on.

That makes sense, I’ve had that same issue, I get the feeling.

But I also know that it’s easy to say that because it’s impossible to prove if it’s true.

The seller could also know something you don’t know. They may be looking to offload the business before a certain event either comes to light or transpires that hurts the business.

Nobody knows a market or customer base better than a successful business owner in that space. They are going to see issues coming towards the business long before a buyer. This is all part of that ‘risk’ that buyers take on when they look to inherit a business.

My recommendation is to ask the buyer to show you this new venture that is so important they need to sell their business to fund it and put time into it. Don’t just wave it off saying “oh, yea, I get why you’re selling.” Make sure the seller really is moving onward to a real opportunity and not to avoid a train wreck coming down the tracks.

Built to Sell Summary

Built to Sell is a great book that any buyer and seller should have dog-eared on their bookshelf.

Hopefully these little tidbits help bridge the gap between the Built to Sell story of an offline advertising logo design service business and an online business you might look to purchase or sell.

There are many similarities between the two types of businesses. Obviously online businesses are a bit different, so maybe I should write that book?

What do ya think?

Library and Books Photo by Alfons Morales 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.