This is a chapter from the book Starting & Sustaining which is a system to help you build and launch a web app with less pain and fewer mistakes. The entire book is free to read on the web.

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Understand the process of selling

Selling a business will likely take months, but there’s a lot you can do ahead of time to decrease the sales cycle. Much of it has to be done either way, but if you do the work before listing and selling the business, you’ll get more value. Since you’ll likely have to do the work anyway, why not do it beforehand and make more money on the business while you’re at it. If you’re thinking about selling in the future, start preparing now.

With Sifter, the entire process–from starting with our broker until we closed–took a little over six months. However, that’s only because we had to walk away from the first deal on the closing day, and we had to begin again, looking for a new buyer. Had that first deal gone through, it would have been about four months, but I’ll get into that later.

When you’re selling a software business, there are several things to keep in mind. So much of the business is intangible that it presents challenges for buyers to validate claims made by the seller. As a result, any buyer will have a lot of questions, and they’re going to want historical data and proof of everything for the last 12–18 months. Pulling all of this information together is intricate work, and this is the part where good brokers earn their keep.

The Listing and Prospectus

The first phase of selling is preparing the listing. Any buyer will want details on revenue, site traffic, search engine traffic, news stories, your road map, the team members, operating costs, personal information, and much more. Since software isn’t as tangible as a traditional business, it needs a lot of documentation to demonstrate it’s not all smoke and mirrors.

Unless you’re very experienced, you won’t think of half the things buyers want to see before they even express an interest. You might even be tempted to keep back some information you feel isn’t flattering, but that would backfire. If it doesn’t come up right away, it will surface eventually. Better to have a potential buyer be turned off by that detail before spending too much time with them fruitlessly.

From my research, this is one of the areas where our broker really helped. The questionnaire they give to sellers, combined with the list of documents they ask for up front, is incredibly thorough. While it’s tedious to gather all the necessary information beforehand, you’ll have to do at some point. By collating it in advance, you can narrow down interested buyers to really interested buyers much more effectively, and that ensures the later parts of the process run much more efficiently.

After our broker gathered all of the details, they compiled it into a 21-page prospectus covering company history, our reasons for selling, market trends, opportunities, traffic, financials, operations, maintenance, support, all of the related domains we owned, and more. These all focused on the last 12–18 months and included raw numbers, graphs of those numbers, and screenshots of graphs from our various analytics tools. Most buyers want to see at least the last year of detailed financial history to get a feel for the direction the business is moving.

One of the key tasks that our broker had me complete was an in-depth questionnaire about the business, related assets, day-to-day operations, support, customer demographics, competitor analysis, marketing history, email lists, SaaS metrics, billing, and so much more. There were well over 100 questions and it took four or five hours to complete. Filling out that questionnaire made me really start to recognize just how little I knew about the information buyers would want.

At the end of this information-gathering process, you’ll have two key numbers. The first is seller discretionary earnings (SDE), and the second is a multiple. These two numbers work together to give you an idea of what your business is worth.

SDE represents the amount of money that’s left over after the business pays its mandatory expenses. The biggest lesson for me was that your salary as owner is generally considered discretionary if the business can operate day-to-day without you. For example, if you have a business making $100,000 per year in revenue with $15,000 in expenses, $80,000 in salary and health care, and $5,000 left over, your SDE could be as high as $85,000. A new buyer might have to hire someone at a lower salary to handle some of your responsibilities, and that would likely decrease your SDE. Let’s say the final SDE ends up being $70,000.

The next key number is your multiple. With SaaS and recurring revenue, valuations will generally be between twice and three times your SDE. While there are quite a few factors that influence the multiple, determining it is more art than science. Is the business shrinking, growing, or stagnating? How steady and reliable has it been over the last 12–18 months? How old is it? What are the churn and average lifetime value of customers? How complicated is the business technically? How good is the codebase? Is there any significant technical debt?

With SDE of $70,000, your business could reasonably be worth somewhere between $140,000 and $210,000. A good broker would give you a narrower band of expectation and be able to give you a more precise multiple. At this point, of course, it’s just an estimate, but a good broker will make it fairly reliable.

The other factor likely to affect the multiple is the deal structure. An all-cash deal would mean a lower multiple, but a deal that’s a mix of cash and financing would generally get a higher multiple: the payments are being drawn out, and the new buyer gets to partially pay for the business out of its profits. I’ll talk more about deal structures later.

Finding a Buyer

Once the prospectus is complete and you have a target selling price, the next step is listing the application and searching for a buyer. Our broker handled this by circulating the prospectus to its targeted list of potential buyers and gradually expanding the circle to a wider audience of buyers as required.

The ability of a good broker to discreetly reach a significant audience of potential buyers is priceless. Not only do they reach a wide audience, but they help screen potential buyers so you don’t end up wasting time.

Based on conversations with our broker, as well as other friends who have sold their businesses, publicly marketing and selling a business leads to an incredible amount of tire-kicking. Some people have no intention of buying; others don’t have the resources; yet more could be fishing for data for competitive reasons. In all of these scenarios, you end up wasting a lot of time with individuals who simply aren’t serious.

Beyond saving you from endless conversations with unqualified buyers, a broker can also filter out serious buyers for whom your business isn’t a great fit. All of this ensures that by the time you’re talking to a potential buyer, they’ve been vetted and won’t be wasting your time.

For Sifter, I took calls with five different people; we received four verbal offers; two of those went on to a letter of intent. Just before we signed our first letter of intent, we received another verbal offer from someone with whom I hadn’t had yet a phone call, but we decided not to pursue it because we were comfortable with the letter of intent about to come across.

Letter of Intent

A letter of intent is a simple document stating the agreed price, closing period, and terms of the deal before due diligence begins. Unless something materially adverse comes up in due diligence, the final deal structure will match the terms in the letter of intent. I’ll address deal structures in detail with a dedicated chapter later.

One other key part of a letter of intent is that it will stipulate exclusivity for the buyer. This protects the buyer from a seller fielding other, perhaps better, offers for the business during due diligence. Since due diligence requires a significant investment by the buyer, it would be unreasonable if another buyer came in at the last second and derailed the deal. Think of it as a sort of engagement period for businesses.

Since we walked away from the first deal, we ended up with two letters of intent. While that wasn’t ideal, it was valuable to compare and contrast the approach of different buyers. I won’t go over the details of how the first deal fell through, because the reason isn’t intriguing: an issue was discovered the day before closing, and we couldn’t reach an agreement with the first buyer about how to handle it.

For context, the issue at closing wasn’t the first problem we’d had with that deal. There were multiple concerns throughout the process. It was clear the buyer lowballed us at first, and only increased their offer after we’d received another. Then the letter of intent was materially different from the verbal offer, and they knowingly made the change without discussing it with us. The deal started off on the wrong foot, and we conceded to everything they asked each step of the way. The issue that arose on closing day was simply the last straw.

With the subsequent–and ultimate–buyer, we were incredibly up-front about the issue, and while it was a minor concern, it wasn’t something he felt was important enough to merit not buying the business.

Working with a broker helped me understand which behaviors and requests were perfectly normal, and which requests were a bit unusual. Their experience and guidance played a large part in my education, and let me feel comfortable standing our ground on the final issue that killed the first deal. More on that later.

Due Diligence

Due diligence is the phase of a business acquisition when the buyer goes over everything with a fine-tooth comb to make sure all of the claims in the prospectus are true and there aren’t any other problems that will come back to haunt them.

With a software business, you’ll effectively have three categories of due diligence: financial, operational, and technical. Any informed buyer is going to want to see real financials, proof that the numbers are real, and evidence that the proof is real. They’ll also want to understand operations. Much of that is related to the financials, but will also include things like the processes for support, customer refunds, and other regular business tasks.

The vast majority of the financial and operational due diligence was handled when they created the prospectus. The only financial due diligence left for us primarily concerned getting all of the PDFs and receipts that proved the numbers were accurate. We had a few calls to answer questions, but they all went very smoothly due to the advanced preparation our broker guided us through. One point worth noting is that not all payment processors are willing to transfer accounts. This can be problematic when it comes time for due diligence, so it’s best to research this well in advance.

The technical due diligence was much more interesting. I don’t remember the exact amount of time, but it involved hours of screen-sharing to dive into the code and tools and processes for everything. What’s the deploy process like? How is everything monitored? How’s the test coverage? What’s the overall code quality? What other applications does it rely on? Where is it hosted? What have the uptime and response time traditionally looked like? Are there obvious opportunities for performance improvements?

Code quality was always something I was concerned about. When I launched Sifter, I cut a few corners, but over the years, I constantly chipped away at our technical debt. It wasn’t perfect when we sold it, but we’ve heard nothing but positive noises from the buyer. With smaller apps and teams, it’s more common for things to be less organized since smaller teams can get away with it a little more easily. You should always be investing in improving your code quality and documentation; but if you’re serious about selling, it’s even more true.

Asset Purchase Agreement

At the end of due diligence, assuming the buyer still wants to move forward, you’ll begin hammering out the details of the asset purchase agreement (APA). Barring any unusual discoveries by the buyer, this will take the deal structure from the letter of intent and add specifics to cover a non-compete provision, intellectual property, and other key details.

Here was another part of the process where our experience with the first buyer was night-and-day different from the final buyer. The first buyer had his lawyers draft the APA–and it was long. Our lawyer’s counsel was that it felt far more complicated than a deal of our size merited. It required a fair amount of negotiation on the finer points, and the exhaustion from going through that process and conceding most points contributed directly to my willingness to not give in on the issue that killed the deal on the closing day.

We had been introduced to the second buyer by a mutual friend, and we had several more acquaintances in common. The entire process took place in an atmosphere of much higher trust and respect. As a result, things moved much faster than the first deal, and there was very little back-and-forth. More importantly, it was an all-cash deal that removed the need to negotiate a bunch of details in the deal structure.

Closing and Transfer

Most closing processes will involve escrow of the cash and domain names until both sides have fulfilled their obligations. With a web application, there’s a whole lot of account and domain transferring going on. Email accounts. Domains and DNS. Source control. Hosting. Exception tracking. Help desk. Monitoring. And a dozen more. We spent a couple of multi-hour screen-sharing sessions to hand these over, and things went pretty smoothly.

As I mentioned earlier, it’s generally expected for the seller to remain available via email, and occasionally phone, for the first few months of the transition. While I’m sure some sellers are dying to move on, I may have been a little more involved than the new team needed me to be because I wanted to make sure they were happy, and that everything was incredibly smooth and transparent for customers.

For the most part, I’ve only been adding notes to support requests as they come in. These vary from adding context and insights to feature requests, to just helping share where to find the answers to certain questions. Occasionally I’ll help troubleshoot a few of the more obscure areas of the application, but that has been pretty rare.

Some Parting Advice

Listen to your gut. We walked away from our first offer on closing day, but in hindsight the whole process had a much more legalistic approach that had been slowly contributing to doubts in my mind long before that. We decided to walk away on closing day, but the original buyer’s requests and behavior had been chipping away at our confidence for months. In hindsight, it’s really easy to look back and see that we should have walked away earlier.

Don’t be scared to walk away from the wrong deal. Again in hindsight, the closer we got to the end of the first deal, the more eager I was to get it over with. Only until the impasse on closing day did I finally feel completely comfortable with the failure of the deal. Of course, there’s no guarantee another deal will come along, but if you’re unhappy on closing day, you’ll end up with regrets.

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