How Do You Know It’s Time To Sell Your SaaS Business?

Selling a business is a daunting prospect for entrepreneurs. It can be psychologically difficult to let go of something into which a huge amount of time, energy, and...

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Selling a business is a daunting prospect for entrepreneurs. It can be psychologically difficult to let go of something into which a huge amount of time, energy, and thought has been invested. In addition to which, many entrepreneurs are uncertain how to go about realizing the best value for their investment. They wonder if now is the right time to sell, how to value the business, and even if selling is the right option at all – perhaps it would be better to retain ownership and control.

At many points in the life of their business, entrepreneurs will be faced with the question: Should I sell? Making the wrong decision is expensive. Business values fluctuate rapidly in response to market pressures, competition, perception, and other factors – many of which are entirely outside of a business owner’s control.

There’s no one-size-fits all answer to the question of when to sell. Every business is unique. However, there are some reliable indicators that – for the benefit of the owner or the business – the time to sell has come.

Overshooting The Runway

Consider this scenario: a developer creates a fairly successful SaaS application. It attracts a sustainable number of paying users and is generating a modest profit. But, if it’s to be a success in a competitive market, the business needs organizational and technological changes so that it can scale. That means hiring a marketing and sales team, a support team, additional developers, and DevOps experts to rebuild the original infrastructure so it’s better able to scale.

The problem — and it’s a common one — is that the business does not generate enough revenue to cover the costs of scaling. The owner is fully invested in the business, and is unable to find additional investors to cover future costs. The business has no more runway.

It’s often hard for entrepreneurs to accept, but in this scenario, selling may well be the best option. The current owner is not in a position to take the business forward, but the existing user base and product have value to a buyer, particularly a buyer who already has the expertise the business can’t afford to hire.

If the owner doesn’t sell, the business may never achieve its potential and, quite possibly, will lose value as the market becomes more competitive.

A Lack Of Enthusiasm For Marketing

For anyone with the ability to code and a great idea, Software-as-a-Service applications offer an obvious route to market. SaaS applications are enormously popular with small business users and have increasing penetration in enterprise organizations. Cloud technology makes it straightforward to deploy the infrastructure to support a SaaS app in next to no time, and the cost profile of IaaS and PaaS platforms offers better value for small business SaaS developers than dedicated or colocated hardware.

In short, bringing a business idea to market as a SaaS app is a smart move.

However, running a successful business involves a great deal more than building the application and infrastructure. Without marketing and promotion, it’s unlikely in the extreme that a business can attract substantial numbers of users. “Build it and they will come” is not a viable marketing strategy.

Marketing is difficult and time consuming. An entrepreneur who relishes coding and product development may not have the time, the inclination, or the expertise required to successfully market their business.

Of course, hiring is an alternative to selling. But for makers who find true satisfaction in building rather than promoting, a sale may well be the best option.

Mitigating Risk In Exchange For A Liquid Asset

Owning a business is a risk. As the business increases in value, so does the risk. When a business is first founded, the risks of ownership are minimal. If the business fails, there is little to lose and the business’ current value doesn’t create a positive incentive to sell. It’s a sad reality that most businesses never move beyond this stage.

But once the business does grow, the value it represents is at risk. Market changes, new competitors, sherlocking, strategic errors, and a variety of other factors can quickly destroy the value locked up in the business.

Selling allows business owners to realize that value and convert it into a liquid asset.

Timing a sale to maximize value is not easy, especially if the business is in a growth phase, but business owners should ask themselves how much risk they are prepared to carry and consider converting the business to a liquid asset.

The tech sphere is littered with tales of businesses that declined a sale and seriously regretted it. To consider one outsized example, in 2008, Microsoft made an offer to buy Yahoo! for $44.8 billion dollars. Three years later, Yahoo’s market cap was just half that. This year, Yahoo’s core business was sold to Verizon for $4.8 billion dollars. Years of managerial errors, market changes, and competition wiped tens of billions from the value of what was once a massively influential and profitable corporation.

The numbers are smaller for the average SaaS business, but the risk and the calculation are the same.

It’s Time To Move On

Running a mature business is not the same as building a startup. Once the thrill of those first few months or years is gone, running a business can seem like just another job. The thrill of creating something new and innovative is gone.

The role of a founder tends to change substantially in the course of a business’ growth. The typical startup begins life with one or two founders who devote themselves to creating a product they believe in. It’s an exciting time, and the founders fill every role in the company.

As the company grows, responsible founders gradually delegate much of the day-to-day development, human resources, support, and marketing work. They hire new people or outsource many of the tasks they were initially responsible for. Running a maturing business is a completely different experience compared to founding a startup.

That’s not a problem if the business’ owners are happy to take on more traditional C-Suite roles, but for some entrepreneurs, it’s the thrill of building something new that drives them. Founders can become bored or burnt out in their new roles.

In an article called Why Founders Fail: The Product CEO Paradox, Andreessen Horowitz cofounder Ben Horowitz discussed what can happen when the founder doesn’t really want to be CEO:

“Not every inventor wants to run a company and if you don’t really want to be CEO, your chances for success will be exceptionally low. The CEO skill set is incredibly difficult to master, so without a strong desire to do so the founder will fail. If you are a founder who doesn’t want to be CEO, that’s fine, but you should figure that out early and save yourself and everyone else a lot of pain.”

Some founders simply aren’t well-suited to a more traditional executive role. In fact, many startup founders created a business so they could control their own destiny and move away from roles they failed to flourish in. A few years later they find themselves enmeshed in running a business, when they really just want to create great products.

For founders in this category, selling their stake in the business is almost certainly the best course of action for both them and the business.

It’s A Feature Not A Product

When it was still a young company, Steve Jobs’ Apple offered to buy DropBox. The DropBox guys turned Jobs down. They thought file sync was a product with a bright future. Jobs, in his inimitable style, disagreed. His position was that file sync isn’t a product at all – it’s a feature. A feature is a tool or piece of functionality that works best as part of a larger whole rather than as a product or platform in its own right.

Time has yet to prove Jobs right here: DropBox is still going strong. But Microsoft, Google, Apple, and others have integrated file sync into their platforms – for them file sync is a complement to existing features as part of a larger platform. DropBox had a head start and its technology is more reliable, but once iCloud’s file syncing reaches parity in features and reliability – or becomes cross-platform – why would an iOS or MacOS user not simply use the tools integrated into their platform of choice?

Many SaaS businesses begin because an entrepreneur or developer spots a problem they’d like to solve. If enough people have that problem and are willing to pay for a solution, it represents a potential business opportunity.

However, entrepreneurs should ask themselves how defensible their solution is: how easy would it be for a larger company to replicate their solution? Would that solution be better placed as part of a broader product set?

If so, that doesn’t mean the company or the product is without value. It has value to established company that wants to offer its customers a ready made solution or broaden its product set.

Venture capitalist Mark Suster talks about group messaging from this perspective. Group messaging was an obvious problem and many businesses have tried to solve it:

“Group Messaging is a feature, not a company … there’s a lot of good companies that do it, but they’re going to have to evolve into broader product sets. I have nothing against anybody in group texting. Just sending messages is a utility product and Apple killed that, not me.”

Of course, lots of businesses are created with exactly this sort of exit in mind. They build something just so it can be bought by an established company. Even if that’s not why you founded your business, selling to a dominant organization in the same area may well be the right move.

Better As Part Of A Larger Whole

In many cases, a business has a great product with a viable business model, but the market conditions and potential synergies dictate that a sale is a positive move. This situation often arises when a new company creates a great product which is a natural fit with another product or platform in the same space. Both could do well alone, but they could do even better together.

An example of this scenario is Drip, a marketing automation company that recently sold to LeadPages. Drip built a powerful set of marketing automation tools, and was generating substantial revenues. LeadPages is a larger company in the same space with substantial VC investment. LeadPages were looking to acquire intellectual property and better serve the enterprise market — an area in which Drip had made substantial progress. Many LeadPages users were also users of Drip, and were actively campaigning for the two companies to integrate.

The purchase of Drip by LeadPages strengthened the position of both companies, and the combined platform stands to generate more revenue with lower costs than would have been possible if the companies had remained independent.

Users But No Scalable Business Model

SaaS-based businesses in particular invest a lot of money upfront in user acquisition. The basic idea is to get as many users as possible, and to figure out how to generate money later. Twitter is an obvious example of this approach, but it’s also common in smaller companies relying on a freemium model.

They create a great product and give away the basic features for free. The intention is to introduce paid or “pro” tiers later with the expectation that the majority of users will continue to use the free tier, but a substantial minority will opt for the enhanced feature tiers. All being well, the paying users generate enough revenue to support themselves and the free tiers.

This is a common but risky strategy. If the application’s market fit is not quite right, or if the number of users moving to paid tiers is substantially lower than expected, the company may not generate enough revenue to satisfy investors, even if it’s generating a profit.

On any given day, Hacker News’ readers will see several “Our Company Is Closing Down” posts, and a substantial proportion of those closures occur because the company failed to enough generate revenue from paid tiers and investors wouldn’t or couldn’t pay for a pivot – the app’s users are sad, but not sad enough to pay.

A recent example is Snipt.net, a SaaS service for sharing code snippets. Originally free, Snipt.net later tried to transition to a paid model, failed to convert an appreciable number of users, and was forced to shut down. It’s a sad story, because it was a very popular service in its niche. It just didn’t have a business model.

In Conclusion

Some founders start their business with the intention of selling it, but for some the decision to sell is one of the most difficult they’ll ever make.

In either case, selling should always be an option. While entrepreneurs invest every ounce of their passion into bringing their plans to fruition, they should also take the time to rationally assess the value of their business, the risk , and the upside of converting that value into a liquid asset.

by Thomas Smale

thomas-smale

About Thomas – Thomas originally founded FE International in 2010. He is a respected expert in the industry with particular experience in due diligence, online business valuation, and strategic exit planning. FE International has completed over $70 million in SaaS, e-commerce and content business acquisitions.

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