In 2005, Craig Walker left Yahoo to start his own company GrandCentral Communications. Two years later, he sold it to Google for $US 95 million. The core technology behind GrandCentral Communications went on to become Google Voice. In 2012, Roy Reznik, Assaf Rappaport, and Ami Luttwak started Adallom, a cloud security company. In July of this year, they sold Adallom to Microsoft for $320 million. In 2002, Keerti Melkote and Pankaj Manglik founded Aruba Networks, Inc. to provide services in the wireless LAN marketplace. In May of this year, the founders sold their company to HP for a whopping $3 billion dollars.
Much more than the asset heavy businesses, technology service businesses such as IT firms, Software
product firms, Websites, Mobile Apps, etc face almost insurmountable challenges when it comes to
executing an exit strategy. In tech companies most of the enterprise value lies in intangible assets like the intellectual property rights: the expertise, the source code, the team, etc. The value in these real but
intangible assets often greatly exceeds the value in tangible physical assets. Part of the problem lies in the way that accounting conventions require assets to be reported. These accounting conventions arose long ago and haven’t changed much since then. A comparison of book value of tech companies with their market value will tell us how much value does not appear on the balance sheet. Bill Gates famously said, way back in 1999: ‘Our primary assets, which are our software and our software-development skills, do not show up on the balance sheet at all’.
Tech entrepreneurs are great at building and scaling their services and products. They are the brain behind the business. There was a time when they looked after operations, technology, human resource, marketing and what not. They know every inch of the business and the tremendous value they have built all along. Yet, they struggle when it comes to exits, especially small business owners. How do they encash all the value they have built so far? For many, valuing and selling a technology business without any physical assets such as land and machinery is a very daunting task.
The traditional road to riches for larger companies has been going public. You sell your firm to the public in an Initial Public Offering (IPO). Classic examples include Facebook, Twitter, Square, GoDaddy which IPO’d to provide liquidity to shareholders. But the road to an IPO is not easy for SMEs. Right from hiring merchant bankers to cost of compliance to the risk of a failed IPO, all odds are against a small business.
Several software companies simply just shut down or sell out at the real estate valuation. This is sheer
destruction of value created over a long period of time. But the ones which successfully exit, we see a
common pattern among such SME owners on SMERGERS. These business owners are able to successfully find many acquirers and cash out at fair valuations. The enterprise value of a business is determined by the future cash flow estimates. Typically we see that the enterprise value is anywhere between 5-10x times EBITDA (earnings before interest, taxes, depreciation and amortization) for IT businesses on a no cash, no debt basis. SME owners with an exit on their mind, realize that the most important factor in an exit strategy is relationships. Networking is key. They seize every opportunity to meet with investors and attend investor conferences regularly. They constantly showcase and update the investor with new patents, certifications, awards achieved. They have a positive outlook towards each interaction and come prepared to the table with updated information memorandum and financial projections. They are believers.
For SME business owners who are seeking to sell eventually, the single most important advice is to start networking now with strategic investors and industry experts. And over time nurture these relationships and continuously signal your business strength. Eventually, when you are ready to sell, when you’re ready to take that long break you deserve, there are several ready and keen buyers to take over your business.