Know what buyers want

Going through due diligence and seeing your business under a microscope opens your eyes. You get to view the business from someone else’s perspective and see where you went wrong. That experience is what prompted me to update this book. Ideally, you’d know everything ahead of time so you can make the best possible decisions about selling your business and getting the most possible value in return.

One of the most important things to keep in mind is that buyers will look back over at least the last twelve months’ performance. You can’t just do a few months of housecleaning in preparation for a sale. Changes made to a business just prior to putting it up for sale typically raise red flags. So make sure you make any fundamental changes to the business at least six months ahead of selling.

Let’s look at specific areas of the business you may not have thought about. First of all, there’s you. Yes, buyers will pay for your business, but your reputation and past performance can either raise concerns or reassure a buyer.

You

Buyers will look at your history and career. That means Google searches, reviewing your Twitter profile–all that good stuff. They want to see a track record of responsibility and care for the product. Anything unsavory they discover might not prevent the sale, but every little detail affects negotiations and the final price. If buyers are concerned about anything, they may still be interested, but they’re likely to make a lower offer.

A big warning sign for buyers is an owner without a good reason for selling. If it looks like you’re trying to hand over a ticking time bomb, you’ll struggle to convince someone else to pay much for it. If your business has critical flaws you can’t fix, you’ll be in a tough spot. Nobody wants to be left holding the bag on a product that’s falling apart.

Don’t lie or mislead someone about your reasons for selling. You know that unloading an unhealthy business isn’t a reliable exit strategy–if you don’t want it, why should someone else?

Another important factor is the amount of time you spend on the business. For any buyer, the value of the business is inversely proportional to the amount of time required to keep it running. A business spinning off $4,000 each month in profit but taking 40 hours a week to run won’t look as good as a business needing one hour a week to make $3,000 a month.

This is where automation comes in, and it pays dividends in spades. If you never sell, automation saves you time so you can either work less or invest your time more effectively. For every task you (judiciously) automate, you’ll reap rewards–both before and after selling. Reduce your overall time commitment through automation, and you make it easier to train someone new–whether a new owner or just a new hire–on the business as well.

In my case, since I had years of medical issues leading up to the sale, it was indisputable that Sifter ran mostly by itself. My only regular time commitment was support, and most of that was very low-tech support like trial extensions and pre-sales questions.

Financials

Naturally, buyers will scrutinize your financials. Often, small businesses aren’t mature enough to have well-organized books, so they need to be closely examined simply to decipher them. On the other hand, where there’s smoke there’s fire–if your books look like a mess, there’s a good chance they are a mess, and your valuation will suffer as a result. At the very least, the due diligence will take longer than it needs to.

Few founders enjoy bookkeeping, but it’s one of the best ways to measure the health of a business or root out any abnormalities in cash flow. As a buyer, nothing is more attractive than a healthy and consistent cash flow. Growth is good, but growth can stall. A business that’s held steady for a year or two gives good reason to believe that it will continue to hold steady for the foreseeable future. Of course, growth is key for increasing the multiple that you’ll receive for the business, but a business with a long history of steady performance is still valuable.

Maintaining healthy books and monitoring your expenditures shows your business in a good light. It’s one of the best and easiest areas to outsource because it requires little effort to get a bookkeeper or accountant up to speed. It’s also not a core competency: there’s no benefit to you managing your books compared to a trusted professional.

With Sifter, I outsourced a lot of work to friends. It was stuff I could do on my own, but I wasn’t obsessed with profit–it was simply fun to work with friends. I’d often enlist the help of others and spend a little cash just for the fun of collaborating. These expenses were all fairly random, but they raised a lot of questions around operating costs. They were easy to explain, but too many things like this can sound just enough warnings to kill a deal or hurt your valuation. Keeping organized and consistent books from one month to the next helps illustrate consistency, and buyers like that.

Make sure that all of your accounts are distinct from any other businesses and not comingled with personal accounts. The more separation, the better. Otherwise, due diligence will involve untangling the mess of deposits and expenses, and it opens up room for errors. The more mistakes that show up during the sales process, the more opportunity there is for the buyer to lose confidence and walk away, or–you guessed it–lower their offer.

Maintain detailed payment processor records: you’ll need proof that the business makes as much money as you claim it does. For that, you’ll need records from your payment processor that show you aren’t inflating the numbers. These records are usually easy to pull together, but it’s worth noting that you will need them at some point. They’ll be cross-referenced with deposits into your bank account to verify the revenue and deposits.

The last things on the accounting front are your prepaid accounts and associated revenue. If your customers pay annually or have otherwise prepurchased, you will have received revenue for a service the buyer will be obliged to deliver. For instance, if a customer prepays for a year in January and you sell in July, you will have received twelve months of revenue while only having been responsible for six months of service; the remaining six months of revenue technically belong to the new owner. You’ll need to calculate these figures and factor them into the sales price.

While payment processor records will show how much money is coming in, your bank records help reconcile those numbers and show how much money is going out. If you forget to include certain expenses in your profit and loss statement, they’ll surface here during due diligence. Review your bank and credit card statements yourself ahead of time. Any expenses that show up as surprises and weren’t originally documented can raise red flags. Too many even accidental omissions can torpedo a deal or at least decrease the buyer’s confidence.

Processes and Documentation

It’s one thing to have clear processes and documentation, it’s quite another for someone else to follow along. Document all of your processes in an easily shareable format.

This means documenting everything, including manual processes. Code reviews. Contact information. Contracting with freelancers. Yearly certificate renewals. System architecture. Vendor information and usage. Support processes, like trial extensions and refunds. Release management. Payment processor usage. Every time you preform any task related to the business, document the process.

For much of this, you probably rely on a set of administrative tools, either custom-built, or vendor products and services. If you frequently perform any tasks by hand from a command line, you should create some sort of web interface for these. Again, even if you never sell the business, both you and your customers will benefit from being able to perform these tasks faster and with fewer errors.

Feature Backlog and Opportunities

When people acquire new businesses, they often look for opportunities to improve things you missed or neglected. Buyers inevitably want to hear about your feature backlog. Are there high-demand features that could quickly be added? What have customers been asking for? Could they improve things simply by giving better customer support? Have you ever done any marketing? How did it go?

The more opportunities a buyer sees, the more attractive the business is. Provide a detailed list of potential features and other possibilities you may not have pursued. You’ll probably have an informal backlog lying around somewhere. Keeping that list up to date with detailed ideas and insights will be one more little thing that helps reassure buyers that there’s a bright future.

Your Email List

Make sure your marketing email list is clean and that the relevant data is accessible. People know they’re buying more than just a business–they’re also buying the leads you’ve collected over the years.

Every healthy business could use a newsletter, and yours is no different. Buyers won’t just be looking at the number of addresses on the list. They’ll want to know about the frequency of newsletters, recent sends, open rates, click rates, spam rates, and the general quality of the list. It’s unlikely that the lack of a list would sink a deal, but having one is a good sign.

Traffic Data and Sources

With any online business, traffic to your site is one of the most interesting assets to buyers. The amount of traffic is certainly an interesting data point, but the quality of that traffic is even more valuable.

Buyers will look to see if your traffic sources are diverse, reliable, and steady. Are there specific sites that generate most of your traffic? Is there any risk that those sites would remove current links? How’s your organic traffic? Are these sources all free, or are they paid for?

Alternatively, a central traffic question is whether the business relies on a larger advertising spend to maintain growth. After taking ownership of the application, will the new buyer need to continue spending on an AdWords campaign or other forms of advertising to ensure traffic levels don’t drop off?

All these factors further play into your valuation and the overall health of the business. The more diverse, robust, and long-lasting your traffic sources are, the better the future looks–and that’s what buyers are betting on.

Code Quality and Automation

High-quality code is its own reward, but we all know things happen and tests aren’t always written. When it’s time to sell a business, however, code quality is a great indicator of how difficult it will be to transition and maintain long-term: few things are more difficult to clean up right before a sale.

Code quality and automation have their own chapters, but it’s worth explicitly pointing out that they will affect the valuation of your business, as well as the amount of effort involved to teach the new team how to run the show. It will likely affect the number of times they have to ask you for help as well.

Having detailed static analysis reports from a tool like Code Climate, combined with thorough test coverage, goes a long way toward reassuring the buyer that you didn’t cut corners and that they’re buying a healthy application.

And, as an added bonus, the better condition the code and tests are in, the sooner they’ll be able to fly solo and the fewer late night calls you’ll receive with requests to coach them out of an issue.

Code Dependencies and Versions

As an extension of code quality, the code dependencies and versions of the modules and other tools your application relies on will be a factor. If you’re using a version of a framework or language that’s no longer supported or known to have issues, a buyer will see that as something to be addressed sooner rather than later. It’s baggage they know will cost them time and money, and that will inevitably come out of the valuation.

Of course, staying current on versions isn’t just useful when you sell. It also means you’ll run into fewer issues, and you’ll have a more reliable codebase to work with as well. The benefits are far-reaching and help improve the overall value of your business.

Contractors and Paperwork

When you hire contractors and freelancers, you need contracts. They don’t have to be long and tedious, but should definitely cover intellectual property. In particular, you need to be able to tell potential buyers that all of your freelancers have assigned any relevant intellectual property to your company. It doesn’t need to be full assignment, but buyers need to know that contractors and freelancers won’t be coming after the business for any of the work they did.

Vendors and Transferability

With any application these days, you’ll have a handful of vendors: hosting providers, email service providers, source control, and more. Buyers will want a complete list of the vendors and associated costs. They’ll also be concerned with the transferability of the vendor. For instance, with payment processors, not all providers will transfer vaulted payment information. The buyer would require all customers to update their payment information–a lot of additional work and the potential for lost customers to ding your valuation a bit more.

You don’t need to spend a lot of time exhaustively evaluating and documenting the legal terms with each provider, but–for your own sake–you should maintain a list and keep documentation from an operations standpoint anyway. Do your best to keep your vendor list current. And when you’re evaluating vendors, if selling is a possibility, consider whether any particular vendor will make it more difficult to sell.

Competitors

Buyers care about competition. How many competitors are there? What are the differences between your product and the competitors’? Where does your product fit into the overall market?

Competitors provide key context about your business, and most buyers will want some level of insight about your product’s space. You can’t control the marketplace, but its worth knowing you’ll likely need to provide some details about it in a prospectus.

Trademarks and Intellectual Property

Trademarks can be troublesome and tedious to obtain, but once you have the revenue to afford it, it’s a good thing to do. Trademarks decrease risk, and a business with less risk is a business with more value. You don’t have to get trademarks on day one, but keep the issue on your radar and handle it sooner rather than later once you have the resources.

Ownership

Complex ownership structures can lead to complex deals. Do you own the business outright? Are there other founders? Does one person have the final say, or do multiple people have to sign off? Is everyone on board with the sale? Small problems tend to have a ripple effect. Most of the time, you can’t do a whole lot about it, but if you have co-owners on the fence, it’s best to establish clear expectations and agree before talking to potential buyers.

One of the best ways to judge a business is to look back through support requests. Are customers generally happy? Have they been treated well? Are there a lot of complaints? Are there any obvious opportunities? If you’ve provided less than stellar support, some buyers might see an opportunity to improve customer support and reduce churn. Think of all those “Under new management” signs you see on businesses: they’re working to erase any negative history.

If support has been clearly neglected, a buyer could worry that the damage has been done. When a product has a reputation for being buggy or having terrible support, any new buyer will be fighting an uphill battle. Seeing the care given in supporting your customers will also serve as a window into the business and the level of care you put into other areas. Like any other preparation, take care of your customers, and you’ll both help the business and its value on the open market.

Fourteen Things That Will Keep Me From Buying Your App JD Graffam shares the factors that he’s found to be central to his decision-making process when buying an application.

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