Diligence is grueling and getting worse. I was on a conference call today with a close friend who’s an investment banker, and he shared how much more demanding it’s become even over the past few months. Investors, buyers and bankers want more validation, more interviews, more data, more backup and more assurances that their money is being allocated wisely. Risk mitigation impacts everything. SaaS business processes are more valuable than ever.
SaaS Business Processes
And that’s just the M&A side of process and documentation. Even if raising a round or getting liquid isn’t on your roadmap, process has tremendous value to running a predictable, profitable and sustainable SaaS company. It’s also a sure way to sleep more soundly and feel more prepared and professional. But, we’ll write those off as soft benefits and focus more on the hard ones.
Performance, Momentum and Risk
Documentation and process are the keys to proving performance, maintaining deal momentum and mitigating risk. Claims made in a book or business plan become the basis of valuation, conditional bank approval or terms. If claims are unsupported by documentation, deals may be re-traded or rescinded.
I look at the value of documentation and process the same way I look at a home inspection. Homebuyers typically make offers based on cursory tours and facts provided by sellers. Offers are often subject to inspection where a qualified professional takes a closer look to make sure that the buyer is getting what’s expected and that post-purchase risk is mitigated. When inspections uncover material problems, deals are renegotiated and sometimes cancelled. For sellers, inspection problems found by one buyer will likely be found by others. Real problems don’t just go away with the buyer who found them.
This is true of business and process as well. If there are real problems, diligence will uncover them. And, if their found by one buyer or banker, odds are they’ll be found by all. The only solution is to fix the house. And the best solution is to fix the house before its ever on the market—to get the best ‘real’ price that is confident to stick through even the most demanding and detailed examination.
Making the Business and Proving Its Value
Most entrepreneurs view process as distracting and of less value than focusing on the business. Good systemized processes maximize business value, but don’t make business value. So in that regard, the entrepreneurial skepticism is founded. My personal view is that both are needed—the entrepreneurial making of the business and the process driven maximization and justification of its value.
This point meanders a bit, but stay with me… Back on the M&A perspective… Many smaller tech companies think that they’re more attractive to large strategics than they actually are. Many believe they can leverage higher valuations than they actually can. The common understanding of this is that large strategics can expend the same M&A effort to add $100M in ARR as they can to add $10M in ARR. But another part of this is that the $10M in ARR is actually a lot more effort and dollar-for-dollar more risk than the larger company. Why? Because most $10M ARR companies are run like $1M ARR companies. They have few processes. They don’t have documentation. They underinvest in operations, professional services and audits. They are small businesses in practice even if not in revenue—higher risk, more work, less upside. That’s not a super attractive profile for a buyer.
It’s Not About the Toilet Handle
There are two kinds of problems uncovered by home inspections—minor ones that might each adjust the price a few dollars and major ones that blow the deal out of ...