Build or Buy – What’s the Best Route for Business Growth?

One of the most common questions I get asked here at theHostBroker.com is “What’s the best way to grow my business?”. I sure would love to have a simple answer for you, but as we all know, growing a business completely depends on your industry and the business model you have, not to mention a whole slew of other factors.

With that said, when it comes to growing a business there are generally two options at your disposal – you can build, or you can buy.

If you’re a business owner thinking about strategies for growth, you must carefully consider the implications when making the choice between growing the customer base organically or with an acquisition or merger on the other hand.

So how can you make this weighty decision? While the answer may not be simple, these 5 considerations will help to guide you:

Build vs Buy: Choosing the Right Growth Strategy for You

1. Keep Your Focus

As the saying goes, time is money, so it’s crucial to keep in mind efficiencies and resources to avoid being distracted.

  • When considering an acquisition, be honest with yourself about whether you have what it takes (time, human resources etc.) to do the necessary due diligence. Even if you do, you may come to the conclusion after many tens of hours that the deal you have been pursuing is not the right fit for you. This means you will now have to start from scratch with a new opportunity. Including all those sunk costs such as the professional services of an attorney, accountant or other consultants. Can your business handle these realities?
  • The route of organic growth lets you focus on specific products or sectors, allowing you to cherry pick your customers by industry, product type, geography, OS, etc. In turn, you will be more efficient with your supporting systems such as vendors, billing software, and human resources.
  • Rather than doing either build or buy, how about taking on both at once? Tread carefully and take into account workload issues. Can you follow this path while doing them both justice or will you just be doing them both poorly? Every business has finite resources, and you need to be maximizing their use and not diluting your efforts by spreading yourself too thinly.

2. The Numbers

Do the math of the cost benefits of acquiring customers versus opting for organic growth.

  • Acquisition multiples will vary but for an average figure, you can assume 1X the annual recurring revenue from revenue sources that aren’t involving a 3rd party, such as SSL certificates and domains for example.
  • The cost for the acquisition of customers with organic growth varies significantly based on the country in which you are marketing, the type of hosting (such as shared, Dedicated, VPS, Cloud, Managed, etc.), and the tactic to acquire the customer (search marketing, referrals, social media, trade shows, display advertising, affiliates etc.). You can assume however that for all but the very warm sources such as referrals and the pay for performance sources such as affiliates, you can expect to pay more than 1X for organic growth.

An important consideration when scaling a business is how will the customers be affected?

  • With the organic route, growth is incremental and more controlled, mitigating some of the risks. The customer profile is likely more homogenous. This means you can replicate your existing structure to support new customers without needing to also acquire specialized skill sets, network infrastructure, equipment etc.
  • For the acquisition route, a big concern is if you don’t have the background to support the new customers. If you already offer Minecraft or ASP.net hosting for example, adding thousands of new accounts will require some integration but likely no major shift in your operations. If, however, you have never offered this service, you just might find that the learning curve is far too steep (read costly). Generally, in an acquisition, the customer base in question doesn’t get split up, or at least not beyond hosting type or OS. This means you have little control over other variables, such as their geographic location, or the customer profile etc., resulting in a more diverse customer base.

4. Effects on the Sale of Your Business

If you’re considering an acquisition, keep in mind your exit strategy.

  • If as a result of acquisitions, the customer base becomes very heterogeneous, this could have a negative impact on an ultimate exit multiple. Let’s look at a few examples of how this could play out:
  • If there are multiple brands purchased where customers are all paying different amounts for similar services, this can become complicated to keep separate not to mention support so as to prevent cannibalization (in other words, the customers paying more will switch to the less expensive brand assuming the offer is similar).
  • You could be in a scenario where a newly purchased customer base hasn’t been around long enough to demonstrate a history of renewals –particularly true for multi-year accounts..
  • If the only growth is due to acquired customers, typically this means that customer churn will not be offset by organic growth. This translates into a buyer purchasing a decreasing asset, which will negatively impact valuation.

5. Completing a Transaction

This is by no means a complete discussion on doing due diligence and all the steps involved in closing a deal, however, I want to touch on a few considerations and answer some questions related to completing a transaction.

  • Due diligence – requires a clear process. Random questions in no logical order will negatively affect the seller’s confidence, require more time to complete DD and most importantly, will likely mean you will overlook critical aspects of a transaction.
  • How likely can you find a suitable target? There are generally more buyers than sellers for a straight forward hosting customer base. If on the other hand the customer base is more niche, this would limit interest. A transaction takes time with possible hard costs, as we discussed above.
  • Typical structure – normally a deal is done with a larger initial payment upfront (usually in the ball park of 50% to 80%) with the rest coming over time (30 to 90 days for the smaller deals and up to a few years for larger ones). Having said this, there are many formats, which include revenue shares (earn outs), different valuations and payouts for different product lines.
  • Financing – At first glance, growing organically may appear to be a less logical route, but there are other factors to consider. In addition to the points above, you have to have access to capital – plain and simple. Consider too that for attractive and well-run operations, the sellers will typically receive multiple offers, meaning you need to be ready to move quickly with access to financing. Organic growth on the other hand can often be self-financed and could be more manageable to support.
  • So, to sum up…For an acquisition you need…
  • Background and infrastructure to manage new customers
  • The resources to devote to the process
  • No marketing experience
  • Access to capital

Organic growth offers…

  • Controlled growth
  • The ability to focus your efforts on specific target markets
  • A generally self-financed solution

When choosing between an acquisition or growing organically or possibly leveraging both strategies, there are various factors to consider. Ultimately, it comes down to looking at your particular situation and what makes the most sense for your business.

Build or Buy? Growing Your Small to Mid-sized Hosting Business Doesn’t Mean You Have to Go It Alone

You may be interested in listening to this session, which took place at HostingCon Global 2014:

Have you decided that the acquisition route is the right one for your hosting business? Check out our comprehensive list of opportunities and businesses for sale. Interested in marketing options? Contact us to discuss some ideas. Still not sure and wanting some expertise to help guide your decision? Contact us today!

Related Articles:

What Can Go Wrong When Purchasing a Hosting Business or Customer Base? A Buyer’s Perspective

Buying any new business is complicated to say the least and buying a hosting business or customer base is no different and possibly even more complex. Becoming educated on the process and potential pitfalls would behoove you. When looking to purchase a hosting company there are many aspects that a buyer needs to be aware of not the least of which is what can go wrong. The purchasing process is time consuming and costly, so you want to make sure you have evaluated and reviewed all provided information and asked the critical questions before proceeding. Below are some elements to consider as you go through this process, but this is by no means an exhaustive list.

Hosting Acquisitions: What Could Go Wrong?

Poor Fit

A buyer needs to take into account plan prices, customer profiles, type of hosting and the geographic location of the customers to name a few. These can all have a serious impact if they are not compatible with the systems and processes you currently have in place to support your customers or ones that you are capable of implementing.

Don’t rock the boat!

Another common issue we see arise is making too many changes too quickly post close. Changing credit card details, IP and billing addresses as well as changing support numbers, process and service levels are all going to cause instability in the customer base through either a lack of customer confidence or service outages.

Support Levels

In order to achieve your targeted ROI, it’s critical that you ensure churn figures are low. You need to be able to maintain and ideally grow the customer base of the business you purchased and not being able to support the customers to the extent they have been used to will lead to increased churn rates. Understanding the expectations of the customer base you are buying is important. You need to know the hours of support and responsiveness they have been accustomed to and be able to replicate this. For example, do customers have the owner’s cell phone number and use this directly for support? Are they expecting to be supported in another language? What hours are they expecting to be able to reach you or someone? Has support been outsourced historically and if so, how was that structured vs the in-house team? Example time of day, level of support, language etc. Has support been provided by an overseas team and how reliable has that been?

Migration

If as part of your purchase you are migrating customers, you need to have a very well thought out plan to avoid the possibility of a botched migration. One very common issue we see and one which is often overlooked is underestimating the time involved and complexity of migrating data between platforms or systems. Migrating customers to different platforms (billing systems, control panels, etc) can also prove to be problematic again causing instability and delays in the process leading to longer than expected contract periods with old data centers, support staff and 3rd party ISV vendors.

Domains Resolving to Seller’s Servers

As a buyer you should be verifying that the list of active customer domains are actually still pointing to the seller’s servers. It’s common that some customers may no longer be on the seller’s servers even if the seller has these customers listed as active and without verifying where the domains reside, this only becomes apparent on the billing anniversary date. This is not a significant issue for customers on a monthly billing cycle but for those on a yearly or less frequent billing schedule, this may not be immediately apparent.

Buying customers that pay in another currency

If you are purchasing a business or customer base with a large international market, there may be challenges supporting other currencies. This can often prove to be more complicated than it may seem initially. It may involve opening an office in the country and/or having to file tax returns in another country. Another issue to consider is that supporting foreign currencies can create challenges with issuing refunds and for those customers accustomed to paying by check where a physical address is needed to receive the checks and ultimately have those checks be negotiated by the receiving bank.

Establish Rapport with the Seller

As is often the case, a buyer and a seller will have no prior relationship. In these cases, establishing rapport with the seller can sometimes prove to be problematic. It is however critical for an effective and successful transaction that both buyer and seller have trust and a constructive relationship – particularly in the event that something goes wrong. Strong rapport makes it much easier and less costly by avoiding what might otherwise be a long and drawn out legal battle. This is even more crucial in circumstances where the seller is under contract to provide post sale support for some predetermined period of time. If follow up support is required, this may be difficult to obtain with a constrained relationship – particularly if there is no incentive to assist once the deal is complete. Initially getting an endorsement from the seller to their customers will be important if the customers will be impacted in some way by the transaction and this is particularly critical where the seller has had a strong personal relationship with their customers.

Purchasing a new hosting company is an exciting and rewarding endeavour. It is even more rewarding when done right and you, as a buyer, are aware of the implications of the deal and deal structure. Education and experience are a buyer’s best resource. Don’t be afraid to ask questions of the seller and your advisors including your broker – it’s your time and money!

As a buyer, you might also be interested in reading more about why sellers sell by going here.

To sign up for our weekly “For Sale” list click here.

Related Articles:

What Can Go Wrong When Purchasing a Hosting Business or Customer Base? A Seller’s Perspective

When considering purchasing a business, most would immediately think of what can wrong for a buyer, but the reality is that there is just as much risk involved for a seller.

Sales Challenges for You – The Seller.

  1. No Financing Secured

One major issue that can cause a lot of stress for a seller is finding out that your buyer isn’t financed. Unfortunately, this is something that may not become evident until post signing of an LOI (Letter of Intent). At this point, for the seller in particular, there has been a lot of time and resources used to move the deal forward. The best case in this scenario is the buyer manages to secure financing, but the worst case is the seller needs to start the process again with a new buyer. This results in lost time, potential hard costs related to attorney fees or staff resources as well as potentially lost opportunities with other buyers.

  1. Renegotiation After a Letter of Intent is Signed

Another problem we see sellers encounter is the buyer tries to renegotiate the offer during the due diligence period while under a signed Letter of Intent or LOI. While the seller normally enters into an LOI in good faith with a buyer, the buyer, either as a result of a predetermined underhanded strategy (possible but unlikely) or through legitimately finding issues with a deal, revises their offer. This leaves the buyer with a tough predicament. Do they accept what is in all likelihood a less desirable offer or do they terminate the deal and attempt to source new prospective buyers starting the process all over again with no guarantee there will be a next offer or that it will be any better. This of course would again come with the same potential costs as mentioned above.

  1. An Inexperienced Buyer

While it is always preferable to enter into a deal with an experienced buyer, there are more and more inexperienced buyers entering the market. A buyer who is not experienced likely lacks a plan and if a migration is being undertaken, this is likely not going to end well! Although a botched migration will clearly affect the value of the buyer’s new asset, it may also cause problems for the seller. This could be due to a seller’s embarrassment with previous customers with whom they know well including family and friends who may now reside under the buyer’s control. Future payments to the seller may be in jeopardy if the buyer is reliant on the continuity of a revenue stream from the customer base they acquired, and which ends up becoming eroded. The seller may not continue to receive subsequent payments if the buyer either blames the seller or can’t financially afford to continue to pay the seller due to this loss of anticipated revenue. Another scenario may be that the seller was offered a position with the buyer’s company and this may become in jeopardy due to financial challenges or simply just a strained relationship between the two parties.

The root of all problems is not always the buyer however. It can be that the seller’s expectations aren’t aligned with reality in terms of time frames, their involvement and selling price.  A seller also may not have planned well enough to handle the work load and discovers they don’t have sufficient resources (human, time, capital) to support the transition to the extent needed and promised.

  1. Not Meeting Payment Terms

Payment is always a contentious issue. There is a possibility that the seller doesn’t get paid as per the terms of the agreement or that the buyer defaults on payments for various reasons. Some such issues could be a disagreement on the payment terms, a disagreement on breaches of reps and warranties or worse, the buyer simply becomes unresponsive.

  1. Delayed Sales Process

While in the midst of a transaction, time is of the essence. If a buyer disappears or takes longer than is reasonable to perform due diligence and complete the transaction, this delay can result in missed opportunities for the seller. This obviously would cause the seller stress and may have significant financial implications not just with the sale of the business in question, but for future opportunities that the seller may not be able to capitalize on.

Any delay in the process also leaves a seller in a position of wondering whether to wait for the buyer to respond or continue with a new buyer and their potential offers.

Sell Your Business from a Position of Strength

Whether buying or selling a business, there are many factors to consider. As a seller, you must be as educated and informed as a buyer. Being prepared and making sure you have the resources, systems and documentation in place to support a sale before entering into a deal will ensure you are starting the process with a strong foundation and will better position you to deal with any issues that may arise.

For a Free Evaluation of your business click here

Related Articles:

6 Reasons Why Sellers Are Selling Their Hosting Business

When brokering the purchase of a hosting business, we are often asked why the host is selling in the first place – especially if the business is particularly profitable. There are a variety of reasons that sellers sell. In this post we will cover some common scenarios and what you need to know as a buyer.

Hosting Insights: What the Seller Is Thinking and What You Need to Know

1. The seller is retiring

In some cases, it is simply a matter of the company owner reaching the end of their working career. They are ready to move on from the business and are looking to sell. This is particularly true in hosting because it can be very demanding on one’s time.

What you need to know in this scenario:

  • This type of seller is often a one-person shop with some outsourced support during off periods.
  • Often this seller will know each of their customers personally and so it will be important to understand if this relationship is critical to the customers staying on through a transition to a new buyer.
  • Signing a non-compete and non-solicit is usually no issue here.

2. The seller is selling off a portion of their customer base

In this scenario, the seller is only selling a specific part of their business such as selling all of their dedicated customers or all of their Windows customers, for example.

What you need to know in this scenario:

  • Oftentimes this is because they want to grow one aspect of their business and it might not make sense to renew certain contracts to support a specific customer base. For example, the host might need to hire or rehire someone with Windows server experience, secure control panel licenses or sign contracts with a 3rd party data center to deliver some of their services. In these cases, some hosts will opt for selling off the customer base rather than having to make such investments.
  • This scenario can sometimes be deadline driven – i.e. they need to sell the customers and move them out prior to having to recommit to some sort of a contract.
  • This situation leads to questions around who will get the brand. Unless these customers are under their own brand, the buyer won’t likely get the brand and this has implications for renewal rates (churn) as well as considerations for how well the pricing structure these customers are used to works with your existing brand. For example, if the seller’s customers are used to paying $20/month and you are charging $5 for similar services, you will see a lot of cannibalization of these customers. Getting clear on a non-solicit and non-compete for whatever services are being sold is also going to be essential in these cases.
  • Obviously in these cases you won’t get a non-compete, at least for hosting services, but you should definitely get a non-solicit unless there is any overlap in customers.

3. The seller wants to change industries

Sometimes the seller is just bored and wants to pursue a new opportunity.

What you need to know in this scenario:

  • Usually this makes for a clean sale, however the seller may not be able to provide much in the way of seller financing if they require the funds for a new venture.
  • Signing a non-compete and non-solicit is usually no issue here although sometimes the seller may stay in the hosting industry, just not providing the same services. For example, they may choose to become an ISV with a control panel.

4. The seller wants to sell to a new owner and ideally wants a job working for a new owner who has more capital and resources behind them

Sometimes the seller is tired of working for him or herself and no longer wants to deal with managing the business.

What you need to know in this scenario:

  • This can be good for a buyer because the seller (and all of their knowledge and possibly relationships) comes with the purchase for no additional charge, assuming that the buyer would need to hire someone anyway. This can solve the buyer’s problem of finding trained employees and gives both the buyer and seller security and familiarity with the business.
  • Rapport between the buyer and seller will be key here.
  • It will be important to discuss roles and ideally the seller is bringing something to the relationship that the buyer is lacking. It could be that one party is technical and the other isn’t or one has a large network of customers and vendors to leverage for future business etc.

5. The seller’s wife (or husband) is going to divorce the owner if he/she doesn’t spend more time with him/her and/or their kids

Typically, this means that the seller is tired. This scenario is similar to #3 above but can in some cases lead to the seller getting back into the industry if they haven’t fully identified what their next gig will be.

What you need to know in this scenario:

  • This situation can support seller financing if the business is of sufficient size whereby an initial payment will cover the seller’s personal requirements for income for a time before subsequent payments are received. This may not be the case, however, if the seller’s business is relatively small.
  • A non-compete and non-solicit will also be very important here because, unless the buyer has identified their future plans (and even if they have), it’s quite possible they will go back to what they know or some variation of it.

6. The seller is interested in selling into a larger company and being a partner in a larger organization

This is a variation of #4 above but instead the seller becomes a minority shareholder in an existing business or a newly created entity.

What you need to know in this scenario:

  • In this case, having a fair and agreed upon valuation of both businesses will be the difficult but required piece.
  • The other points under #4 above will also apply here.

The above reasons for selling reflect some of the most common scenarios that we come across when brokering sales of web hosting companies and internet businesses. While every sale is unique, these general considerations, which can apply across different situations, are important for buyers to understand when starting on the M&A journey.

If you are interested in selling your business, please contact us for a free evaluation.

Related Articles:

What to Consider Before Selling Your Hosting Business

There are many reasons you might be interested in selling some or all of your hosting business. Some of the typical ones include general fatigue, alternative opportunities, a strategic shift in business concentration resulting in a change in services offered (for example no longer offering shared hosting), a partnership that has gone sideways and many more. Once you’ve made the decision to part with what might be your baby, this may be more than just a rational choice and may also involve some emotional aspects. If you are going to sell your hosting business, you should immediately start to think about valuation and how to maximize this.

In terms of what you can expect to get for your business, generally you will be looking at somewhere around 1X the annual revenues for the customers you currently have. This is very much an average figure and there are many aspects which will move this higher or lower. For example, if your shared hosting customers generate $100,000 in sales monthly, this equals $1.2M per year and your business would therefore be worth somewhere around $1.2M.

This is a very simplistic way of looking at things but is a good ball park calculation to help you understand what your business might be worth. The many factors that can adjust this amount upwards or downwards will need to be covered in another post.

You, of course, want to ensure you get the best price, that you attract your ideal buyer and that the sales process goes as smoothly as possible to ensure a successful transaction.

Things to Think About as You Prepare Your Hosting Business for Sale:

  • Ensure that your financials are sound: They should be accurate and current and separate out multiple lines of business if relevant. This means a separate financial statement and identifying line items for each source of income. E.g. if you offer design and development or sell non-recurring services such as domains, SSL certificates etc. or have multiple brands.
  • Long-term financials: Have available financial statements going back ideally three years and have a current year to date. Hopefully this shows growth or is at least flat.
  • Address different product offerings: If you offer shared hosting, dedicated servers, hosted exchange etc. you should break the revenue down for each of these services by type of hosting as well as any direct (variable) costs.
  • Full customer disclosure: It’s important that you are able to produce reports on customers, as needed, in terms of a breakdown by client that outlines how many users you have for each product, how much they pay, the frequency of payment, how they pay (credit card, PayPal, check etc.) when they signed up and their renewal dates as well as bandwidth usage, disk space, any special supported services etc. Include any client details that would be of interest to the buyer.
  • Consider your assets: Prepare a list of capital equipment as well as the specs for each that would be available to a buyer, assuming this is relevant. Think about what domains and assets would be included in the sale such as servers, equipment, websites, toll free phones numbers, licenses etc.
  • Proprietary technology is not valued as highly: If your business has created its own control panel, for example, it would not be valued as highly as a control panel solution that is well understood and easily migratable, such as cPanel. This is true for billing systems as well – WHMCS is very popular and a customer base using this combination would generally be more attractive and therefore be worth more than a solution you may have created yourself. Think about whether you want to retain ownership of this or if it would be included.
  • Flexibility is key: Your willingness to be accommodating in terms of including staff, if relevant, equipment, terms (timelines) for the deal etc. could spell the difference between a quick and painless sale process and one that either never completes or takes much more time. Of course, much of this is also driven by the desires of a buyer.
  • Be up front and transparent: If there are any red flags, they should be brought up early in a conversation. The last thing you want in a negotiation is for a buyer to uncover something on their own, especially in the final stages of a transaction.
  • Looking to the future: Give some thought to your desired role and if you are willing to sign a non-compete agreement. Many buyers want a non-compete signed which will often state that you have to remain out of the hosting business for some period of time.
  • Existing relationships: Are there any contracts with data centers or leasing companies etc. that would be broken and if so, what are the implications of this? If possible, try not to get into these contracts if you plan to sell before they expire.
  • Due diligence: Be prepared to provide reports from your billing system and closer to the final stages of the due diligence process, bank statements and possibly tax returns.
  • Asset sale or Stock sale: If you are wanting to do a stock sale, make sure your minute book is up to date. The vast majority of deals done are asset deals, however.

The above list covers some of the most important things that should be considered during the process of selling your hosting business. We have included additional information to help those in the market to sell on our  FAQ’s for Sellers.

If you are considering selling your business, please contact us for a free evalulation.

Related Articles: