Maximize Future Value: Key Components to Consider When Building Your IT Services Business
Increasing the value of
your IT services business in preparation for a sale is not something that can
happen overnight. It’s a process that involves multiple components working
together and builds on itself over time, resulting in an increased value.
While your business may
still be young and you’re looking forward to many more years leading its
growth, your exit strategy should still be considered.
We’ve included below issues of finance, profitability,
technology, agreements, and general management for you to incorporate into your
- Keep Separate Books for Different Lines of Business: While your business may be known for one service or set of services, your suite of services could expand over time to include domain registration, SaaS applications, managed IT services, consulting or other tech services. It is wise to keep separate books for each type of service – especially if relatively unrelated and/or non recurring such as consulting or custom development work. At the very least, use a separate line item for each service and associated expenses in your P&L statement. This will provide you and a potential buyer with the information necessary to evaluate all components of your business individually and enable you to more easily spin out select lines of business in the future.
- Track Revenue and Expenses in sufficient detail: Similar to the previous point, it is important to track revenue and expenses separately to the extent that some expenses may be deemed of a personal nature and discretionary (cars, gas, food, travel, health insurance etc) and not necessary for a buyer to assume. By separating these items in your P&L, it’s much easier to recast the financials to more accurately represent the actual costs associated with supporting the business and launching new products and services.
- Use a Popular Billing System: Billing systems like WHMCS and Ubersmith are popular with many hosting providers and systems like Connectwise are commonly used by MSPs. A key component is their rich reporting capabilities and ubiquity. Be sure that the data in your billing system is clean, and you can easily separate paying customers from friends and family accounts, free trials, test accounts, and other types of accounts which are not actual paying customers. Selecting a billing system which is widely used across the industry and allows you to analyze and report on data in multiple ways and will give a buyer the ability to integrate systems of both companies more quickly and easily during the integration period post close.
- Consider your pricing strategy: Legacy high paying customers can be hard to sell. Although it may seem desirable to still collecting $25/month for shared hosting accounts, this would represent between 2 and 5 times the current market rates and although there is high margin, recognize that churn occurs during the acquisition process and when customers realize they are paying much higher than market rates, the will readily leave. This is particularly the case when they learn that the buyer likely offers a similar plan for much less money. This can create an immediate cannibalization of these newly acquired customers.
- Create/Increase Recurring Revenue Streams: A recurring revenue stream ensures that you continue to receive revenue month after month for as long as a customer is using your services. With a recurring revenue or subscription model, the buyer knows they will have guaranteed cash flow from the start, they are buying a more stable business with a greater degree of predictability, and the recurring revenue component acts as a buffer against other areas of the business which can be more unpredictable. It is for this reason that recurring revenue businesses or components of businesses are of more value than one time revenue sources such consulting work, project work, overage fees, set up fees etc. A common threshold desired by buyers for the portion of revenue that is recurring tends to be about 60%.
- Document Processes and Increase Automation: Documented processes and automation increase efficiencies, provide consistency across employees and teams and ensures a smooth transition for your customers from your organization to the new organization. Examples include an automated billing system for finance and written procedures for technical support or customer care teams on how customer issues are to be resolved.
- Differentiation: Within the IT services industry, differentiation can be a challenge. How can you stand out? Differentiation centers around value-added services, capabilities, industry specific knowledge and resources such as increased automation, more in-depth technical support, and specialization. Trying to be all things to all customers by offering additional services, such as more costly managed IT solutions to what might be a primarily shared hosting customer base or a VAR business, will dilute your abilities and messaging. Customers are looking for an IT service company to deliver a high level of performance, security, support and reliability.
- Proprietary Technology: While your team’s technical expertise may enable you to build a proprietary control panel which enables customers to provision and manage their own services in a unique way, the value of this customization may not equate to an increase in valuation in the eyes of a buyer. While proprietary technology enables you to build a solution that is specific to your needs, a new company may be unable to integrate your solution and data into their existing IT infrastructure and applications. Also, the addition of your customer base may be small relative to the buyers operation and therefore the adoption of proprietary technology across an existing larger customer base may not be feasible. Unless your data is easily portable, consider implementing more widely used technology that can be easily migrated after the company’s sale.
- Straightforward and Uncomplicated IT Resources: As your hosting business grows and employees and customers come and go, there may be a tendency to implement different IT resources based on personal bias, vendor relationships, or other preferences. This can result in the use of multiple control panels, platforms, data centers, and other IT resources that are run in parallel. This can be costly for you to maintain and time-consuming and costly for a buyer to integrate. Utilizing an efficient structure limiting redundant vendors will translate into a smooth transition and ultimately a higher valuation for the seller.
- Utilize Current Technology/Hardware: Deploying the latest infrastructure resources and offering the most current hardware, current versions of software, and security technologies to your clients has a two-fold benefit. First, it demonstrates that you are focused on your clients’ success and the value that these resources can bring to their business. Second, it assures a future owner that there will be little to no additional expenses required to migrate existing customers to the latest technology. This can be a significant cost and time savings for them. Again this translates to further value to a seller.
- Migrations: Migrating clients from one platform to another or one software version to another can be a long and involved process, especially if you are migrating your entire customer base. If it is a migration which will result in any amount of downtime, you will need to inform them that the migration will take place, what the process will be, what they should expect, how they should communicate with you if they have any technical issues during the migration, if they will experience any downtime, how long the whole process will take and the ultimate benefit to them. As a result, it’s best to not embark on a migration just before selling the business. The actual migration and news of an impending sale of the business may prompt some customers to leave and will add unnecessary stress to your team who could be asked to migrate customers and help manage system integrations with a new buyer at the same time.
- Short-Term Contracts Are Better: A new buyer will want to negotiate and sign their own contracts withsoftware vendors, data centers, building owners, and others. If your goal is to sell your business within the next 6 months to 2 years, don’t sign long-term contracts unless the contract states that the terms can be renegotiated if the company is sold or unless you can agree to month to month terms. This will have a very real negative impact on the valuation.
- Reputation Value: The value of a business’s reputation is often overlooked or under-appreciated. Online customer comments such as Google reviews, complaints to the Better Business Bureau, or corporate litigation can live on long after they are initiated. Online searches can bring to light business or service challenges which may have impacted the company years earlier. While negative comments may have been overcome and the situation addressed and the company is once again on solid ground, any disparaging comments, no matter how old, may hurt the perceived value of the business. Ongoing reputation monitoring and management are critical.
- Pay Attention to Intangible Assets: Similar to reputation value, there are additional business assets known as Goodwill which add value to your organization, but which can be overlooked. Goodwill is considered an intangible (or non-current) asset and may include the value of your company’s brand name, your domains, intellectual property (IP) such as patents and trademarks, and proprietary technology.
- Plans for Your Team: Have you thought about what will happen to your employees when the company is sold? Will you require or prefer that all your employees or just a select group be kept on after the sale? If so, for how long? Will they be contracted to complete the integration and then leave after X number of months or will they be able to stay on indefinitely? What about yourself and your business partner(s) if relevant?Do you want a role in the new organization? What does that look like? Will you be a fulltime senior executive or take on a consulting role for a limited time?
- Decrease Risks: Decreasing potential risks or possible disruptions to your business will help increase the company’s value for you and maximize the return for your business’ new owner. A few examples include selling your customer base with your brand included. Work to prevent outages that will harm your brand and cause customers to leave. Require customers to pay by credit card or PayPal to ensure you will be paid and to make the transition to a new owner easier (mailed checks are harder to manage and require customers to update addresses.Don’t implement sweeping company changes, large price increases, changing out existing 3rd party vendors or make other significant changes that could disrupt customers and internal company processes.Focus on employee retention, since happy and knowledgeable employees will help maintain smooth sales and operations.
- Strategically Plan Promotions: Corporate marketing strategy and promotional campaigns are often planned 12 to 18 months in advance and align with your go-to-market, product launch, and business goals. As your plans for the sale of your business get closer, it is important to strategically position your promotions to avoid an onslaught of new customers immediately before the sale. Marketing promotions often include discounts to entice many new customers to come on board over a short time. While this can be perceived as a benefit, it can also reduce the value of your services. It may be perceived by existing customers who are paying the full price that your service is no longer worth the price they are paying or that your prices are not firm and could be changed at any time. It is likely that a seller will view such a large addition of new customers with limited tenure as unattractive due to the lack of a history (concerned that they will not stay), the quality of customers acquired with aggressive pricing promotions tends to be low (high churn rates) and if a promotion for a multi year plan was offered, significant deferred revenue will become an issue.
Of course, when you
start a business your thoughts do not immediately turn to the company’s sale.
You’re focused on growth, delivering the best products and services you can,
providing value for your customers, and determining how to most effectively and
efficiently scale your organization.
For every business,
however, there is an exit strategy. That may mean selling your share of the
business to your partner, turning over control of the business to your
children, allowing your employees to purchase the company themselves, or
merging with or selling to another hosting provider to build a larger and more
Incorporating these key components into your business and model from the start will help ensure you have maximized its value when you are ready to make that exit.
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