Webinar: To Build or Buy? Growth Strategies For Small to Mid-Sized Hosts

To Build or Buy Growth Strategies For Small to Mid Sized Hosts Thumbnail 1

Hartland and Devin lead a discussion of best practices for growing your web hosting firm. In this session, we will discuss considerations for organic growth as well as growth through acquisition.

Webinar Transcription

Devin: All right. Welcome everyone to The Host Broker’s newest webinar. Thank you very much for joining us. I’m joined today by my boss, Hartland Ross, and my name is Devin Rose and we are from The Host Broker and eBridge Marketing Solutions, and today’s presentation is entitled “To Build or Buy? Growth Strategies For Small to Mid-Size Hosts”. And it’s interesting because Hartland and I have actually given this presentation before or a very similar one, but it was back at Hosting Con in 2015. So needless to say a lot has changed in the industry since then.  I would say a ton has changed since then. So in process of going through the old presentation and looking at it and, adjusting it for today’s marketplace, it was really interesting to consider everything that has changed and we’ll touch on some of those things throughout the presentation.

eBridge Marketing Solutions

Devin: And so Hartland I’ll, maybe I’ll tell them a little bit about eBridge on the next slide there. So eBridge Marketing Solutions. We are a boutique marketing agency and we service IT service providers like MSPs web hosts, and IT service firms. And we were established in 2001 and really offer a full range of marketing services. And the presentation today is entitled To Build or Buy. And the build portion of the title is really referring to the marketing component of growth. So pertaining mostly to, you know, eBridge side of our businesses, and you know, how to grow organically at a consistent rate over time, versus, you know, growing through acquisitions, which I’ll let Hartland talk about on the next slide. 

The Host Broker

Hartland: Excellent! Thanks, Devin. So as Devin said, we started, eBridge about 20 years ago and, focused on the IT services space, and, really based on client demand, we had a lot of groups that were looking to grow through acquisition. And at the same time, we also had, some groups that were interested in, for one reason or another exiting the industry. They perhaps were burnt out, on some cases they had other interests, they had other businesses. We’re now finding that retirement is a, you know, a possible option for some groups. And so as a result, it just made sense for us to put those groups together both buyers and sellers. And so we began The Host Broker, which is a division of, eBridge. And so, my name’s Harland Ross, I’m the founder, and I’m happy to be with you today and thanks for joining us. I’m going to run the session on the M&A piece and growing through acquisition and then Devin, we’ll pick it up at the end here to talk about some of the options for growing a lot more organically, and we do have a lot to through, so I’m going to move fairly quickly and I apologize in advance for that, but to try and give you as much value as you can in as little time as possible, if you do have any questions, feel free to reach out to us, to me, [email protected] is how I can be reached. We’ll have contact information at the end as well. And we do publish our opportunities, our lists companies for sale on thehostbroker.com. There’s a reasonably good chance, you’re already subscribed if you’re listening to this, but if you’re not, you can check it out.  And we also have a managed service providers, data centers, and generally IT Service Firms, is sort of our focus and wheelhouse. We also deal a lot with IP address blocks. So if you’re looking at buying or selling blocks from any of the regions, we’re happy to help you, and those are on our list as well. I won’t be going into that discussion today. That’s a whole other topic for a different day, but we’ll focus here really on growing through acquisitions from a web hosting perspective. I am focused on primarily on addressing this towards buyers. On the other hand, I will address sellers from time to time throughout the session, but certainly, you can put the other hat on if you are, if I say something’s good for a buyer, it’s probably not as good for a seller.

The Environment for Buying

  • Reasonably strong demand from buyers
  • More consolidators that strategic buyers
  • Fewer sellers, especially mid and upper market
  • Sellers exiting mostly due to growth ceiling
  • Lifestyle and personal reasons
  • Partner or founder wants out
  • Business interests outside hosting

Hatland: So, with that in mind, we’ll jump through here. So where are we at right now? What’s the environment. So, it is, and has been, a very strong, from a perspective of a seller, because there are so many buyers, so there’s strong demand from buyers, that means it’s really, these are more of a seller’s market has been like that for a long time. Who are these buyers? Well, there’s a number of different groups. There’s, what we call consolidators. These are groups that are already in the industry that are looking to grow through acquisition. They already have customers. They have a, probably a data center or at least a contract with a third-party data center, and they have a support in place and a team of some sort. Then we’ve got the strategic buyers, which don’t makeup as large of pool as the consolidators, but strategic buyers are groups that have been perhaps on the sidelines, maybe in a related space, and have decided that this would be a good bolt-on and that they would be interested in acquiring customers, because they feel that there’s opportunities to cross-sell or upsell those customers.  We don’t see nearly as many of those in the hosting space, although we do see them in the MSP space. For example, like a photocopy, a printer, resellers are picking up managed service providers, that’s an example, but hosting not so much. The other one we see is, which I didn’t put on here, but it’s financial buyers. These are oftentimes private equity groups and whatnot, and they are looking at hosting. They have looked at hosting, but not as much activity anymore, and they’re really interested in larger opportunities. And there aren’t as many of those. What we’ve seen is really a bifurcation of the markets. So a lot of the bigger players have acquired the mid-market., and so as a result, we’ve got these sort of fewer sellers, there’s the very small group, and then there’s the upper large group, like the GoDaddy and whatnot.  But that mid-market has essentially kind of disappeared over time.  

Hartland: And sellers are exiting for a variety of reasons I mentioned earlier. But, you know, they may have hit some kind of growth ceiling. They need additional capital in order to grow, and they’re just not prepared to do that, or they don’t have the ability to do it. There may be some lifestyle or personal reasons, could be health reasons, as I said, at this point, there are some who are reaching retirement, and in the early days it was founded by teenagers, have a lot of cases. And so they were selling in their, you know, their twenties or thirties and looking to do something else. And, and then, of course, they just, maybe a partner or founder wants out one person can’t buy the other one out and that sort of dissolves the business. And then there may be some other interests outside of hosting. In some cases, it might be related to it, or it might be, you know, real estate as act as a common exit as well for founders or sellers. 

Financing Sources for Buying

  • Equity partners including VCs
  • Debt Financing
  • Cash from operations
  • Vendor Financing

Hartland: So one of the questions I get from some groups is, well, I’m interested, but I just don’t have the financings do you know anybody who would be interested in lending, and do we, what are my options there? Would I be able to get financing from a seller for mine that’s referred to as vendor financing? And so there’s a few answers to this, we don’t get involved in sort of, the fundraising process, but your options really amount to getting some kind of angel investor, or we’re getting some equity from a VC firm. Not probably the most common method that we see. Typically it’s gonna be debt financing. Most of the time it’s going to either come from a bank or actually more often than not. It’s going to be the SBA process, particularly right now with the government looking to kind of stimulate the economy and whatnot. SBA is a great program, downside is, is that it’s a time-consuming process, although they will tell you otherwise there are a lot of hoops to jump through, and sometimes securing a transaction, going up against groups that can simply write a check is a challenge if you’re looking at going that route, but nonetheless, that’s certainly an option. And then probably the most common one is cash flow from operations. So you just accumulated cash over a period of time, and then you can deploy that cash from your existing business or perhaps other businesses and then deploy for an acquisition. And then vendor financing, and you know, vendor financing is always available. It’s just a question of to what degree, it wouldn’t be a recommendation that I would make to go in and pay a hundred percent cash for a business.  Although, you know, there are groups we’ll do it. You may be able to get a very good deal and get a lower multiple effectively by doing it. But typically we’re seeing somewhere in the neighborhood of 60 to 80% down on close with a balance paid over some period of time commensurate with the transaction size. And so, if you were to put down the 60, 80% well we’re, of course, the balance is going to come from vendor financing. And so, so long as they can feel comfort with you as a buyer of them, then that shouldn’t be an issue. They may ask for either personal guarantee, or they may also ask for the other methods of kind of securing that, for example, like a lien against equipment or something. So bear that in mind, but, it’s certainly an option for you at some level. 

What Actually Gets Sold?

  • Most transactions involve assets (not stock):
    • Customer Base
    • Equipment
    • Licenses
    • Leases
    • Softward
    • IPs
    • Domain Name
    • URLs
    • Websites
    • Employees
    • Intellectual Property
    • Etc.

Hartland: So what are we talking about in terms of what’s actually being sold? Most transactions are being done as an asset transaction, not a stock or a share deal. And the rationale for that is that most buyers are looking for revenue, they’re looking to achieve synergies and realize cost savings. And so the cost structure that a seller has is not really indicative or overly useful for a buyer because they’re going to get rid of a lot of those costs. So to worry about what the margin is typically not going to be a factor. Having said that, of course, it does depend on the nature of the business being acquired. And in some cases, if it’s going to be essentially left as a turnkey business and customers are going to remain in the same data center or perhaps they have to.  And then certainly, the margins are going to be more important. And, and of course, some cases where we might see shared hosting customer bases or even BPS for that matter being sold at very low price points and then servers being oversold as the way to make up some of that margin that may be a problem for a buyer. And if you are a buyer to recognize those issues, because you may not be able to realize the same margins that a seller realizes if they’re overselling their equipment. So what are we looking, talking, about selling? Uh, well, of course, this concludes there, the customer base, which is the revenue base, equipment, potentially not always included, but oftentimes a buyer may not even want the equipment if it’s old. But oftentimes we’ll be available if a buyer wants it, licenses to take over the licenses ake over the leases, assing that they’re all assignable and that, that can be done.  Software licenses, IPs, if there are any, that’s a whole other discussion as I mentioned, but it’s a problem these days because IPs are a lot of cases are worth more than my customer base or worth a substantial amount relative to the value of the customer base. And so in some cases, it actually may make sense for the seller to tell the buyer, sorry, to tell their customers to, to find a new home for hosting so they can free up their IPS and sell their IPS for as much or more than the customer basis worth. So that’s an interesting one to navigate. And as a physical being known a bit of a tricky one over the last few years, and I guess there’s a bit of a process that we’ve been able to figure out, a path on some of them, but it still makes it, an interesting transaction.

Hartland: Domain Names, obviously not just the brand domain name, but related ones as well. So you should expect those, the website, employees. You aren’t going to necessarily, you’re not buying those, but you would simply take those employees over and provide your own contract to them. Of course, some of them may not stay, but, and you may not wish to, as a buyer to have them, but in the event that you do, sometimes this is a good way to pick up resources that in some cases are scarce and they know the customer base and they know the systems that might help you to make more of a seamless transition and, and to reduce churn, which of course is really the most significant component of these types of transactions. Intellectual property, in some cases, usually that’s not a factor, but can be in some cases, included as well if the seller has built something, for example. 

Overview of the Process

  1. Broker’s agreement & responsibilities
  2. Non-disclosure agreement
  3. CIM/Overview/Package&Questions
  4. Valuation
  5. Deal Structure
  6. Negotiation
  7. Due Diligence
  8. Closing to migration

Hartland: So I’ll just go over the process. This is our agenda, and I won’t read through each item here, but we’re, there’s a slide or more that I’ve devoted to each one of these. So, we’ll follow this process, which is essentially starting off at the beginning of, well, I’m interested as a buyer, where do I start all the way through to completing a transaction. So we’ll just walk through those steps now in the next number of slides. 

Broker’s Agreement & Responsibilities

  • Assuming there’s a broker involved…
  • Buy side vs. Sell side
  • Roles and services provided
  • Legal, financial, and operational due diligence
  • Fees

Hartland: So the first step, at least from our perspective, and I know this is fairly common across the industry, is that there’s a broker’s agreement of some sort. So what does that do, that outlines the responsibilities that we would have to you as a buyer and what services are provided, what aren’t provided and, and of course, how we’re compensated.  So there’s, buy-side versus sell-side. We are paid by the buyers. And so, our fee is entirely success-based. So if a transaction completes, then we are paid, we are not paid any sort of retainer or consulting fee, but we are also tied, our fee structure is tied to the deal terms that are agreed to. So for instance, if a certain percentage of 60% were paid on clothes and the balance were paid in for argument’s sake, 12 months, then our fee would be commensurate with that same schedule. In terms of legal, financial, and operational due diligence, as much as we will help steer that and help ask questions, ultimately, the due diligence would rest on the shoulders of you as a buyer. And of course, the seller is going to be obligated to provide the relevant supporting material. But you’re going to have to be the one as a buyer to make sense of that. And you may find that you may need to bring in some additional resources from your CPA or your attorney to certainly, you know, draft up agreements and review those types of things, but we would be helping you to kind of navigate the process, avoid some of the issues that we’ve seen in the past and bring up any red flags. 

Non-Disclosure Agreement

Hartland: So next step, after agreements are in place, is the non-disclosure agreements. So pretty straightforward,  to sign an agreement that states that you’re not going to talk about the business or share any materials with anybody who’s not in your inner circle of advisors or employees. And that agreement is typically between the seller and the buyer. Or if there is another broker involved, then it may be an agreement between you as a buyer and the brokerage firm. 

CIM/Overview & Questions

Hartland: So once that’s in place,  then you would have access to the materials which have different, I guess, terminology, but oftentimes it’s referred to as for some the Confidential Information Memorandum, or overview or book or package, essentially different terms to mean the same thing. And that will give you the financials and give you the background on the business, and then would allow you to review it and decide whether it’s of interest to you.  In some cases, there will be a preapproval needed by either on a brokerage firm, to get you as a buyer approved, or, if there is seller, as mandated by the seller, then they may want to, to approve, groups on a case by case basis. And then your questions that you would come up with as a buyer for the seller, would be provided to certainly to us as a broker to provide answers to those questions. Either we may be able to answer them directly, or we may have to find that information out from the seller or from a seller’s broker, and those questions can be emailed to us, or sometimes, they’re facilitated through conference call environment, although typically, email would be the place to start. And then a conference call would sort of build on that afterwards. 

Devin: And Heartland, question on that, if you don’t mind, is there any particular good questions that you’ve come across that you think people should be keeping in mind for this stage of the process? 

Hartland: Well, one of the things that, and I have a slide at the end of this presentation I’m addressing is that I think it’s always a good idea that the buyer has a predetermined list of questions for their transactions so that they’re not winging it, but that they have an established process for evaluating these types of opportunities. And that they’re clear on what they’re looking for. The questions are really, ss many as, although you may have a lot of questions, a lot of times those questions are going to be answered. So each time, the questions are going to be unique and specific to the opportunity at hand. So, it’s that the templated questions is an important exercise, but not all are going to apply. And so then it becomes a matter of identifying which ones are outstanding and those are the ones that  I suggest that you know, provide in an email or addressing in a conference call environment. 

Valuation

  • Rule of Thumb: 1x annual run rate (12 months)
  • Higher for larger transactions
  • Varies and depends on many factors

Hartland: So one of the questions that I often get is, well, how much are hosting companies selling for, and what does that look like? So,  if I give you a quick answer to that, it’s a one times as a multiple of the annual run rate. So this is going to be your recurring revenue. So if a company is doing $500,000 a year in revenue, then what next is going to be one times 500,000 and it’s going to sell for $500,000. And so, that’s the quick answer the reality is that there are a lot of factors and I’ll talk about those in a few moments. But, the figure will vary also, of course, for transaction size, the larger the transaction, generally speaking to the greater, the multiple. And as I mentioned, that these businesses are typically valued as a multiple of top-line and not cause a multiple of EBITDA, but again, that’s not true across the board, larger businesses, especially ones that are going to remain as intact, if you like, as a going concern are going to be valued oftentimes as a multiple of their EBITDA or perhaps, as the seller’s discretionary earnings. 

Factors Impacting Valuation

Hartland: So what are some of the factors, well, there’s there, we really, grouped them for the purposes of this presentation to any way into financial, technical, and human. And so I’ll address each one of these, but to the extent that you, as a seller can start putting checkboxes in these, you will realize an additional premium for your business. And of course, on the flip side, as a buyer, to the extent that a business does not have some of these aspects, you will be able to justify a lower offer. 

Financial Factors

  • Growing or declining (churn)
  • Different lines or business valued differently
  • Accounts prepaid or paid monthly (deferred)
  • Assumption of Contracts
  • Payment Terms

Hartland: So starting off with, financial factors, is the business growing, or is it declining? So, or is it flat? I mean, we see that as well. We’re really not much has changed in the last three to five years. And so, important to understand if it is declining, so there’s churn and is typically underlying churn. Anyway, it’s going to be in a 1 to 2% per month range as an average, but that may be offset through our organic growth, and ideally is offset that way. So, looking at the churn numbers is key and recognizing that well, if I buy the business now for my example of $500,000, if I do nothing and it’s already going down at 20% a year, then, of course, you know how many, it doesn’t take that many years before the there’s really nothing left for the business.  And so what kind of a return am I looking for? So, that exercise needs to be gone through. Valuing different lines of business differently. So is it shared, is it ups is a dedicated, , is there a, a managed offering and, you know, each one of these will have its own margin and each one of these would be valued a little bit differently. Generally speaking, shared and BPS are going to be valued more highly than like a. For instance, a dedicated or co-lo business. Primarily for the reasons that, as a result of them being, essentially a virtual business, they can be migrated, move virtually. And so it opens up the market to anybody anywhere, essentially, versus dedicated and colo, which is more regionally specific. And there’s, of course, more costs to, you know, rack and stack these customers and to ship them at overnight FedEx or back of trucks or whatever it is. 

Hartland: Another factor is whether there’s a deferred revenue. So essentially deferred revenue is revenue that’s being paid for some period in the future. And anything that exceeds one year is typically defined for purposes of hosting transactions as deferred revenue. And so if there’s revenue that is deferred, it will oftentimes not always, but oftentimes, and you as a buyer will want to consider whether you want to do an adjustment on that. So for instance, if a customer were to pay a hundred dollars a year for three years, so they paid $300 and they paid that yesterday and a buyer buys the business in two months, there wouldn’t be an adjustment for that first year, but there would be an adjustment for those two other years. So in other words, you, whatever the offer is in the end, you would subtract $200 to a hundred times each of those two years as an adjustment for that deferred revenue. 

Hartland: Another factor is the assumption of contract. So typically as a buyer, you’re not ideally wanting to take over a lot of existing contracts, the more you’re taking over of their system, the more you’re going to be stuck with the same model, the same margin that the seller has got. And, and although that may be decent, a lot of times, there’s opportunities to realize gains there. And so to the extent that you can consolidate and not have to stay with the same data center contractor or bandwidth provider or whatnot, will help you realize an upside. And then there’s of course, payment terms. So generally speaking, if you want to get a better deal, you’re going to pay more upfront. And if you want to pay more, but you want to have some financing from the vendor-provided, then you’re going to pay, you’re going to pay more, but you’ll pay it over more, over a longer period of time. Most transactions we’re seeing are sort of six to 12 months, but certainly, there are structures that we’ve done where it’s three years and I’ve heard of, of longer than that as well. 

Technical Factors

  • Nature of client base (Windows vs. Linux, et.)
  • Ease of account migration
  • Use or proprietary software
  • Inclusion of IP blocks
  • Age/condition of hardware
  • Compatibility of infrastructure
  • Loacation of infrastructre

Hartland: Technical factors. So windows versus Linux, well, Windows is typically worth less than Linux, often in most cases. And it’s a large part as a result of the licensing fees. But also just, there’s more buyers, I guess, that are familiar and comfortable with Linux. And so it puts a bit of upward pressure on it, as well as a supply and demand exercise. So ease of account migration, can the customers be migrated. And so that speaks to the billing software, it speaks to control panels and the ability to get out of if there’s proprietary systems, then that’s typically, unless it can be gotten out of easily migrated out of, typically not valued as highly. We talked earlier about the inclusion of IP blocks. So if there are, there’ll be a potential lift there, although generally speaking, we’re talking about unused and utilized IP blocks, if they’re used in the business, then they, aren’t going to realize additional value hardware. 

Hartland: Did you buy it all yesterday as a, if you’re a seller, if there’s a new equipment, then as a buyer, you might justify paying a little bit more. If there’s the equipment’s old and needs to be replaced, or, you know, even if it’s a year old, it’s just going to be asked to be included as part of the transaction, and there’s no premium to be paid for extra hardware. Now having said that there might be some expensive switches or sands or something like that might, realize some additional benefit, but generally speaking, servers don’t. Compatibility of infrastructure is another piece. And, and then of course the location of the infrastructure. So is it in North America? Is it in Europe? Is it in Eastern Europe or Asia somewhere? Uh, what are the, what abilities are thereto, to relocate and, or consolidate that, those footprints.

Human Factors.

  • Reason for selling
  • Owner’s relationship to customer base
  • Strategic benefit to buyer
  • Competing offers
  • Seller Support
  • Brand Reputation
  • Geography of customer base 

Hartland: So why is the seller selling? Well, obviously if they’re selling, because there’s some desperation for money, they’ve got, they own their data center money, they’ve got other debt and they need to offload this quickly. Maybe they’ve got another businesses, absolutely taking off and every day is, that their investment they’re spending in our hosting business has taken away from you know, the opportunity costs in this other business. And so there’s a motivation for them to get a transaction done quickly. Uh, so that would have been a factor, owner’s relationship to the customer base. Do all of the customers have the owner’s cell phone number or are they used to using a help desk? And if the owner is entirely removed from that process, then all the better for, from a buyer’s perspective, if they’re reliant on the owner, and then there’s a concern, of course, then with the new owner that some of those customers might leave. Is there a strategic benefit to the buyer and if they are looking to get into a new market or there’s a good fit, sometimes by industry, not so much with shared ups hosting, but there might be some strategic benefits in some cases,  from alignment of geographically or by industry or by technology, maybe like VM-ware, for example, if you’re a VMware shop and, and there’s an opportunity there, and then there might be some strategic benefits there and allow you to, to get better pricing with the vendors as well, with a larger footprint of customers. Competing Offers, obviously, if there are competing offers, then it’s conceivable that as a buyer, you might need to overpay. And as a seller, you might realize that I know a higher valuation than you would otherwise, sell seller support. So is the seller willing and able to provide support? Usually, there’s a requirement for support at some level, but how far does that extend, and then brand reputation and usually brand reputation is going to be reflected in the growth for the business, the underlying organic growth. So if they’re a strong brand reputation, then their businesses growing, if the businesses growing, and then that’s going to realize a higher valuation

. So it’s not necessarily so much the brand that’s giving you the higher valuation. It’s, it’s the result of a stronger brand that will provide a lift on the valuation and in the geography of the customer base. So if it’s north American based or Western Europe,  that those will realize a higher valuation than for instance,  if it’s in South America or Africa, which we had, or, or for that matter, perhaps Eastern Europe or parts of Asia. So, you know, looking at that, and, and there’s, there’s the location of the seller, which may or may not have any relationship with the location of a customer base. The customers may be in the US with the seller being in Eastern Europe, for example, or the seller may be in the US but the customers are all in Asia. So looking at the geography of the customer base, and that’s typically more important than the geography of the seller.

Devin: Hartland, just a question on, on this, going back to your first bullet for the reasons for selling, I was wondering how has the environment that’s been, you know, the pandemic environment that we’ve been operating in? Has that offered any other reasons for selling any additional reasons for selling for owners of hosting companies? 

Hartland: Well, we’ve seen that with, with MSPs.We haven’t seen that in a hosting space, I think has been insulated. Certainly, , from a shared hosting perspective, there’s a bit more insurance-chaired VPS. You’ve got a large customer base and, and of course, a relatively low cost to keep those operational, , certainly there’s been some impact, no question about it on the one hand with businesses going out of business. But on the other hand, you’ve got people who haven’t had jobs who have now said, well, I’m going to start up my own thing because, you know, I, I don’t have any other options. And so there’s, it’s been a bit of an offset. So I think overall, we, the, the feedback is, is really, it’s been a kind of a non-event for, for the hosting space. But as I say, MSPs have been, in some cases, the beneficiary of it, and in some cases, it’s been a real hit depending on how much exposure they had to COVID, affected businesses. 

Deal Structure

  • An inquiry does not equate to an offer
  • Importance of understanding seller’s motivations
  • Mitigation of downside risk
  • Allocation of purchase price
  • Payment Terms

Hartland: Deal structure is so, so just, I, I think the one important thing is to recognize that as a buyer of making an inquiry does not mean, well, now I’m buying a business.  It doesn’t obligate you to buy a business. It doesn’t equate to making an offer simply looking, much like looking at for a house simply going to an open house and walking through doesn’t mean you’re buying the house. And so I would encourage you if you are considering it as a buyer to kind of dip your toe in the water and to look at opportunities. And similarly, you know, if you’re looking at selling, listing your business for sale, doesn’t require that you accept an offer. Having said that, I think it’s, it is important that sellers and one of the things that we do ensure is that sellers do have reasonable expectations. If they’re out of line with respect to the market, then, you know, probably doesn’t make sense to, to go down that path very far. 

Hartland: In terms of a deal structure, it’s important to understand the seller’s motivations. Do they need to cash tomorrow? Are they struggling financially? Uh, are they trying to fund another business or is this just they’ve already got a day job, and this is a side operation, which we get quite a few of those. And so they’re not desperate for their cash, but they just can’t keep both things going at the same time in terms of deal structure,  mitigating downside risk. So what kind of risk there is in the customer base and putting a deal structure together that might have some retention, as part of that, most of the time, sellers, aren’t going to be keen to take on that risk, because they’re no longer in control, but there may be some extenuating circumstances if there’s a lot of customer concentration. We see that, more so on, like a, you know, a managed or dedicated or co-lo type business where, you know, two or three, four or five customers might dominate 25, 50% of the revenue. So structuring a deal that mitigates that.

Hartland: Allocation of purchase price is important from a tax perspective. So even if it’s done as an asset transaction versus a share transaction, that there’d be a portion allocated towards our Goodwill, and that there’ll be oftentimes a portion allocated towards the fixed assets that are being acquired. And that was good for the buyer, is not good for the seller. And so understanding those differences. And I won’t go into that into much more detail here at this point, but there’s implications there for tax on both sides. And then payment terms. So, as I mentioned before, obviously the more aggressive the payment terms, that the lower the valuation typically would end up being.

Negotiation

  • Understanding where in the process the deal is
  • Speak to seller’s motivations
  • Importance of establishing rapport
  • Estabilishing deadlines (DD, close etc)
  • Term sheet (LOI) vs. purchase agreement

Hartland: So negotiating, you know, it’s, I think it’s important as a buyer to understand where the seller is at, in the process.  Have they got other offers, they just listed, what kind of interest level is there, is there a timeline for the seller to make a decision by, and try to speak to the seller’s motivations? So if they want cash upfront because they need it and they’ve got debt to pay off,  obviously just structure a deal that’s geared more towards a cash upfront type situation. I think it’s always important to not simply make an offer sight unseen that their rapport is oftentimes a very important factor, as a buyer and as a seller to ensure that report exists. And so really what it speaks to is trust kind of trust, that this buyer is going to have a competency, the ability to follow through with their payment terms where I think they can handle this transaction. Do I like working with them? Do I think that I can work with them through, what will be a fairly intimate back and forth process, deadlines? So, understanding that there should be some thought put together for outlying, how long due diligence is going to take, when a targeted close date might be. if there’s a decision process, you might, as a part of your term sheet or LOI, you might put a deadline for the, as a buyer, for the seller to make a decision on, on going ahead. And you can decide where you want to extend that as a buyer, on some cases, though, some buyers will, on some cases they won’t, if they don’t make a decision by end of day, Friday at five o’clock, then my offer’s off the table.  So putting together deadlines and understanding what those are, are going to look like, and the implications that are certainly as a buyer, if it has for you on, on the various members of your, kind of your team. So the doing due diligence team and the migration team, etcetera. And then, putting together a course, initially a term sheet or a letter of intent, which is, in almost all cases non-binding, meaning that both parties can cancel that if they need to, usually that doesn’t happen. It’s certainly not a desirable outcome, but it’s certainly a possibility. And then, once that has been signed and negotiated and due diligence has been started partway through that process, a purchase agreement would be produced and, that’s also will be part of the negotiation in the sense that there will inevitably be terms in the purchase agreement that will need to be discussed that haven’t yet been addressed for the LOI. 

Due Diligence

  • Financial statements (or revenue and expenses)
  • Tax returns?
  • List of assets
  • Customer breakdown (by plan, country etc)
  • Leases, contracts
  • Merchant and bank account statements

Hartland: And then, so once the LOI or term sheet has been signed or memorandum of understanding, whatever term you’re more comfortable with, the due diligence process begins, typically that would start with a financial exercise and financial due diligence, ensuring that there is a good understanding of what the revenues are and what the expenses are. Following the revenue from the billing platform, which for example, might be, an oftentimes WHMCs, but there are other systems, Uber Smith, host bill, plastic, etcetera. And that,  those systems are aggregating the billing and then there’s merchant accounts. And then the bank statements, which will be, the show, the deposits of the merchant accounts. And so following that cash all the way through, , and in some cases through to, to tax returns, oftentimes that’s not part of the due diligence. 

Hartland: It doesn’t go that far, but in some cases it’s requested. And just to ensure that the revenue is in fact legitimate and as a buyer, it’s important to understand that the revenue is real. But there aren’t customers who are showing as paying customers, but in fact, are family members who have got free accounts and that type of thing, and that there’s not canceled counts, that are show still showing as active. A list of assets. So what other assets are there and what are the ones that are included and what are the ones that you as a buyer, aren’t going to include, maybe you don’t want to the co-location least, maybe you don’t want to assume the office leads that they have, et cetera, that type of thing. Understanding the breakdown of the customers buy, buy plan. So how many are BPS? How many of your are Linux, how many are windows, how many are shared, how many are dedicated and the history of those customers. So when did they sign up? Do they all sign up yesterday? And in which case there’s not a lot of history and retention there. Where are they located, where they come from, so a country. And if there, if there’s a time zone issue, there might be applications for support, and then what leases or contracts are included or at least need to be addressed one way or the other. 

Closing to Migration

  • Assuming there’s a migration…
    • Seller to provide migration assistance
  • Buyer responsible for churn
  • Buyer generally paying for expenses

Hartland: And then after the due diligence process is kind of starting to wrap up, and you move to close, and then the, of course, the purchase agreement has been negotiated by this point and signed. And so there’s some sort of a migration, it may be oftentimes it, it may be that the migration is nothing more than a handoff process with logins, and you still want to call that a migration. There’s also another level of a billing migration, which is we’re leaving all the customers where they are,  but we are migrating all of the billing into our environment, our system. And then there’s a full server migration, which is moving the customers of course, to a different facility, which is the sort of most onerous and, and disruptive of the processes. So, it would be incumbent upon the owner to provide a migration assistance. But, as a buyer, you wouldn’t be expecting the seller to provide technical support, be answering tickets, rebooting servers and things, but rather to, to kind of help, steer the process, provide oversight, perspective on different customers and their needs and why, that the migration might be done one way or another, based on the nature of the customer base. So it’s typical that the buyer take responsibility for churn, because the seller is no longer going to have control of the customers, that if something goes wrong with the buyer is going to be the one on the hook for that. And I mentioned that earlier, the only issue that could come up is if there’s customer concentration, and then there might be some shared risks that are, that’s assumed. And that generally the buyer pays for expenses.  They’re paying for legal costs to draft the agreements they’re paying for their costs for their, their team to do the migration. They’re paying for the, you know, essentially any other costs with the transaction and the transition and whatnot. And it may be that they also are picking up the costs of some of the employees to help with the migration, even if they aren’t going to keep them on a long-term. 

Keys to Success for Buying

  • Establish a process with clear objectives
  • Start small and move to larger deals
  • Build your team
  • Secure financing
  • Allocate the time
  • Clear valuation expectations
  • Prepare examples of previous success

Hartland: So keys for successful buying process, and you know, I, Devin, you had a question earlier with respect to two questions in advance. So I think it’s, it’s important to understand that you have a clear process and an objective. So what types of businesses are you looking at? What types of businesses are you not looking at? A, it becomes a clear set of filters that you can use to evaluate different opportunities so that you’re not sort of chasing everything and then end up with a business that frankly, in the end, if you decide as a buyer to sell down the road, you haven’t got a business that’s sort of a hodgepodge of different customer basis, that all came from different places on different stacks, different environments, and really, there’s not a synergistic effect that’s been had. I do suggest moving from smaller to larger transactions, get your feet wet. You never will be, you’ll learn and better to learn what probably be some lessons that are not ideal. And to learn those on, on smaller transactions, obviously, we’re here to help mitigate that. But there may be some things that are beyond anybody’s control and there may be some things that you decide to do differently next time. And then to build your team. So, you know, whether that’s in-house or having your counsel in your corner and making sure that, that group is kind of aligned and knows the process. The financing piece to have that in place, whatever that looks like for you and not to be when you’re trying to negotiate that, if, as part of your due diligence, because a seller may not be willing to sort of wait out that, that process.  So having your ducks lined up in advance is, certainly advisable and then allocating the time because this is going to be a distraction as a buyer. And as a seller to frankly, if you’ve got other things that you’re interested in pursuing, there is time that needs to be spent on both sides. And so ensuring that, there’s an allocated amount of time to this and that you’re not being constantly drawn into fires of the day-to-day management of your existing business. Clear evaluation expectations. So you’re clear on what you’re prepared to pay for what and know what your stopping points are, I guess, where you’re going to exceed your comfort zone and sort of, either pull out of an opportunity or cap it and say, look, that’s my best offer. And then ideally, and of course in the beginning, you may not be able to do this, but providing previous examples of other transactions, other successful migrations or acquisitions that you’ve done, or at the very least there may be some other internal similar processes. maybe you moved from one billing platform to another, yourself, even if it wasn’t part of an acquisition, so prove or provide examples of previous successes. 

Pros and Cons of Buying

So some of the pros and cons of buying, obviously, you, so some of the pros you can do this, you grow the business more quickly. You can gain a competitive advantage more quickly as well. Particularly if you’re trying to have a, get a foothold in a different, you know, whether it’s a geographic area or competence around a certain type of customer base, you know, technical or otherwise,  there are costs associated with going through the acquisition. But typically those costs, if all goes well, are going to be less than they would be, if you were to try to grow the business organically. You may end up with a heterogeneous customer base. So to recognize that as well, which could be a good thing, or it could be a bad thing. Meaning that you end up with different profiles of customers and will allow you to also diversify, you know, your customer base a little bit and, and then efficiencies.  So, recognizing that this is an efficient way to go about growing, that you’ll realize efficiencies with your, whether it be the data center, your staff, your support team might be more efficiently utilized. And of course, you’ll realize cost savings in this exercise, some of the downsides, well, of course, you need the financing to do it. There is obviously the potential for risk here. Customers could leave, you could have an outage. They may not, you, you may not, you may kind of be in over your I guess, up to your neck or you know, your ability to support those customers, may be exceeded. And so you’re going to have to hire additional support people or something. So, as a result, support levels could go down that type of thing.  So there’s a risk associated with that disparate tech and teams and systems. So you’ve acquired, you know, done an acquisition, and now you’ve got different teams, different time zones, different places, different customer basis, and whatnot. So bolting all of that together, so that it is effective. And, you know, you can got multiple billing platforms and whatnot, and not too much manual work. So there’s that aspect. I mentioned that this is certainly a time-consuming process, and you need to be able to have time to devote to it, and that there are some hard costs, which you won’t recuperate, you know, legal fees, due diligence time, brokers fees, that type of thing. And that, you know, it also recognizing that it is competitive environment, in a lot of cases as a buyer. And so just because you are interested in an opportunity and you make a strong offer, doesn’t even necessarily mean you’re going to get the, and so yet you’ve spent that time, those resources to go down that path and then it’s not successful. And so then you’ve got to try it again, and inevitably you’ll be successful at some point, but it may not be your first time or two. And so you need to be, you know, prepared to invest that and recognize that there’s some cost associated with investing that time. 

Hartland: So I’m going to pass it over to Devin now, who’s going to handle the last, a little bit of this session here, and you mentioned there’s a lot to go through, so, thanks for bearing with us, but hopefully that’s been helpful for you and Devin is going to cover a little bit about building organically. 

The Environment for Building

  • Extremely competitive
  • Niche companies doing better
  • Growth in SMBs
  • Cannel partners
  • Hosters have been a  beneficiary of COVID

Devin: Thanks, Hartland. So, you know, going back to comparatively to our presentation that we gave in 2015 at hosting con, you know, one thing that has remained the same since then is that the web hosting space for marketing is extremely competitive. And you know, there are just a ton of players. And I think part of the reason why is that hosting doesn’t have a lot of barriers to entry. So you know, that the way that shapes up is you’re going to have a lot of competition. And so in an environment where there’s a lot of competition, the general strategic advice is to differentiate with a niche and it’s no different with hosting. So, you know, we’ve seen companies like, they’re hosting companies who offer a website specifically for real estate agents, for instance, where, you know, the templates that they offer are, you know, catered towards, real estate.  There is native integrations into the real estate listings. So just, you know, it’s not just basic hosting and there’s a few things bolted on top that add value to realtors in particular. And that’s going to give you the, like a really strong niche for which you can focus your marketing, and you’ll have a better inroads than if you’re just trying to market generic hosting. And, you know, similarly, we see like the website builders or really anything where there’s a niche more than just playing, hosting, those sorts of things are doing a lot better. There is growth in SMBs as well, you know, especially during Coronavirus, there’s people who are starting up their own small businesses as side hustles. I know for myself, recently identify with this because I just recently made us a very simple website for my dad who is a woodworker. 

Devin: So I think that there’s a lot of people who are doing similar things like that, having a little bit more time these days, and are starting up websites for their side hustles. Also, the environment for hosting a channel partners are an important avenue. You know, partly because it is harder to do marketing more generally these days. It helps to have a channel partner who can be your trusted source, the, you know, the trusted advisor for the end-user, who can, you know, recommend your products in your services above another hosting companies. And as you know, as Heartland mentioned earlier on in the presentation, holsters have been a beneficiary of COVID to a degree, certainly have not been as impacted as other industries. So, you know, that’s one positive environmental factor that we have that’s recent. 

PROs and CONs of Building

Devin: So what are some of the pros and cons of, of building through marketing? One of the pros is there is some low hanging fruit, if you are having the basic elements of your marketing mix in place, including a website that’s working for you, SEO that is getting people to arrive at your site, social media, to re-engage with people, and to get some more eyeballs and your brand, all those good things, email marketing, you know, that can all lead to low-hanging fruit. There’s just a, you know, when you have those elements of the marketing mix in place, there are going to be people coming into your website. So, you know, there is some low-hanging fruit in that regard. There’s also steady and manageable growth, especially if we consider, you know, the, on the contrary, the buy-side and growing through acquisitions where it’s a little bit more, you know, you go in spurts with, in terms of the growth marketing can be more steady and manageable over a long period of timeless disruption. So similarly, it’s just going to be more consistent. You’re not going to have as drastic ups and downs, you can hedge against churn. So, you know, a turn rate and it services fairly predictable. You know, I’m sure listeners have a good idea about what their churn is in terms of an annual rate. So, you know, you can use marketing to overcome that and, and to counteract that, the loss of customers that you experienced through the normal churn and yeah. Cost can be controlled and adjusted. So, you know, for instance, right now, I think there’s a lot of businesses that are starting to open up more, more in terms of their budgets and looking to grow as you know, the end of the coronavirus is insight here. So friends right now would be in a time where it would probably make sense to adjust marketing budgets up a little bit, to try to get a little bit more coming in, given that there is an opportunity there’s some, there’s some latent demand that has, you know, that’s a factor here for businesses that are considering new IT investments. 

Devin: So one of the cons is that the costs is likely higher. And in this regard, we are talking about the cost per acquisition for a customer. You know, when you take the rule of thumb about the one-time annual revenue, being the evaluation factor for, for hosting business. And if you were to do the math and figure out what the acquisition cost is per customer, generally speaking, it’s going to be lower than it would be for marketing. It also does require patience. This is especially true for tactics like search engine optimization, where even if you were to really start an SEO blitz on your website right now, get it all the SEO elements on site up to speed, start creating some really good content for the site. You’re probably still not going to see any results for three to six months.  So, you know, it depends on the tactic that you’re using, but for a lot of marketing tactics, it is a longer-term objective. Whereas obviously acquiring a company is more direct, although you do have to factor in the time to close and all that, it does require a commitment. So, you know, a good example of this is with blogging, you know, blogging, there’s a couple purposes for it, there’s SEO, but there’s also like the user benefit of having people read valuable information on your website. For both of those objectives, it does require a consistent commitment if you’re only publishing blogs every once in a while. You know, Google’s not going to appreciate it as much as they would, if you were publishing fresh content in your blog on a consistent basis, likewise of users they’re going to come will be more likely to come back to your blog and stick around if you are publishing regularly. Less Time, so kind of going back to the requires patients, it just takes a little bit more time to get things ramped up. Used to be a little bit easier back in the old days with affiliate marketing and things like that, where you could have an affiliate campaign, you know, get it in front of a new audience and start getting some results right away, where you’re essentially paying per customer know the affiliate programs. These days aren’t working as well. The CCC in the states has the trade commission rather, they’ve cut down on affiliate marketing to a large degree, and it started to require people to have a more comprehensive disclosures when they’re when they’re receiving affiliate revenue. Uh, so that’s really dried up a lot of the affiliate revenue opportunities for hosts.  And there are lots of constraints, unfortunately, marketing for web hosting companies. There are more constraints than there are opportunities. So there’s is like the competition, the regulation there’s just, there’s a lot that goes, kind of there’s a lot to overcome for marketing. And so you have to have a well-oiled machine for it to really be working well for you. Yeah. And there are hard costs with no guarantees of results. So, you know, you can invest in content. Now you can invest in advertising campaigns or your website,  and it is difficult to project, exactly how, what you’re going to get out of that. And if I were to compare that to the buyer side of the business, it’s a lot easier to project, you know, I’m gonna acquire this customer base and this is the revenue stream I can expect. And this is the turn that I can expect. So, the buying side of the business is much more predictable in terms of the results, than the building side. 

Keys to Success for Building

  • Clear target market
  • Testing and tracking
  • Realistic expectations
  • Dedicated resources
  • Creativity
  • Credibility and reputation.

Devin: So what are some of the keys to success for building through marketing for web hosting companies, having a clear target market, going back to our example of realtors, just you know, you can’t just compete generally anymore. You need to focus in,  it’s, it’s also especially true for things like SEO, where if you’re trying to compete for general key phrases like web hosting or, you know, shared servers or whatever, you’re pretty much dead in the water compared to the bigger providers. So, if you want to compete, you gotta start somewhere and, find a niche, testing and tracking. So have a website that’s set up with, with Google analytics, you want to be tracking proper conversions. So obviously the main conversion that you wanna be tracking is sales, but also things like live chats that have been started, emails that been initiated towards your sales team.  Maybe even support requests, if you’re interested in that, or that would be kind of a secondary one, phone calls as well is a really important one. Because you want to know which of your traffic sources are actually performing for you. And to try to, you know, understand that as best you can, even though there are a lot of constraints around that these days having realistic expectations too is important. You know, I, I think it’s fair to say that the days of, of, of growing really quickly through marketing for hosting are behind us. It is more of a gradual process, a slower process, and there’s not really any magic bullet. It is about having a good marketing mix that is strategically sound and not necessarily flashy but just makes a solid strategic sense. Dedicated resources, a big one too.  So, you know, say for the blogging example, if, if you don’t have a dedicated copywriting resource, chances are, you’re not going to be publishing your blogs on a regular basis. Let’s say the marketing person on your team also has some technical responsibilities. Inevitably their technical responsibilities are going to take precedent over their marketing responsibilities and the marketing is going to fall through the wayside which, you know, counteracts the entire goal of having that predictable growth to offset the churn creativity. You know, I, I don’t know how many web hosting companies have the same images of stock, support agents on their website. I don’t know how many web hosting companies have the exact same photos of stock images of servers or server racks on their websites. It just, you know, if you’re going to be generic like that, you’re just not going to stick out at all. You just going to be another, you know, another face in the crowd. And so it’s sticking out, it pays to have some creativity, whether it’s something like a mascot or, you know, be a little bit out there with your messaging, just something to stick out a little bit more.  And also credibility and reputation. Especially for savvy people, savvy customers, rather, there’s a lot of web hosting companies over the years who have not done themselves any favors in terms of how they’ve treated their customer base and have had customers, you know, feel alienated, especially after something like, a migration that’s gone wrong. I mean, there’s been many stories of that in the news and, that can really alienate your customer base and result in bad reviews on Google. And, you know, because the affiliate sites that we used to see, like the, the hosting review or the hosting listing sort of variety of sites have kind of gone by the wayside due to the affiliate marketing, no longer being, you know, really an option for them. People are really gathering their information and their research, but hosting companies through Google reviews and Facebook reviews. So you want to make sure your customers are happy. You want to have good reviews. And so a new leads can see that you do indeed have happy customers. 

Since 2015, opportunities to grow by building have been outpaced by the opportunities to grow by buying.

Devin: So, you know, thinking back to our presentation that we did at hosting con in 2015 and comparing it to the presentation we did today, I think it’s fair to say that Hartland spoke for the majority of the hour here. And that is reflective of the fact that opportunities to grow by building have really outpaced the opportunities to grow by buying. And, we’ve seen that in our own business when, in terms of the interest in marketing and the interest in, on the host broker side as well. So, we are, we can certainly help with both and, and it can talk to you about both, and you know, would be happy to, discuss growing the company through marketing towards an acquisition as well. 

Thank you!

Devin: So thank you very much for attending today. I really appreciate everyone’s attention. And, if you have any other questions after the presentation, I know we’re a little bit tight on time to answer questions today being over the hour, but you can reach out to us at contact. The contact information provided there it’s [email protected] and we have our phone numbers there as well. And if you’re interested in speaking to us about either the marketing side of the business or growing through acquiring other web hosting companies, It would be great to speak to you on a meeting. 

Hartland: Yeah, thanks. Thanks, Devin. And, as Devin said, please if you have any questions, feel free to reach out to us. From a marketing perspective,  we are doing this session was really geared more towards the sort of the hosting shared VPs end of the spectrum versus like data center operators and infrastructure and whatnot. So, that’s a different story. So I think it’s important to recognize that, you know, that a lot of the work we do on the marketing side is more with infrastructure providers, data centers, and, and managed service providers as well as vendors to the industry. And that’s a whole topic for another day. So if those are areas, there’s certainly more opportunity and we’re happy to chat with you. And, and as I say, as a buyer or a seller, so feel free to reach out as info, what the host broker, we didn’t put it up, but you could also do [email protected] as well, if it’s marketing related and, otherwise thank you very much for your time. We’re literally three minutes over the hour. So apologies that we knew we had a lot to get through, but I think we did it. And, look forward to, to speak with you and, and have yourself a great rest of your day. 

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