I Merged My One-Person Software Company with a Bigger Player (2018) | Hacker News Reader

I Merged My One-Person Software Company with a Bigger Player (2018)

philderksen.com

82 pointsrwalling30 comments

In the text the author discusses also selling the company outright - question: how does one calculate a price for this usually? A few years' profit?

Yes, service companies usually sell for 2-3.5x annual recurring revenue (ARR), which is measured by averaging your last 3-5 years of revenue.

And you'll need to be easily replaceable.

Recurring revenue or profit?

Revenue would be nicer I guess, but if it's software that simply works then maybe they are not much different? Not how revenue and profit compare in other types of industries that is.

In the few conversations I've had, it's always been revenue. This provides an incentive to spend lots of money on user acquisition, even if doing so means losing money (or not making as much).

I wish there were a standard assumption that if a business is profitable, then we use profit instead of revenue, and (crucially) use a much larger multiplier. It feels like I'm always having to remind folks that revenue ≠ profit, and that normal guidelines (we invest in companies with $X00,000 revenues) might need to be adjusted for smaller, breakeven or profitable businesses.

Typically an earnings multiple will be higher than a revenue multiple (e.g 8x vs 4x - which can be equivalent if the profit margin is large enough)

It's almost always revenue, but I'm not sure why.

I'd pay more for a business doing $500k in revenue with $250k profit (50% margins) than a business doing $1M in revenue with $100k in profit (10% margins).

Usually it's dependent on the person selling (or their advisor). If a company is very profitable (e.g 50% margins) then an earnings multiple makes sense and the advisor will essentially present the company in such a way that it's pretty clear to the potential buyer that they're expected to think of valuation in terms of profit multiple. Incidentally, lots more buyers out there are comfortable doing that then revenue multiple. However, a revenue multiple has become the norm for companies with very highly recurring revenue (e.g. SaaS) and where the company has been run for growth instead of profit. There are many fewer buyers who will do that though, and getting leverage for deals like that is harder (a big driver of returns for some funds)

No sensible buyer (i.e. not strategic) is going to pay high revenue multiples for a private illiquid company. Exceptions to this might be when they have some advantage (existing customers etc) to sell to. But nearly all PE shops overpay on large deals.

By strategic, I don’t mean “sensible” or “smart”, I mean it’s a buyer where the asset is considered strategic, hence it would always fit under your “when they have some advantage” umbrella.

It assumes a lot of costs are fixed, and do not scale with income. Software is weird like that.

Double the 500k R / 250k P company without more expenses, and you now have 1 M R / 750k P. Double the 1M R / 100k P and you now have 2 M R / 1.1 M P.

Especially if a firm can come in and do a round of layoffs (Replace support with outsourced, fire marketing, replace devs with outsourced).. it would be pretty easy to get the margin really really high for a few years, which is all they may be looking for.

Also maybe, some forms of financing are based on revenue, and just care that there is enough profit to cover the interest e.g. https://en.m.wikipedia.org/wiki/Revenue-based_financing

Could be either one. The methodology you use for valuation reflects your priorities. Warren Buffet calculates valuations based on free cash flow[1].

For what it's worth, the company I work for currently just got sold off for $4.4bn USD by our parent company. Based on quarterly filings, that equated to about 2x annual revenue and 9-10x EBITDA for last year (not sure what the multiple was for net).

[1] https://www.entrepreneur.com/article/66442

The company in the article appears to be more of a software company & less of a service company. From the conversations I've had, I would expect to see a valuation in the range of 2-5x the company's earnings.

(The term of art is SDE/Seller's Discretionary Earnings, and is basically the sum of all the money the owners are able to take out of the business, including paychecks and bonuses.)

FEI and other brokers write a bunch about valuing small businesses: https://feinternational.com/blog/how-do-you-value-an-online-...

Depends on kind of business, profit level and size.

A small (sub $1m in annual revenue) services company will typically sell on some multiple of "seller discretionary earnings" - basically; how much cash can the owner operator take out in a year (including their own salary). A "typical" multiple would be 2-4x SDE.

A larger services company will typically sell on some multiple of EBITDA (earnings before interest, taxes, depreciation and amortization). The main way this differs from the above is that the owners/CEO salary is not included. Traditionally the multiples here has been 4-6x EBITDA (which is what a "value oriented" private equity fund will seek to pay), but recently there is so much dry powder in the private equity world that those multiple has been pushed up, particularly for technology companies. 6-10x is not unheard of, more is possible.

A product or software (especially SaaS) company might sell on a multiple of gross revenue instead of earnings. Depending on how profitable the company is, this may or may not be a higher value than the above EBITDA multiple. Above a certain size, I would expect a SaaS company to sell for at least 3-4x revenue, more if growth is strong, even more for larger businesses.

In general you'll see multiples go up for a) strategic fits for larger acquirers (eg they can sell your product to their existing customers) b) growth and c) larger revenue companies.

This latter point might be confusing - why would a larger company not only get a higher price because the earnings/revenue is higher, but also get a higher multiple of that revenue? This "multiple expansion" occurs because there are (lots) more available capital to buy larger companies. Smaller companies are riskier and also the transaction and other costs (operating, optimizing) are similar for a $100m vs a $10m deal. There is also more leverage available at better terms for buyers of large companies.

Wow this is a fantastic explanation of multiples expansion. Exactly answered the question I had while I was reading. Thanks

IIRC I think it was Instagram that when they talked about being bought by Facebook that they sat down and agreed that if Facebook bought Instagram that Instagram would be X% of the value of the combined companies and thus they came up with that number.

It seemed like a non traditional route as it wasn't the usual X earnings multiplied by a time period.

I want to make a minor point that is not a critique but more a statement so first of all, congratulations on your success!

I think we as a society need to stop referring to single member entities with no employees (meaning a single, sole person) as a "company."

"Business" seems like a better term, or even just "product" if that's what you're selling. But "company" naturally implies multiple people, which lends credence to the business as it means the business can support more than one income.

a company is a separate legal entity, not a collection of humans

Not only is this completely wrong from a legal and business standpoint, why would we even need this as a society?

I find the term personally confusing when only one individual is involved. Most definitions of the word include multiple people. It would seem that's an unpopular opinion here. Meh, can't win them all.

It's about establishing and limiting legal liability. Being able to establish a solo business as a company means that you don't lose your house and possessions if your company fails.

There is very little liability protection for a single-member company. You are usually going to be personally liable for your actions, and can get sued individually along with the company. Incorporation / LLC does not protect you from acts where you are also personally liable, and it does not shield your personal assets in that case either.

Edit: in the US, that is.

This depends on the country. Most (single member) companies in EU countries have excellent protections in place for directors and shareholders as long as you don't do anything illegal.

This.

For Canadians: https://www.ic.gc.ca/eic/site/cd-dgc.nsf/eng/cs06641.html

The main issue for single-member LLCs in the US is to actually operate it as a separate entity. Don't share assets, accounts, etc. Don't personally guarantee debt unless you absolutely have to (and then you'll be liable for that). And of course you're still liable if you personally break the law. If you hire an employee and they assault a customer or something, your company may be sued like any larger company, but they probably won't be able to pierce the veil and go after you personally to collect.

What? This is 100% incorrect. Unless you make obvious errors, all of your personal assets are protected.

> Like shareholders of a corporation, all LLC owners are protected from personal liability for business debts and claims. This means that if the business itself can't pay a creditor—such as a supplier, a lender, or a landlord—the creditor cannot legally come after an LLC member's house, car, or other personal possessions.

https://www.nolo.com/legal-encyclopedia/llc-basics-30163.htm...

Obvious errors being breaking the law, paying for your business loans with personal funds, etc.

A lot of people fought for the legal framework to become competitive enough to include single member entities in the word company, as it inherits all the privileges of multi member companies without the administrative hassle or prerequisites. Another definition just because your society hasnt caught up to the legal benefits conveyed would be redundant and not be informative at all.

This is a significant reason why you would lack consensus on this opinion.

Most single person consultant companies have more than one shareholder.

In the UK my mother was the company secretary for my Fathers company he used for consulting.

I think I'll be the oddball here, and lightly agree with the gist of the comment. "Company" as per dictionary definition is "a number of individuals assembled or associated together; group of people" and in this context, "business" is at least equally as accurate, if not more so. Because you can be a "company" of chorus singers that go door-to-door giving out free song, but "business" much more precisely means you provide something in exchange for currency, either by yourself or as part of a larger group, and really "software" can be set up to be a "zero person" company, something capable of making money regardless of the people involved. That's something you can really sell.

I think the reason this comment is so disliked is because it's strongly worded as if the original word usage was a horrible, systemic mistake.

> we as a society need to stop

This is unnecessary. Sure, the vocabulary choice would probably be improved a bit with "business", but it really didn't take away from the story. If not for it saying "one-person" in the title, it might haven taken slightly longer to process "Oh, solo entrepreneur, got it" vs "small company with a few employees" - which is not totally insignificant. It's a bit of a difference between a personal choice that affects one person vs. a leader and some followers who are being taken down a different path.

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