I often hear board members, CEOs or advisors say that a business needs to be profitable before it can be successfully sold. Or that it has to be over $10 million or even $50 million in revenue. Sometimes, they say it has to be over a certain value threshold, like $50 or $100 million.
That may even have been true a decade ago, but today the economy is quite different. Successful exits can now be executed before the company is profitable or before the company has reached its first $1 million of revenue.
All You Really Need is to Prove the Model
While it's possible to sell a business just about any time, the earliest you can expect a good price is after you 'prove the business model.'
What it means to prove the model depends on the type of business. For example, think about a business that has a recurring revenue model--one where customers pay every month. In a recurring revenue business, you can prove the model when you can build a spreadsheet with actual results (not projections) that shows the:
- Gross margin per customer
- Customer lifetime (or churn)
- Cost of customer acquisition
In other words, "How much is a customer worth and what do they cost to acquire?" For a business to be saleable, the customer value has to be several times larger than the customer acquisition cost. Sometimes, when you finally do prove the model, the result is that you've proven that the cost to acquire a customer is higher than the customer value. In that case, you have succeeded in proving the model, but the answer isn't the one you were hoping for.
Once you have proven the business model, it's a straightforward process to show a prospective buyer that if they paid $X million to buy the business, and then deployed $Y million more to acquire a specific number of customers, that the new value of the business would be $Z million greater. At this point it becomes a matter of negotiation about what part of Z the buyers are willing to pay you ($X).
It is often possible to 'prove the model' long before a company is profitable, and often before a company gets to $1 million in revenue.
The Trend is Toward Even Earlier Exits
I've been recommending that entrepreneurs and investors capitalize on the trend toward early exits for several years--even before I wrote "Early Exits." This is not a personal preference of mine, but instead a recognition of a structural change in our economy--driven by a combination of technology and business evolution. But even I had to admit surprise when I heard just how early Google wants to acquire companies.
Charles Rim was one of the five most senior M&A professionals at Google worldwide. He did an interview for Corum's online "M&A Class" a couple of months ago. Here are a few fascinating quotes from the interview:
- "90% plus of our transactions are small transactions. So that would be less than 20 people, less than $20 million and that is truly the sweet spot"
- "we do prefer companies that are pre-revenue"
- "technical staff, engineering, a strong engineering team, these are the things that we think are very important to the future success of Google and important for us to use acquisitions in that manner."
Google actually prefers companies that are pre-revenue. In other words, Google doesn't want to buy the business, they want to buy the team--the people. The entrepreneurial ingredient that they know they need to keep Google vibrant and growing.
These points are from one of the guys who really knows--you can sell a tech company today long before it's profitable, even before it has revenue. And if it's up to Google, it's the latter. Hear Charles Rim's interview, and read more on this trend here.
And here are two real life case studies of companies that sold even before they had revenue. Brightside was a University of British Columbia spinout that sold to Dolby Labs for $28 million, pre-revenue. Pacinian was a company in Idaho that designed thin keyboards, they sold to Synaptic for $30 million, again pre-revenue.
When you are developing the strategy for your business, and thinking about the optimum time to exit, please don't be constrained by old preconceptions about how early you can exit.