Your Company Is Worth What You Can Get
Joshua D. Wachs, Founder, President and CEO, Natural Intelligence
There are dozens of ways to set a value on a business, including using a multiple of revenues and/or profits, comparing like-minded companies to yours or even rolling dice a few times. What I found, after looking for a couple of months for the official formula, is that there is no set rule—especially for a service company. Your company's value is as much as you can get in negotiations.
Some people start companies, especially in this Internet age, with the idea of selling out as soon as possible. That's about get-rich-quick and get-out-quick, but if that's what I was doing, I wasn't doing it very well. Natural Intelligence was founded in 1987 and sold in 1999, in our 13th year.
Natural Intelligence, a Macintosh custom-software company, developed client-server solutions for Fortune 500 companies. In 1995 we developed a product called "Roaster," a Java integrated development environment (IDE) with a "clean room" virtual machine, which gave us wonderful marketing success and exposure. Roaster and Natural Intelligence were covered by almost every Mac newspaper and magazine out there. But we managed the product division very poorly. We cannibalized our consulting division by moving staff and most other resources to the products division and completely took our eye off the books. For most of our previous existence, we were used to having a lot of money from consulting and being very cash rich—but we ended up putting the company close to bankruptcy.
The Value of Loyal Employees
At that point we weren't really preparing ourselves for a sale—we were rebuilding. That took being brutally honest with those who were staying with the company, and sharing numbers on a weekly basis with our entire staff. We had regular meetings to explain how financial statements worked and what ours in particular meant to our growth. At one point we had almost $400,000 in debt, guaranteed by me personally. I did not take a salary for almost an entire year but didn't even announce that for six months, because I was concerned that people would worry about their jobs.
When the employees finally found out, it actually gave morale a boost. If I was going to make that commitment, then so were they. Even before we were bought, when we were close to signing but things were not yet official, we had a company-wide meeting and said, "Hey, we think this is good for the company, here's what it's about, what do you guys think?" If I had gotten a big revolt and if people were going to leave in a mass exodus, it wasn't going to do the company any good.
Our employee retention through all the adversity was a huge benefit for the buyer. The biggest problem with high-tech companies is the ability to hire and retain their staff. I recently heard that there are six million high-tech jobs to fill in the United States, and only five million techies available. The fact that our employees stayed with us at a time of serious crises and adversity, when many of them could have left for higher-paying jobs or a more stable work environment, showed that we had a core group of people that an acquiring company could and should really value.
The Value of Accurate Figures
Before we accepted an offer to buy Natural Intelligence, we were negotiating with a couple of companies. One potential buyer was more interested in what we were making in profits. Another was more interested in gross sales, because they wanted to see growth. We didn't have to factor in product development costs, because by this time we had completed our turnaround and the product division had been completely spun off.
As a small company, we didn't have audited books. It's a very expensive process and not usually needed. We were often asked, when people were interested in buying us, if we had audited financial statements, and each time we'd reply that we had never had them done. What ends up happening is that the buyer comes into your office and creates audited financial statements, after you have signed a letter of intent regarding the sale. Our account department gave out every bit of financial information it could possibly get: last two years' revenues, profits, contracts with clients, contracts with employees, phantom stock plans, outstanding debts and bank statements, personal resources charged to the business—it was a complete audit.
The offer we accepted was close to twice our forward revenue, higher than we were originally expecting. When someone offers you more money, you don't want to ask why. Just make sure the check won't bounce.
The Value of Effective Partnership
We were actually doing business, as technical partners, with an organization formerly known as Circle Interactive, before either party entertained the idea of merging. It was a very good, profitable and productive partnership for both of us. Circle Interactive had approached us and given us some offers early on, but despite our relationship, we were actually minutes away from being sold to another company. Circle had dropped out of the negotiations at that point. Then, without exaggeration, 43 minutes before I was going to sign with the other company, Circle called up with a significantly better offer. It was also better than their earlier one, and it really made sense for our business.
The bottom line is that no matter what lawyers and evaluation specialists tell you, your company is worth what you can get for it. The most important thing to do is to shop around and see what people are willing to pay. We did talk to a number of companies, but the two we got close to, in the end, had approached us. So, in this business, it's better to be the hunted than the hunter. We really didn't plan to sell out for another year, but this happened to be the right match at the right time.
The Value of Hindsight
Given what we've seen paid for other companies and how well they performed, versus how well we performed, in regards to retention and profitability and such, I think Natural Intelligence justified a better multiple. Could we have known that in advance? Absolutely not. Is there anything I could have done differently? No, other than perhaps being more aggressive in our projections. Maybe if we had put it into metrics, we could have said, "We're able to retain 90 percent of our employees over the next year," or other similar projections. Still, I think we were paid very fairly for what we had.
You have to consider as many different formulas as you can, until you get to a place that feels comfortable. You'd be doing yourself a disservice if you based your valuation on just one formula. You want to get as much information as you can—such as sales, formulas other people may have, and gut checks with people in the industry.
Here's what I think a start-up can do to maximize value for prospective acquirers:
Find a company that you'd like to work with. The odds are that within a year most entrepreneurs leave, once their business is bought. Ask yourself what's going to keep your skin in the game and what's going to make you want to leave.
Get a really good lawyer or law firm with experience in your industry.
Get help from your peers. I belong to a group called the Young Entrepreneurs Organization (YEO), made up of individuals who are founders or primary owners of corporations doing over a million dollars in sales. I leaned on that group a lot for resources, to find out how one valuates a company. YEO was invaluable to me in providing financial, technical and emotional support.
Take that partnership. If you think somebody's going to try to buy you, figure a way to work with them ahead of time. If they fall in love with you, if they get excited about your culture, it's going to make them that much more excited about acquiring your company.