M&A Insights

Harbor Ridge Capital Launches Contract CFO Services to Companies Preparing for a Capital Raise or M&A Transaction

We understand the hoops investors and buyers make you jump through
Like many founders, running your business and making sure you hit your projections, to achieve your desired valuation, is a top priority. However, you’ve started engaging in discussions with buyers or investors, and the information requests are beginning to ramp up quickly. Or perhaps you have an offer in hand and received a due diligence list, which you’ve never seen so many document requests in your life! How can you be expected to run your business, and generate such a vast amount of information in parallel? How should this information be presented to best represent your company’s value? How can you be certain you are talking to the best investors or buyers? What if all this time spent, negatively affects your business, and you don’t end up closing the transaction?

How Our Contract CFO Services Can Help
We’ve helped many founders and business owners in your position and may be able to help you as well. Harbor Ridge Capital provides contract CFO services to properly prepare companies for a transaction of this magnitude, allowing you to remain focused on operating your company. We act as an extension of your management team, working with key managers, to help implement best practices for M&A and capital raise preparation.

How We Work With You
Specifically, we engage with companies on a project basis, for typically 2-3 months, where we start by analyzing the company’s current state of organization, and map out where you need to be, to become prepared for transaction. Thereafter, specific deliverables include:

• Company presentation – helps with proper positioning, storytelling, key operational and financial information, and unit economics/KPIs
• Financial model – detailed projection with implementation of KPIs, unit economics, top-down and bottom-up analysis, laying in of the use of proceeds from capital raise, and incorporating the acquisition
• Data room review – ensuring the right documentation is populated and organized based on future expected accounting, operating and legal due diligence lists
• Accounting and reporting – advising on how financials should be positioned and organized; potentially modify accordingly
• Moving from cash based accounting to GAAP accrual, which is required by buyers/investors
• other advisory related to the contemplated transaction

Once the above tasks are completed, and you are satisfied with the deliverables, we can part ways at such point. However, we’ve found that many founders request us to stay engaged going into the transaction process, to support and advise in other areas. Please note, our M&A and capital raise advisory engagements include the scope of work listed above.

We Would Love to Work With You
For more information on services or pricing, feel free to reply to this email with background information on your company, the contemplated transaction, and any questions you may have, so we can set up a call and discuss.

About Harbor Ridge Capital
Harbor Ridge Capital (HRC) is a boutique technology-focused M&A advisory firm, working with companies in the $5-100mm revenue range. HRC has completed over 30 transactions, representing over $300mm of transaction value. The firm’s professionals have diversified, well-rounded experience including investment banking, private equity, and CFO roles for companies as large as $25mm in EBITDA. We look forward to working with you on your strategic objectives. www.harborridgecap.com

A lot of us have witnessed what is referred to as a “heat check” in basketball, where James Harden or Steph Curry will jack up an ill advised three after having made a handful of buckets in a row, to assess how hot they are at the time. This may appear to the layman as a crazy shot; however, there’s a high probability that they will make the basket because they are hot, and often they do, thus confirming their scorching status.

This concept can be likened to today’s climate as it relates to M&A valuations, in exploring whether a business owner can take advantage of our current valuation heat, to receive a premium. So, the question is, how can an entrepreneur cut to the chase on the front end to assess if they’re a likely candidate to realize such an outcome without getting dragged into a rabbit hole of time spent and potential wheel spin with M&A/funding discussions which may negatively impact their business?

For starters, it never hurts to have a brief discussion with an M&A professional or even go back and forth on email a few times to figure out where your candidature stands- are you an ideal candidate, not so great fit, or somewhere in the middle (e.g. nice profile yet too small)?

Here are a few basic fundamentals that would qualify a company as a “great candidate” that will have options, and is something to be mindful of before starting any discussions:

Technology/Business Services 

• =>$10mm in revenue and =>$2mm in profit
• Growth of ~20% (higher the better)
• Gross profit of ~50% (higher the better)
• Recurring revenue of ~75%+ (higher the better); low churn of 1-2%/month (lower the better)
• Specialized offering, more verticalized (application or vertical) vs. horizontal
• No client greater than 20% of revenue
• EBITDA Multiple of 7-15x
  • range depends on how good or bad the numbers above look
  • businesses w/very strong business models and profiles per above are selling at a premium of 12-15x

Software

• >$5mm in revenue and modest loss to profitable if SaaS; >$10mm in revenue and $2mm profit if on-prem license + support/maintenance and prof serv revenue
• Growth of ~25% (higher the better)
• Gross profit of ~75% (higher the better)
• Recurring revenue of ~75%+ (higher the better); low churn of 1-2%/month
• Specialized offering, more verticalized (application or vertical) vs. horizontal
• Revenue multiple of 3-7x for SaaS; EBITDA Multiple of 7-15x
  • range depends on how good or bad the numbers above look
  • businesses w/very strong business models and profiles per above are selling at a premium of 5-7x

If you’re near, at or above the size/operational thresholds noted above, and want to get more specific valuation feedback, let’s have a 20-30 min call to discuss the particulars and see where you are likely to end up in today’s market, and if you may be in line for such a premium. It’s always good to track the items mentioned above regardless, and have them available for the last handful of years as well as year to date, and current year budget, to not only see how you’re business is trending as an owner, but also be able to quickly share these high level stats, to receive quick tangible feedback, so as to  not waste time, energy, and cycles. Most acquirers/investors have defined strategies and mandates which the investment profile must fall within, otherwise they can not and will not proceed.

Thanks, and enjoy the rest of your summer.

One of the most common questions I get asked when speaking with the many entrepreneurs of cloud and managed IT service companies, is “what are companies in my industry selling for, and how are they valued?”. My response varies depending on a culmination of factors, yet after a high-level assessment, it’s somewhere between 1-3x revenue. So, what drives this range, as there is quite a bit of variability between 1-3x? What time frame is this multiple tied to? While there’s no perfect science to get to an exact figure, as the market bears what the market bears, below, please find 6 key drivers of value, with their reasons, which will provide a sense of where you may fall within the range:

1. Amount of Revenue: there’s always a premium for larger companies as the adage goes, its more work to do a smaller deal than a larger one, as naturally a smaller company has less sophisticated and organized accounting and reporting. Not to mention, smaller companies do not move the needle compared to that of a larger company, as well as it’s generally harder to reach “scale” i.e. a larger size, thus larger companies are rewarded value-wise. In the lower middle market, the key revenue threshold which divides the small vs. large is $10mm, then step functions up from there to $25mm, $50mm, 100mm, etc. The exception here may be if a company is growing fast and projecting $10mm in the current year, and they’re run-rating (mid-year performance extrapolated out) an amount on pace to comfortably hit the projection of $10mm.

1. Margin of the Revenue: While revenue size is very important as noted above, equally if not more important are margins attached to this revenue at the Gross level, as well as at the EBITDA levels. There are two noteworthy examples here, one being VARs, which have become highly undesirable businesses due to low margins and disintermediation. Typically, Gross margins here are 10-20% and do not have a recurring nature to them, which is a double whammy. As a result, these companies are being valued somewhere between .25-.75x of revenue, or even a multiple of Gross profit. Another example is resellers of public cloud services, AWS and Azure for instance. It’s fascinating, as these resellers are in a hot, high growth space (public cloud), and have recurring revenue, where there is strong demand from acquirers and investors who are seeking acquire a “platform”. However, folks are reluctant to pay a strong multiple for these companies as their gross margins on such revenue is still in the “VAR range”, of ~10-20%. Also, it remains to be seen the long-term viability to grow such margins, as where is the true value proposition to demand a higher vs. lower margin on revenue? Companies have combatted this issue by wrapping other services around the resale business, which is helpful to the cause margin-wise, yet be mindful that sophisticated investors/acquirers will segment out the revenue by type and apply a lower multiple to the resale vs. the services (project vs. managed), despite there being robust growth and a recurring nature to it.

1. Recurring vs. Non-Recurring Revenue: It’s no surprise that recurring revenue is highly sought after, and the reasons are quite self-explanatory. Thus, recurring revenue will generally receive a higher value than one-time or project-based revenue, however, the Achilles heel of recurring revenue or subscription-based businesses is their churn. So, if you look at two businesses, both with $15mm of ARR (annual recurring revenue) and one may be receiving a 3x multiple and the other 1.5x. The key difference may be the churn of one being 5%/mo, vs the other being .5%/mo. High churn negates the stable nature and value of recurring, in terms of being able to predict future cash flows, so this is certainly something to be mindful of. While project-based businesses are inherently less desirable, some IT services silos who are experiencing rapid growth, such as ERP cloud consulting (CRM, SAP, Oracle), and the public cloud partners, are seeing strong multiples, due to the robust performance and large go-forward market opportunities. Another example where project-based revenue receives strong value is if they have sticky, repeat revenue who can be substantiated year over year, as well as those with multi-year contracts. These types of companies have been valued of late in the 2-3x range.

1. Composition of Revenue: This is an interesting one, as you can compare two recurring revenue businesses with $10mm of ARR (annual recurring revenue), yet one may be worth double the other. A good example here would be a horizontal player, vs. a vertical player. Naturally, the horizontal player will be less specialized than that of the vertical player, therefore require less specialized solutions, personnel, and thus pricing will be less. The horizontal player has a larger market opportunity yet faces greater competition. The verticalized player requires more specialization and thus will charge more for their solutions. Further, this provider will have naturally created a stronger barrier to entry, and in turn have less competition. While the vertical player may have a smaller market opportunity, they will have a better likelihood to monopolize that smaller opportunity, than the horizontal player, in a stable profitable fashion. This is attractive to private equity and strategic acquirers who are seeking to grow their investment 3-5x over 3-5 years, rather than acquire the next Uber. Further, with larger consolidators exploring buy vs. builds for offering more solutions or use cases, the acquisition of smaller specialized players makes a lot of sense, vs. another competitive yet smaller horizontal player. Vertical centric examples include healthcare, legal, financial, security/compliance, and or application-centric specialization such as ERP, CRM, etc…, or perhaps a combination of both.

1. Growth of Revenue: This one when combined with the positive elements above, is arguably the most critical factor to sway the revenue multiple to the top end of the range. Companies seeing 30-50% growth, where it’s sustainable and predictable within a large market, is the most attractive and will likely generate the highest multiple. Realistically, to receive a strong multiple, IT/cloud service companies who are generally bootstrapped, are expected to see growth in the ~25% range, while maintaining healthy gross and EBITDA margins, ~50% and ~20% respectively. What is key here is to be mindful of which buckets of revenue will generate the most value long-term, to strategically position your company as such, for instance only offering resale revenue if they will take services along with it, which may reduce overall revenue and growth, yet increases margin, as well as customer penetration/stickiness, which drives overall value.

1. IP: those who have developed and own IP, which is used in delivering their service, should see an increase in value, possibly incremental to the 3x figure. Whether it’s around management of the environment, for optimization purposes, or generally to enhance the solution for the customer, as well as to automate the process/workflow for the vendor, this should lead to scalability and increased margins over time, and thus creating a higher near-term value. It’s important to note, that this solution should be unique or differentiated to what’s available in the market from a 3^rd party tools perspective, as why would you re-invent the wheel, and spend considerable resources doing so. Also, to receive value for this component, the vendor should be actively using this IP within their business as an integral component of delivering their solutions, vs. a customized solution built for one customer, to which there are grand visions of what’s possible for the product, yet it has limited traction.

Cyrus Maghami is Founder and Managing Director of Harbor Ridge Capital, which advises lower middle-market technology services and software companies on M&A and institutional capital raising. Prior to Harbor Ridge Capital, Cyrus was a private equity investor for both Kayne Anderson Private Equity and Shackleton Equity which he made considerable investments in the IT services and software verticals. Cyrus Maghami is a Registered Representative of and Securities Products are offered through Fallbrook Capital Securities. cmaghami@harborridgecap.com.