Correctly Valuing An Owner/Operator Company of One
February 19, 2023
by a searcher from Duke University in Westfield, NJ 07090, USA
Does anyone have experience valuing deals where there is an owner-operator selling and no team staying on after the transaction? I am looking at a company selling profitable Shopify apps, but it’s more of a one-person-show rather than a “company” in the sense that after the apps were built there is (supposedly) little/no maintenance needed. I am a software engineer by trade so that doesn’t concern me, however I am trying to think through what happens if/when I grow and decide to sell down the line.
For context, he is currently at $280k ARR and ~$250k SDE selling for ~5.5x. The company is 93% margin, and per the above there is little to no operating team aside from occasional maintenance from a contractor.
Assuming I hire someone (let’s say $150k salary for now) both my margin and enterprise value drop based now on $100k SDE. Is this really worth the 5.5x on $250k I’s be paying?
In contrast, I am looking at a similar business with a team. They do $600k ARR with the same $250k SDE, but have a team in place for both CX and 2 software engineers that are needed to support the day-to-day operations, and could also help grow the business without additional investment. It is also valued at around 5.5x SDE, but is obviously a more complex, lower margin operation.
On one hand, the higher margin, lower effort business seems more valuable in the sense that all my effort could be on supporting growth, vs. maintaining the business as is. However, I am questioning whether I’d be acquiring it during a period of temporary stability, and in reality I just am not factoring in the future team appropriately. Perhaps the higher ARR opportunity despite lower margin could be better to fuel necessary growth.
Curious to get this group’s thoughts as I can see both sides of the argument. Thanks!
from Duke University in Alpharetta, GA, USA
People costs are front loaded for software and content. We need people to build / create it, but once created, apps and websites can self-manage until the traffic declines. Don't neglect written off investments in failed apps and website features... those will happen (despite a nice IRR, we have a ton of content which doesn't rank on Google) and are a very real business cost. In that sense, you may want to look at this as a parts sale vs. a business acquisition.
By the way, you may *not* need to hire someone for $150K to run the business... what would they do? Software development? You can outsource that cheaply. What you need is niche identification and product development and there you face another challenge: anyone good enough to be worth hiring (finds profitable niches, builds efficiently in a startup environment) is also competent enough to take those ideas and build them for themselves. Within a larger organization, you can play the benefits package & stable employment card as a means of recruiting non-rogue product execs, but for a thinly capitalized startup... the risk of getting sacked from a manager role is basically equivalent to becoming a failed founder...
So how we solved this... was defining our vision of the firm at the holding company level. A core set of capabilities (niche targeting, development, monetization) that we apply across opportunities. These were built independently of the acquired websites and support organic development efforts as well. This also enables us to apply a "build vs. buy" assessment to any new opportunity, forcing an intellectually rigorous deconstruction of how the deal will create more value than the alternatives.
Sometimes the results of this analysis are very counter-intuitive. For example... generating the same SDE despite 2 X sales and funding 3+ headcount? I'm not hearing any job descriptions I'd align to product innovation & audience growth... sounds like that would need to come from you if the founders are exiting... software engineers & CX people are often tacticians vs. growth strategists. I could argue the first business (no staff) is actually a better asset...
from University of Oregon in Portland, OR, USA