You've successfully attracted a buyer and secured an LOI? Congratulations!
That’s an exciting milestone. But it’s not quite the finish line yet - you are now entering the due diligence phase.
While due diligence is often the part of the process that sellers dread the most—and we will admit it’s definitely not the most exciting aspect of M&A—there are things you can do to prepare and minimize potential hurdles.
Due Diligence Explained
Essentially, due diligence (or "DD") is the buyer's way of confirming that all the information shared pre-LOI is correct and ensuring there are no hidden surprises before proceeding with the transaction. It involves a thorough review of financial records, legal documents, operational processes, and more.
The scope of due diligence can vary depending on the business or type of transaction. For example, a shares deal generally requires a more extensive review than an asset deal—see our article on deal structures here. Another key factor that impacts due diligence is how detailed your pre-LOI discussions were. Spoiler alert: the more detailed, the better, if you want to avoid bad surprises and renegotiations during the due diligence process.
What to Expect
At the start of the due diligence process, most buyers will submit a detailed data request outlining all the information they need to move forward. For sellers who are unprepared or unsure where to find this data, this part of the process can be absolutely overwhelming and lead to a frantic search for documents. If your responses are disorganised or incomplete, the resulting back-and-forth can be extremely time-consuming, especially for business owners who are already busy running their company, and can cause frustrating delays in the process. In the worst cases, if you cannot come up with the requested documents, or the buyer finds discrepancies in what you have provided, the deal can fall apart.
The good news is that it doesn’t have to be that way. If you work with a good M&A advisor, they can help you prepare for that phase and do a lot of the heavy lifting for you. In most cases, they will be able to anticipate the most important requests, so you’re not taken off guard.
The scope of due diligence can vary depending on the business or type of transaction. For example, a shares deal generally requires a more extensive review than an asset deal—see our article on deal structures here. Another key factor that impacts due diligence is how detailed your pre-LOI discussions were. Spoiler alert: the more detailed, the better, if you want to avoid bad surprises and renegotiations during the due diligence process.
In this article, we will highlight the 10 main things you should expect to be asked about during due diligence if you are selling a SaaS business. If you are part of a professionally conducted process, many of these points will have been at least partially covered pre-LOI. However, most, if not all, of these things will be reviewed in more detail during formal Due Diligence.
1. Corporate Documents and Financials
Buyers will want to make sure that your corporate house is in order. This means they will need to see your articles of incorporation, bylaws, and certificates of good standing. Buyers are also going to want to see financial statements. How extensive your documentation will need to be varies with the size of the transaction and the industry vertical. However, at the very least you should have an up to date income statement, balance sheet, and statement of cash flows ready to go when you start speaking to buyers.
Most business owners have some kind of internal financial reporting. But when it comes to M&A, it is really important to have accrual based financial statements if you want to avoid bad surprises during the negotiations…
Not sure what accrual even means? Or want to read more about why it's important for M&A? Check out this article
2. Customer Retention, Churn Rates, and Revenue Retention
Buyers will closely examine your churn rates and revenue retention. High retention rates indicate customer satisfaction and a reliable, sustainable revenue stream, while high churn rates may signal issues with your product or service. Prepare detailed records of monthly and annual churn rates, ideally segmented by customer cohorts, to give a clear picture of customer behavior and product engagement. Be ready to discuss the strategies you've implemented to reduce churn and retain customers, along with any ongoing initiatives to improve these metrics. This transparency will reassure buyers about the sustainability of your customer base.
Not sure where to start or what to optimize for? We’re always happy to offer advice on strategies that can help enhance these key metrics ahead of an M&A process.
We know that tracking all these metrics can be challenging, but we've seen so many cases of processes being delayed by months because the data wasn't ready, sometimes missing out on great opportunities (time is the biggest deal killer after all...). The good news is that there are tools — like Baremetrics — that can streamline data collection, organize historical info, and automate reporting. Setting one up early not only helps ensure you're prepared for an exit but also offers valuable insights that you can leverage while running your business.
3. Revenue Streams and Growth Projections
Buyers want to understand the composition of your revenue and the future growth potential of your business. You should be able to clearly distinguish between recurring and one-time revenues and highlight the proportion of revenue generated from different product lines or services. You should prepare detailed revenue breakdowns and growth projections based on historical data and market trends. Including various scenarios, such as best-case, worst-case, and most likely growth projections, provides a comprehensive view of your business's potential. Knowing how and what to present in forward-looking projections can be more art than science and this is an area where an experienced M&A advisor can add a great deal of value.
4. Customer Acquisition Cost and Lifetime Value
Buyers will scrutinize your customer acquisition cost (CAC) and customer lifetime value (LTV) to understand the efficiency and profitability of your sales and marketing efforts. Be prepared to discuss how these metrics have evolved over time and any strategies you've employed to optimize them. Providing insights into your sales funnel, marketing campaigns, and conversion rates further illustrates the effectiveness of your customer acquisition strategies.
5. Product Roadmap and Development Pipeline
Buyers will want to know about your product roadmap and development pipeline to assess the future potential of your offerings. Present a well-defined product roadmap that outlines planned features, enhancements, and new product launches to showcase your commitment to innovation and continuous improvement. This can include timelines, resource allocations, and milestones to provide a clear picture of your development plans. You should be able to discuss how customer feedback and market research have influenced your product roadmap and how you prioritise different initiatives. This demonstrates to buyers that your company has a strategic vision for the future and is well-positioned to adapt to changing market demands.
6. Operational Scalability and Efficiency
The scalability and efficiency of your operations are vital considerations for buyers, as they impact your ability to grow and maintain profitability. Document your operational processes, systems, and workflows to demonstrate your operational maturity. Buyers will be interested in understanding how you manage key functions such as customer support, onboarding, billing, and infrastructure management. Highlight any automation or process improvements that have enhanced efficiency and reduced costs. Additionally, be able to discuss your plans for scaling operations to support future growth, including any investments in technology or personnel. Providing this level of detail gives buyers confidence in your ability to sustain and scale your business effectively.
While revenue growth tends to be most entrepreneurs' main focus, having a clear view of your cost structure is crucial when preparing for an exit. Overlooking your costs—or reviewing them too late—can result in leaving significant value on the table.
At Nextoria, we address this early to help ensure our clients maximize their valuation. See this video for examples of the interactive dashboards we use to track performance.
7. Open Source Licences in Code
Every buyer is going to insist that you list out all of the open-source licences in your code base. Many of the common open-source licences permit incorporation of such code into software and for that software to be sold commercially. There are a few open-source licences that are copyleft licence which require that any software incorporating that code must be distributed as freeware. Most buyers will insist that the seller guarantees that there is no code in its code base that could affect the buyer’s ability to sell the software. This guarantee means that you as the seller will be financially responsible (even after the transaction closes) should there be a copyleft license in the code base. Therefore, it is very important that you have an accurate listing of all open-source licenses you have used.
8. Support Tickets
Almost all software has bugs in it. Buyers know this, but you as the seller should expect Buyers to ask for your support tickets going back for a period of time. Buyers want to know they are buying a product that works like it is supposed to work, and this sort of customer feedback is a key datapoint for that sort of validation. These support tickets and bugs will bleed into a discussion about the ongoing support you as the seller will provide the buyer after the transaction closes to ensure that everything works as the buyer expects. You should be prepared for this discussion about transition services and should expect to be available to at least answer questions for several months after the transaction closes.
9. Contracts to Assign
Certain customers can drive an outsized portion of revenue. If a single customer provides 5% or more of your total revenue, a buyer will want to take a close look at your contract with that customer. The buyer may even want to speak with someone at that client to make sure your client won’t jump ship after you sell the company. It is also important that all of your subscription agreements have the magic legal language letting you assign or transfer those contracts in the event of a sale. Otherwise, you could face some headaches and it may delay your ability to sell your SaaS business.
10. Ongoing Litigation
No one wants to buy into a lawsuit. Lawsuits are expensive and time-consuming. Buyers are going to want to know if your company is involved in any litigation, and they are also going to want to know if there is any threatened litigation that could take place soon after the transaction closes. So long as there aren’t any lawsuits against your company, there won’t be any problems. If you are embroiled in litigation, then you will need to communicate this to the buyer and don’t be surprised if the buyer loses interest in your company or insists that the purchase price be dropped.
Armed with some knowledge and preparation, you will be able to successfully navigate the due diligence process and close on a successful sale of your SaaS business, and the earlier you start preparing, the better!
Written in collaboration with Barlow & Williams, M&A law firm for the Digital Age
In this article, we will highlight the 10 main things you should expect to be asked about during due diligence if you are selling a SaaS business. If you are part of a professionally conducted process, many of these points will have been at least partially covered pre-LOI. However, most, if not all, of these things will be reviewed in detail during formal Due Diligence.
