How to buy a tech business

What are the steps to successfully buy a tech business?

In general, the basics of an acquisition remain the same across all sectors, but there are specific considerations that any buyer should be aware of when targeting a tech business. Here is an overview of the steps to follow.

1. Defining the acquisition strategy

Before starting your search, you must identify your own objectives. What do you hope to achieve with this acquisition? Is it to increase revenue? To access a new market? To acquire strategic talent or complementary technology to better serve your customers?

Draw up an acquisition plan that will serve as your roadmap for the next steps.

2. Identifying acquisition targets

Once you have defined your strategy, the challenge lies in finding the right businesses at the right time. You have three main options.

Targeted approaches

This method involves approaching interesting businesses that have not yet publicly expressed an intention to sell. This approach requires more time and perseverance, as you often have to knock on a number of doors before finding a business that is looking to be acquired. However, it can sometimes enable you to find that rare gem at a more reasonable price.

Ecosystem and networking

Your business network is a powerful tool. Talk to people in the tech ecosystem and ask them if they know of any businesses for sale that match your criteria. You could contact incubators, accelerators, entrepreneurial circles, as well as venture capitalists and growth funds.

Specialized intermediaries

Bankers specializing in mergers and acquisitions, or specialized firms, can give you access to more mature businesses, as well as quality information about them. However, since these businesses are clearly up for sale, you will likely face competition, and valuations will generally be higher.

3. Initiating exploratory discussions and negotiations

Once the targets have been identified, you can begin discussions. At this stage, it may be a good idea to sign a non-disclosure agreement to encourage more open discussions.

Schedule a series of meetings with the seller. Explain your intentions, try to understand the reasons for the sale, and obtain basic information about it, such as the sales figures, the gross margin and the business model. This will give you everything you need to draft a letter of intent, which will include a price range for the acquisition (the final price will be determined following due diligence).

4. Carrying out due diligence

Due diligence is an important step in any acquisition, but it is particularly important in technology, where much of the value lies in intangible assets. A few aspects are particularly important to keep in mind when buying a business in the tech industry.

Intellectual property

For a tech business intellectual property is often the most valuable asset. At this stage, it is essential to ensure that the business actually owns the rights to the technology it has developed (source code, patents, licences and agreements with developers or external partners).

Expertise

Intellectual property is important, but often those who developed it are just as important to the success of the business. Therefore, take the time to identify the key individuals involved in the development and operation of technology tools. You should also make sure that they are satisfied and committed to the business, and that they want to work with you after the acquisition. Without them, it could be difficult to get the most out of the business.

Cybersecurity

A significant security breach detected after acquisition can be extremely damaging to the value of the business. For this reason, verify that your target has strong security measures, in place and that its practices comply with regulations and industry best practices. If certifications are required in the field in which it operates, make sure that it holds them.

Technical debt

The technology your target has developed may work very well for now, but if you go ahead with the acquisition, you will have to take control of it later on.

For instance, if your target’s core software was developed twelve years earlier and has been modified a number of times without complete documentation, the source code may have become very complex and accumulated several technological compromises over the years—this is technical debt. In the long run, this can not only affect the software’s efficiency, but also hinder your ability to add features, modernize the solution or may result in bugs that are difficult to fix. As such, be sure to assess the extent of your target’s technical debt before finalizing a purchase.

Barriers to entry

With the rapid development of artificial intelligence, businesses are able to develop software more quickly than ever before. You will therefore need to ensure that your target’s technology is not easily replicated.

You should also try to determine whether it has sustainable advantages that set it apart from the competition beyond its source code. For instance, a difficult-to-obtain regulatory certification or deep integration with major customers can be much stronger barriers to entry than the code itself.

Once the due diligence process is complete, you can finalize the purchase price and negotiate the terms of the contract, taking into account the risks identified.

5. Implementing the integration

The integration of a tech business can be particularly complex and is a step that is too often underestimated. It’s not just a matter of merging finance and operations departments, but also of integrating technologies, databases and specialized human capital. It is also important to make this transition without impacting customers. To ensure successful integration, start thinking about your strategy as early as the due diligence stage.

How to evaluate a tech business?

Evaluating your target business is a crucial step in the business acquisition process. However, evaluating a tech business has its own specifics.

The value of a traditional business is often based on a multiple of its EBITDA. However, since tech businesses are rarely profitable, as they reinvest heavily in their development, their value is more often based on a multiple of recurring revenue. This multiple may vary depending on a number of factors.

Revenue quality

Not all recurring revenue is created equal. Certain revenue streams, for instance, are based on solid contracts spread over a number of years. Typically, higher-quality revenue streams, such as these, which show low attrition, can justify a higher multiple. 

Gross margin

For a tech business, a higher gross margin indicates that it can deploy customers more easily, which supports growth and positively influences valuation.

Customer acquisition cost (CAC)

In a tech business, particularly one operating in SaaS mode, CAC must be analyzed in relation to customer lifetime value (LTV). The LTV/CAC ratio is a key indicator in that it directly influences the ability of the business to transform its growth into economic value. For a SaaS business, the healthy range for the LTV/CAC ratio is generally between 3 and 5. A ratio within this range is indicative of an effective acquisition model that can support growth while justifying sales and marketing investments, which typically results in higher valuation multiples during an acquisition.

Its subsector of activity

A business in a sought-after sector such as artificial intelligence, financial technology or cybersecurity, among others, generally trades at higher multiples.

The rule of 40

This rule is widely used to assess the performance and health of a tech business. It involves adding annual revenue growth to the EBITDA margin. If the sum of these two figures is less than 40, this rule indicates that the business is generating little overall value given its total investments, particularly in sales and marketing, but also in R&D, technology infrastructure and operations. A low score may therefore translate into a more moderate valuation multiple. For instance, a business with 60% annual growth and an EBITDA margin of -15% would achieve a score of 45 (60 − 15). Under the rule of 40, its performance would therefore be considered strong.

The financing package for a tech acquisition

The financing package behind the acquisition of a tech business differs in a number of ways from the financing package for a traditional business. Key differences include the following:

Specialized partners

For a number of reasons, but mainly because tech businesses are valued differently from other businesses, financing for a tech acquisition often comes from specialized financial players, such as venture capital funds or growth funds, as well as banks that specialize in technology and intangible asset financing. These institutions are generally better equipped to evaluate and structure transactions where a significant portion of the value is based on intangible assets.

The importance of the balance of sale

The balance of sale is a portion of the payment to the seller that is paid at a later date to ensure their continued cooperation following the acquisition. This element is often important for a tech acquisition, since the value of the business is often based on intangible assets and the expertise of key personnel. Withholding part of the payment encourages the seller and technical teams to remain committed during the critical transition period.

Inclusion of a performance-based earn-out

This earn-out is a portion of the purchase price that is paid to the seller only upon the achievement of certain future performance targets. Since tech businesses are often acquired based on their ability to continue to grow, this element is particularly relevant in the case of a tech acquisition.

Incentives for key personnel

Retaining key personnel during your tech acquisition can be crucial. It is therefore important to involve them in discussions about the acquisition from the outset and also to offer them financial incentives. For example, consider involving them in the share ownership or offering them stock options.

Next step

Ready to get started? BDC can guide you through every step of your acquisition with tailored financing solutions and the expertise of its specialists.