The Value of a Market Check – Adding New Channel Partners


It is well understood that partnerships are one of the most effective means to accelerate revenue growth in a SaaS software business. Formal reseller relationships are often the most fruitful, as your product explicitly complements your partner’s product or service offering, helping to enable their sale. When the synergies are particularly clear, and if the partner company is acquisitive, then sometimes the conversation will eventually turn to the prospect of combining your firm with theirs through acquisition; your partner prefers to lock in the synergies indefinitely and make the relationship permanent. Prospective acquirors are almost always larger with a broader sales reach, and they plan to harness synergies by pushing your offering into other markets or geographies, furthering the level and depth of integration by tapping your development team to integrate your product directly into their platform, and beyond. 

The question is: what if you could run this ‘partner then be acquired’ strategy in reverse? In order to explain the idea, we need to re-introduce the idea of a market check. A market check appears very much like a full sale process and the preparation is nearly identical. The key difference is that in the one-page teaser email distributed to prospective buyers, we explicitly state that we are checking the market for interest in the context of surfacing strategic alternatives, which may include partnership, investment or outright sale. 

Coupled with the anonymity of a teaser (a teaser does not identify your company by name), a market check process is the most effective means to instigate dialogue with the market without declaring your company for sale. They are also a great way to open doors with prospective partners. In the case of a recent mandate, we focused our target list on strategic partners in a complementary product category. The adjacency is the most obvious ‘downstream’ complement to our client’s solution, and customers almost always need to purchase both products together. 

To date, as a direct consequence of our market check process, our client has papered partnership agreements with two new partners. Reseller partners are a critical and growing component of their revenue, representing over 30% before these new deals were signed. With a 12 – 18 month exit window, our client is also ready to go to market in a full sale process with an expanded list of interested strategic buyers and enhanced revenue growth. 

Please let us know if you’d like to setup a meeting to learn more about how Cardin Partners organizes and runs a market check process. 

Raise & Grow vs Exit Now


One of the most common questions we face as advisors is simply: should we raise more capital, or less, or no capital at all; should we exit now, raise another round of equity capital and grow, or limit ourselves to organic growth so that we can hold onto more equity? And finally: if our SaaS economics prove we can make good use of growth money, could we raise non-dilutive or minimally-dilutive form of capital like venture debt or revenue based financing and essentially enjoy a free non-dilutive ride?

Asked from the founders’ perspective and assuming a standard equity raise: how much more value must we create and by when, on a risk-adjusted basis, to justify owning 20 – 30% less of the company than we would have otherwise owned if we hadn’t raised equity financing and had instead elected to exit?

Please note we are assuming the company could pursue an organic growth path at its option; for many companies, particularly in the early to mid growth stage, having raised a few rounds of equity capital and staffed up to shoot for the moon, this simply isn’t an alternative! The first round of capital set the wheels in motion, the second funding round lead to a significant expansion in staff, and the next growth round is necessary to keep the dream alive. Assuming SaaS unit economics remain viable throughout the journey, if not fantastic, then this path makes sense; there is an explicit understanding that you will run short of EBITDA profitability until size and scale are achieved and this is the explicit game plan; the VCs are on board, they want you to spend the growth money, and everyone understands that at least one more round of capital will have to go in order to cross the finish line and exit.

This same logic does not apply to a business that is bootstrapped, or any business (SaaS or otherwise) which has entered the domain of EBITDA profitable. They have options. Let’s imagine that MidChurn is a B2B Enterprise SaaS business with $2M of ARR, a fully burdened contribution margin of 70%, and total fixed S&GA and R&D expenses of $1M:

Revenue $2.0M 100%
COGS $0.6M 30%
Gross Margin $1.4M 70%
Operating Expenses $1.0M 50%
EBITDA $0.4M 20%

MidChurn has a binding LOI on the table from Rollup Star Inc. with an implied valuation of $6M calculated on a cash-free, debt-free basis, and Rollup’s offer is at 3X TTM recognized revenue (it would ordinarily be pegged to a multiple of current run rate revenue, and would factor in growth, the relevant SaaS metrics, buyer revenue and cost synergies, and myriad other factors -- but let’s keep it simple and stick to the terms of the offer as presented in the LOI). As an alternative, they have a VC term sheet on the table for a $2M growth investment at the same $6M pre-money valuation (again, the pre-money VC valuation would not typically be identical to the exit Enterprise Value for several reasons, but let’s keep things simple). Assuming common shares (to avoid the complexities of analyzing the liquidity preference) and 100% founder ownership pre-investment, their new VC partner will own 25% of the company post-investment. By extension, the founders will have diluted themselves down by 25%, and once spent, the newly-injected treasury capital must increase equity value by at least $2M (on a fully discounted, risk-adjusted basis, assuming the money is spent to grow as intended) in order to be break even on the deal.

Enterprise Value $6M
Equity Value pre-investment $6M
Treasury Raise Total $2M
Post-Money Equity Value $8M

Fast forward to 12 months post-investment, and our hero founding team and their company MidChurn have efficiently deployed all of the growth capital; they ramped up R&D, added customer demanded features and functionality and incorporated key 3rd party integrations, raised average ACV, and have acquired new customers and expanded within existing accounts. In spite of their fantastic effort, and partially because they were so head-down on product, their financials now show recognized revenue of just $2.5M. This 25% growth is not 50% or 100% growth, clearly, but everything else looks so good: product, average ACV growth, negative churn. However: not only are they nearly out of runway, but let’s take a look at what the founders’ equity would be worth if they received an offer at the same 3X TTM revenue multiple:

Enterprise Value $7.5M
Equity Value (assume no cash remains) $7.5M
Founder Ownership 75%
Founder Proceeds at Close $5.6M
Investor Proceeds at Close $1.9M

Now, there is arguably a case for a higher revenue multiple, here. Both because of the intangible value in the now superior product, the fact that the company is larger with more customers, and is another year de-risked in the market. However, there is something else going on here: notice that the equity value of the VC investment is underwater at $1.9M versus $2.0M invested. And it’s also a full year later! This is because the $2M of invested capital needed to grow the revenue by at least the implied entry multiple, just to keep pace. In this case, the $2M needed to grow revenue by $2m / 3X = $667k, whereas actual revenue growth was just $500k. But there’s more: both the VC investor and the founders expect to be compensated for risk. VCs call this their required IRR, and founders should really think about it the same way. At 30% / year, the equity value of MidChurn needed to grow from $8M to $10.4M:

Initial Post-Money Equity Value $8M
Risk-Adjusted Rate of Return 30%
Required Equity Value +1 Year $10.4M
Required Revenue +1 Year $3.47M
Required Revenue Growth Rate 73%

This is quite a remarkable result. If the founders had not raised any money whatsoever, then they would have achieved exactly the same result with just 30% organic growth:

Initial Equity Value $6M
Risk-Adjusted Rate of Return 30%
Required Equity Value +1 Year $7.8M
Required Revenue +1 Year $2.6M
Required Revenue Growth Rate 30%

The take away: equity is expensive. Imagine if the founders could have found a way to achieve the same growth with non-dilutive debt or revenue based financing; their equity value remains entirely preserved. Said another way: sometimes outside equity capital is the only way to the finish line, but certainly not always!

If you’re in the crucible of the equity versus exit decision and would like to know what you’re signing up for if you take on an outside equity partner, please try our interactive calculator, below:

Defending M&A Exit Value: Part 1 – How to ensure Unearned Revenue does not reduce Shareholder Proceeds at Exit.


Q: We sell monthly and multi-year annual pre-paid contracts. Our Deferred Revenue liability account scales consistently with our ARR. How should we expect this will affect any adjustments to the amount of money we receive as shareholders, when we exit?

A: When defending value on exit, our starting point is that it should not reduce shareholders' proceeds whatsoever: the deferred revenue that originates from pre-paid SaaS contracts is recorded as a liability on the balance sheet, but it isn’t a liability in the same sense as ordinary debt. Read on to learn more, and to calculate the expected level of deferred revenue on the balance sheet.

Deferred or Unrecognized Revenue can be a controversial topic when it comes time to apply closing adjustments in a SaaS company acquisition, or M&A transaction – but it needn't be: in the case of a typical B2B SaaS business with outsourced hosting infrastructure, the real costs incurred to retire this debt are equal to the incremental cost of hosting and delivering the platform at scale, which are typically minimal.

As nearly all Letters of Intent (LOIs) are written on what is termed a ‘cash-free, debt-free basis’, the buyer’s starting presumption might be that deferred revenue should be a dollar-for-dollar reduction in the shareholder proceeds at close. The easiest way to avoid this is to have the buyer explicitly agree to exclude deferred revenue from the definition of indebtedness when reconciling the proceeds due to shareholders at close. In other words, it’s not included in the adjustment math, period.

In our view, ensuring an explicit up-front understanding of how deferred revenue will be handled is in both parties' best interest, and we recommend (typically insist) including this term in the Letter of Intent, regardless of whether we are acting on behalf of a seller or buyer. A clear understanding avoids a potentially nasty battle post-exclusivity, once early drafts of the definitive documents are turning back and forth. In the worst case, it may not otherwise become a topic of conversation until the proposed Flow of Funds and Closing Adjustments are contemplated, shortly prior to close; sprung on the seller at this late stage for the first time, it could very well derail the entire deal.

Any large deviations from historical levels of unrecognized revenue are a reasonable exception to the above. Imagine, for example, that immediately prior to close, the seller signs a 5Y pre-paid contract and has a truck load of cash sitting in the bank and an equal uptick in the deferred revenue account; naturally, the seller should not expect a dollar-for-dollar credit for the increase in cash, with no offsetting decrease associated with the uptick in deferred revenue.

In order to get to the bottom of this math and the projected implications at the close of an M&A transaction, please take our calculator for a spin, below:

M&A Expert Value Creation Points -- #4, Building The CIM -- Industry Technology Solution Stack

This slide should be included in all cases that an enterprise software product is complementary of a larger set of solutions that encompass the totality of what the end customer should be deploying to run their business. It shows a few things:

  • Where the company fits into the ecosystem;
  • How the target company solution might complement the strategic buyer's existing solution;
  • Which integration points and API interfaces are typically owned by which vendors, and therefore where certain channel lever points and partnership opportunities might exist;

In this hospitality example, the core Property Management System (PMS) offering is represented in blue. Key 3rd party solutions are in green, the Target Co fits into the CRM module. The CRM module itself is most directly complementary of the Central reservation PMS module, and is directly complementary of the 3rd party-provided Revenue Optimization/Yield module; as you'd expect, target list for this company include the PMS vendors, and the Revenue Optimization vendors, as well as all of the more and less obvious players in each of the other boxes.

The solution stack slide not only helps the strategic buyer to understand how a company fits into their ecosystem, it proves that both the company and their banker understand how to articulate the fit.


M&A Expert Value Creation Points -- #4, Building The CIM -- Industry Trends

The Trends slide is really about highlighting the tailwinds in the industry; the reasons why the target company has macro factor help and will succeed, regardless of their own relative stand-alone out-performance relative to the competition. The kinds of things to discuss here include positive shifts in buyer behaviour, the retirement of legacy solutions, and other broader secular trends that point in the overall direction of sustained growth. It's often helpful to find those trends that are empirically proven and clearly manifest in the company's income statement, thus proving directionality, but still relatively early in the customer adoption cycle (with significant room for further growth).

Some of the points raised on this slide are:

  • Content Quality - Customer expectations have gone up, and the hoteliers must catch up with an email marketing solution like the one provided by Target, in order to stay in the share-of-voice game;

  • Pre-arrival: The concierge experience is going digital, and it's moving to the pre-arrival phase of the customer journey, when the guest is first ready to start planning their trip;

  • Survey Juice: Survey results are the 'SEO juice' of the OTA (Online Travel Agency) booking universe, and hoteliers that don't have a means to drive reviews will lose on occupancy and revenue;

  • Channel re-direction: OTAs can cost hoteliers upwards 30% of their revenue, and for every dollar of re-directed channel books, the hotelier is keeping 30% more in pure margin; there are many dollars to be saved, here;

  • Personalization: the system must be able to anticipate the guest need before they ask.

  • Data Consolidation: there must be a single, unified view of the guest.

Stay tuned for the next in this series: the Industry Tech Solutions Stack.