Developing Your Acquisition Profile

We recently blogged about an emerging trend in social media acquisitions: buying up assets and talent as opposed to streams of cash flows (i.e. entire enterprises).  We concluded that start-ups should consider positioning themselves as potential targets for asset acquirers.  But how can this be accomplished?

First, you must redefine the profile of your core customer.  While you should of course remain focused on your current user base (and growing it, if your value proposition involves increased market share or lead generation), your customers are now potential acquirers.  Determine what industries your product would serve, then generate a list of customers in each.  Recognize that you are now selling yourself as an off-the-shelf IT solution and, as is the case when contemplating an in-house IT project, you must justify the expenditure by demonstrating the ways your product can create value for the buyer's business.  For each customer, place yourself in the role of CIO.  How does your product fit into the customer's IT strategy?  Will your product help to streamline operations?  Increase market share?  Lower the buyer's customer acquisition costs?

Once you have the answers to these questions you can begin to approach prospective acquirers.  You may find that many will be receptive to your overtures, especially as the economy continues to improve and IT budgets increase.  However, once your pitch is complete the response you are likely to hear is: "You've got a quality product, a great team, and we see the benefits you can bring to a company like ours.  But why should we pay you what you're asking when we can build a comparable system for far less, or even outsource the development to India and get a comparable product for $50,000?"  In other words, why should they pay you more than replacement cost for a non-cash-generating asset?  For your response, you have several options:

Lower Total Cost of Ownership (TCO) /
Higher Return on Investment (ROI)
If possible, demonstrate how the all-in cost of acquiring you will be less than a custom-built application for the duration of a typical project length (five years). Point out that your costs are clear and are known upfront, whereas an outsourced or even an in-house build can suffer from significant cost overruns and result in outsize maintenance and support costs over time.  If applicable, underscore how your product will deliver a pool of account leads or eyeballs for CPM purposes, and, preferably, that your acquisition will result in an increased conversion rate for the buyer.  If the deal entails the transfer of human capital, underscore management's intimate bottom-up knowledge of the product as a key driver of value going forward.

Quality Control
Point out that, while an outsourced custom solution presents an attractive business option, it can be difficult to administer and, given the inherent complexity of software development, can often result in buggy code, sluggish performance, and an overall brittle application. Moreover, the identification and resolution of bugs occurs over time and in the live production environment. The result is at best an inferior product, and at worst additional costs in the form of lost productivity, lost customers and revenue, and additional capital outlays.

Evolving Functionality
Explain that custom-built applications tend to be rigid in their satisfaction of specific client requirements and do not provide the necessary flexibility to handle future changes. With your knowledgeable team in place, the customer will have the capability to regularly enhance the application with additional features, and to upgrade existing functionality. Conversely, upgrading a custom application will require a significant level of effort and expenditure.

Faster Time-to-Market
In addition to valuable resources, a custom-built application requires a substantial investment of time. Requirements analysis, design, development, testing, implementation, maintenance and support are all important factors when considering in-house or outsourced development.  Acquiring your product, however, will enable the customer to deploy in a matter of days as opposed to weeks.

Obviously you will want more than replacement cost, but how can you justify this?  In the absence of cash flows, you need to identify the unique value your product will bring to the acquirer over time.  They key is being able to the quantify the value, and to demonstrate it in dollar terms. This is difficult, and will likely require customizing your product's value proposition for each buyer, but with a bit of research and reasonable assumptions, not impossible.  In our next post we will focus on various methods for valuing your product as an asset acquisition.