The Keys to Successful Web Hosting Acquisitions

(Ping! Zine Web Hosting Magazine) – Web hosting acquisitions are very specific business transactions. A buyer looking for a web hosting business is typically a person already running one and is interested in acquiring another one to merge or to help build his business. Depending on the acquisition, a new business can be run together to create competition with each other or to maximize winning over more customers with the theory if a customer doesn’t choose business A – he just might find business B more desirable.

From a business point of view, the acquisition of a web hosting company is a boon for the industry as small fragmented hosts consolidate to provide better business plans and more efficient services to clients. Many times clients have no idea their web host has changed since there is normally no disruption of service, and often even if the client finds out and decides to change, there is always the possibility of the client winding up with the same company, the same server platform, and the same support – just with another name. Alternately however, most web hosts do not hide acquisitions and sales and most will issue a press release to announce the good news.

So how does one manage an acquisition? Although this is not a complete list of “how to,” and is not meant to replace legal or other expert advice, these suggestions might help serve as a guide to a better understanding of the techniques and processes used to successfully acquire a web hosting organization.

How do I begin?

Depending upon someone’s experience and of course budget it’s always best to start small. Small web hosting organizations are generally categorized with annual revenue under $1 million. These companies are in high demand because there is room to expand with the pricing still remaining moderate. Medium businesses with revenue ranging from over $1 million to $10 million will generate higher asking prices as will larger companies that exceed $10 million with market conditions often determining the sales or purchase price.

Buyers always need to do their own due diligence so what they think they are getting, they are really getting. A detailed study of an organization’s customer base, assets and an analysis that the expectations are realistic should be sought through records of revenues, profitability, cash flow, and the stability of the customers. It’s not always obvious if current customers are happy and likely to renew which can affect the long term success of any acquisition, so check out the current quality of customer support, downtime, and web hosting blogs or reach out to some of the customers and get their feedback.

It’s also wise to remember that other variables can be involved as to the buyer’s demands at the time of the sale or if the purchase of a web hosting company might be more of a strategic acquisition as opposed to a financial one where the purchaser uses the company’s revenue as the only consideration when making an offer.

Therefore a safe way to start would be to ask for financials, including the profit and loss statement, a history of customer add and deletes as well as site traffic to know what type of traffic the web hosting site is generating which is critical to the conversion rate, and what you would want to do to increase conversion profits, and all contracts, partnerships, and any current contracts that will continue after a purchase.

In addition, according to Cheval Capital, Inc., not all revenues are created equal. Here are some examples that can affect value:

  • Domain revenues have a different profitability than hosting revenues.
  • Cash flow can vary by type of payment plan. For instance a customer paying their monthly hosting account one year in advance may appear on a Profit and Loss statement as revenue each month, when in reality that particular account will not bring in cash until a year later. Multiply that by a large number of accounts, there may be cash flow problems.
  • A purchaser has to take into consideration the likelihood of a customer renewal that initially paid three years in advance two years ago versus that of a customer that has been paying every month for the last two years.
  • And finally placing different values on recurring revenues as opposed to one-time revenues – i.e. setup charges, consulting charges.

Of course, there are many more contingencies to consider, and by this time the need for expert advice should be on the top of any purchaser’s list.

How much are clients worth?

According to Hillary Stiff of Cheval Capital, Inc. small shared web hosters typically sell for around one times annual revenues. This can vary based on the type of customers (Small business clients are less likely to leave a web hosting company than customers with personal websites). Smaller dedicated hosting company demand is not as strong and their economics not quite as good. As a result, small dedicated hosters frequently sell for less. For both shared and dedicated hosters, prices are higher for well-run organizations and the possibility of positive growth. Most purchasers are seeking to increase their customer base, cash flow, equipment and brand. These purchasers plan to consolidate the seller’s customers into their own operations and typically are not concerned with, or plan to take over any of the seller’s expenses; however “there are buyers interested in purchasing the whole company including assuming infrastructure and expenses. These buyers are interested in the seller’s cost and typically price their transactions as a multiple of EBITDA (earnings before interest, taxes, depreciation and amortization),” states Hillary Stiff.

A purchaser’s concern is with the client base and the likelihood of customers renewing. While some customers may pay ahead for one year at a time, if the billing is equally distributed through the year, cash flow should be no problem. Will they renew at the end of the year sometimes becomes questionable. Monthly customers, since they reaffirm their desire to be a customer each month, are easier to follow as to their satisfaction as clients. Customers with longer term contracts (two-years or more) tend to have little value for a would-be purchaser and therefore decrease the client value except perhaps in situations where the history of renewals (normally in larger transactions) are positive and transparent. It’s harder to procure new clients as compared to keeping existing ones so more value may be placed on new clients.

A key component to valuation therefore seems to focus on acquiring customers and how profitable the customers will be for the new purchaser using their own systems if there were no price changes and limited growth.

Is there a value in a brand name?

Besides buying a client base to integrate into a web hosting acquisition is the decision about the brand name. Is the purchaser intending to use that name and to build on it, or just to absorb the name in an already well-established web hosting organization? General averages indicate a discount of 25 percent if customers are being sold without a brand.

According to Hillary Stiff, “There seems to be two approaches to purchasing a brand. Some buyers consolidate all purchases under their own brand, so they are indifferent about whether they get the old brand or just the customers. Many buyers will keep the brands they purchase and for these buyers, the brand has real value and it is something they look at carefully. As to how many clients will leave, it really depends on how well they were being treated pre-acquisition, how well the acquisition communication, migration and transition are handled, and how well they are treated post acquisition. We have seen acquisitions in which no customers are lost, and we unfortunately have seen cases where something is mishandled, like a migration and a lot of customers leave.” Therefore if a purchaser plans to keep the brand of the company and the brand has definite vibrancy, the price can be generally higher.

What about the assets of a company?

Hardware and its values are determined by the age of the equipment. Depreciation rules are generally standard, and traditionally not much of an issue except if the hardware is obsolete and has to be replaced. Cheval Capital states purchasers require all the assets which produce revenues, cash flow, and earnings for the business to be included in the acquisition of the company.

A purchase agreement should list all assets for the acquisition including domain names, brands, servers, routers, websites, software licenses, as well as and not limited to all assets and information verified by the seller.

Are liabilities a risk in an acquisition?

Is the purchaser planning to retain any employees or is that part of the purchase agreement? Some sellers will include such verbiage in their contracts. How about any existing contracts with vendors – i.e. data centers and software? A purchaser will have to determine if the costs are reasonable and if the contractual agreement can be terminated if not needed in the acquisition.

When purchasing real estate all liens to the property are recorded. Title companies insure purchasers any liens will be satisfied prior to a real estate closing. In a web hosting acquisition, hidden liabilities are always a risk, and similar to real estate purchases, debt and equipment leases are traceable with a UCC search. Buyers should consult their attorney. “Most deals are Asset Purchases versus Stock Purchases. In an Asset Purchase, the buyer is only buying a specific list of items, whereas in a Stock Purchase they are buying the whole company (warts and all),”states Hillary.

Cheval Capital also pointed out that hidden liabilities can be a key area. Deferred revenue liabilities simply means that money is received by a company for services in advance and not yet provided. In this example a customer might pay for five years of service in advance six months before the sale of the web hosting business, therefore throwing the onus of the next four and a half years of service on the new purchaser for no money.

Can I suggest a payment plan?

In most acquisitions there is usually a tiered payment plan with the majority of the money paid at closing or migration. Using an escrow service helps to guarantee a purchaser gets what was agreed upon in the contract. The remainder of the balance is usually paid off within a year, and a good way for a buyer to get what he paid for is to keep the seller around for an agreed upon time – either as an employee or a consultant. Standard fare is for the seller to sign a non-compete agreement and a non-disclosure to protect the privacy of the purchaser.

How do I find a web hosting company for sale?

Many times word of mouth in the industry leads purchasers to sellers. Sometimes a purchaser will just approach an existing business and ask them if they are interested in selling even if the organization isn’t officially listed for sale. One technique suggested by Cheval Capital is for a hoster to know the other hosters in their area or data center. By developing a relationship, they will be first in line when they decide to sell. Buyers also consult with intermediaries to help find prospects, provide market information and aid in the transaction. Cheval Capital has a very active practice helping acquirers and distributes a weekly list of assets for sale to its group of buyers. When a purchaser wants to acquire another web hosting business, there is always someone who wants to sell.

I found my acquisition – now what should I do?

The world is far too complicated to do any deals based on a handshake and a handwritten agreement. It is very important to be represented by an attorney who specializes in transactions and understands all that is involved. A reputable attorney will provide a purchaser with an agreement that spells out exactly what is included, how, and to what extent. Read everything pushed in front of you before you sign your name and write out that check. If you do not understand something, ask for an explanation. That is part of what you are paying an attorney to do for you – protect your rights, your money and to make sure you understand all that is involved in the acquisition.

If the seller’s business is poorly run, they should expect a low offer. “The buyer has to clean up the mess which cost money and lengthens the rate of return for the buyer,” states Adam Habach of CyberLynk Sales/Support. “Poorly run businesses can expect to see an offer around 0.2 to 0.5 times annual revenue. Everyone thinks hosting companies are always sold for 0.8 to 1.5 times annual revenues, but this year as we focused on acquiring poorly run smaller hosting companies, the majority of them were acquired for 0.2 to 0.6 times annual revenue.”

More about the seller’s organization can be found in their customer billing format and how easily it can be migrated over to a buyer’s billing system or continue to use what is already in place without disrupting customers and having them reenter their billing information. “Any time that you require any additional steps to be taken by an existing acquired customer exposes a new buyer to an additional attrition risk, and the value to the seller will usually be discounted accordingly,” states Chris West, of CDGcommerce.com.

Chris also suggests purchasers and sellers clearly understand the tax implications. Sellers have the potential to take long term capital gain treatments at the current highly favorable rates in an advantageous tax environment are “definitely something that can be leveraged by a buyer to help induce a faster transaction with a seller. Naturally a buyer should be cautious as to not make any commitments to a seller as to how a transaction will be characterized with certainty and in fact a buy-out agreement should specifically disclaim any liabilities related to that from the buyer’s side,” explains Chris.

As in every sale – sellers want to sell high and buyers want to buy low. The bridge a seller and purchaser build between each other’s expectations will mean either success or failure.

Disclaimer: This is a general purpose article and is not meant as financial or legal advice, a recommendation to buy or sell any companies, or a complete disclosure of risks involved in purchasing a company. Cheval Capital assumes no responsibility or liability for any of the information supplied in this article. The information was supplied to the author of this article as general information only. It is this author’s recommendation that every potential purchaser consult with their legal and financial advisor.

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