MBA1710 Q&A Wednesday: What should I look for when buying a software business?

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Hey, welcome to the Hundred Doll Golden Business Nuggets delivered every single day with our daily 10 minute business lessons for the real world. I'm your host, your coach, your teacher Omar Zenholm. I'm also the co founder of the $100 MBA, a complete business training and community online over at100mba.net Today's episode is a Q and A Wednesday episode. On our Q and a Wednesday episodes, I answer a question from one of you, one of our listeners. If you have a question you want to ask, just go ahead and email me@omar mba.net today's question is from Rob and Rob asks, hey Omar, love the podcast. Would love your advice on something. I'm looking to buy a software company. It's still in its early days, making $10,000 in monthly recurring revenue. I'm an engineer myself, so I'm pretty good when it comes to understanding if the software is technically sound. But what else should I look for in terms of the business side of things? What are some of the things I need to check to do my due diligence to before making an offer and buying this software company? We'd love your thoughts. Thanks for bringing the heat every day on the podcast, Rob. Thank you Rob for asking the question. Great question by the way. Buying a business is A great way to get into entrepreneurship. If you are listening and you've never started a business, but when it comes to buying software companies, there are particular things that I recommend you check. You make sure that this company has before you sign on the deadline, I'll share with you exactly what are some things that that are vital to the success of your business moving forward. If you buy, as well as why Rob's particular business that he wants to buy is a sweet spot. That 10k MRR mark, let's get into it. Let's get down to business.

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So today's Q and A, Wednesday's question is from Rob. And he's looking to buy a software company. He's an engineer, so he knows the tech stuff is sound. But what about the other aspects of the business? What should he look for? What should he check before buying? Before we move off totally on the technical side, I do want to mention if you're buying a software company, technical documentation is incredibly important. If you're buying a company that's doing 10,000 in MRR, there's a good chance that it's a small company right now, it's a small team, maybe less than five people. And when you have a small team, often, especially if they're just trying to get traction in the beginning, they're not really spending time documenting how the app works, why it works, why they written the code that way, what are all the contingencies and the integrations and the tools they're using and all that kind of stuff, There's a lot of things that need to be documented because often when you have a small team, things just live in the people that are running the business's head. And that's a no, no, because that means all that knowledge, all that information is only accessible if that person's available. What if that person moves on, changes jobs, or their business gets bought because you bought it from them, Right? You need to make sure that the brain trust of the actual product is written down. Basically, you want to make sure that the information, the knowledge, the IP is separated from the people. Now, you might be inheriting the team, you might be you know, buying the company and giving them jobs, but still you do not want your company to be reliant on individuals. When I talk about documentation, I'm talking about literally, this is how the app works. This is why we built it this way. These are the decisions we made. It's called technical documentation, but it could be written in layman's terms. There's nothing worse than hiring a new engineer to join your team. And they're reading this code and they can't make any sense of it. Why do they write it this way? What's the point here? There's no comment on the code or commenting on the code. There's no documentation to refer to to understand why the code is written this way. This is going to take a lot of time out of your engineer's hands trying to just understand what is going on so they don't break anything when they try to fix it or improve it. You want to just avoid all that so they can hit the ground running. And essentially this documentation is going to help you tremendously as you scale the business. Now, if the company does not have this documentation, you can make the deal contingent on it, where basically you approve that those documents are good enough, right? That this is enough information for me to carry this business on. Next, you want to take a look at the churn rate of this business. Churn is the rate of customers that don't use your product anymore. They cancel that, leave your doors. Now, Rob mentioned MRR, which is reoccurring revenue. That means this is a SaaS model, software as a service. So churn is a big factor in the success or failure of a business. Now, every industry's churn will differ, but you want to make sure that the churn is lower than at least 20%. Why do I say that? Because if your churn is 20%, then your growth rate rate has to be 21% for you to be growing. And 21% growth month over month is not easy. It's doable. But that's why I said the maximum. As a company grows, as it matures, as it gets more stable, churn should drop. It can go to single figures. It can go to 5, even 3%. Some people have negative churn because expansion revenue outpaces their churn. But you got to make sure the company has a handle on the churn. It's not wild where the churn is like 90%, where they get a hundred people to sign up, but 90 of them leave the next month. Next, take a look at their marketing, their Branding, their website, the social media profiles, how are they being perceived? What are people saying about them? What's their brand like? Are you aligned morally with that brand? Is this a brand you're comfortable with inheriting? And even if you are looking to change the branding, which is totally doable, how much do you have to change it? Is it a total left turn or is it just a slight pivot? A major rebranding is going to cost you a lot of time and money, and it's something you need to think about in factoring in the cost of this business when you buy it. One of the things that people forget about when it comes to buying a software company is looking at its customer service. What is the customer service reputation like? Take a look at their metrics. If they're using something like Intercom or Zendesk, a tool to manage their customer service, then there's got to be some sort of reports of a happiness rating of how satisfied are customers when they speak to customer support. Again, you can turn customer support around, but customer support will dictate a lot of the reputation of the business. So say, for example, their customer support rating is like 60%. Only 6% of people that communicate with customer support are happy. That's a really low percentage. And that means you're gonna have a lot of work to work that back up to 90 plus. And it also means that you gotta dig in to why is it 60%? Is the app not working the way it should? Are the response time support too slow? Are they not helpful enough? Are they underpowered there? Are they not investing in support or tutorials or articles? People come for the solution, the product, but they stay for the support because they're able to get the help. They when they need it, really support is there when you need it. It's like insurance, right? But boy, when support is great, when you need it, you think twice before canceling. You do not want to let go of that relationship. As a consumer, I'm a consumer of a lot of different services and products as a business owner, and I could tell you the ones that have great support, I probably will never cancel because I know they got my back when I need them because they saved me so many times. If you're inheriting the team, when you're buying this company, take a look at the company culture. Take a look at the leadership. Ask if you can interview some of the people that work for the leadership. The engineers. Get an understanding of how they work. What systems are they working in? Is it organized? Is it efficient? Is It a well, the machine or are they just winging it and they just got lucky? Now I want to take a moment to talk about Rob's situation. He's buying a company at $10,000 mrr. That's actually a pretty, pretty good spot to buy a company. Why? Because you don't get $10,000 in MRR if you don't have product market fit. If you don't have some sort of traction, you have something here where people want. Now, $10,000 a month may sound like a lot, but obviously there are a lot of expenses in a software company. So the profit is probably pretty low, but it means it has potential. So buying a company at that level allows you to really buy a lot of upside for not that much money. Okay. People that are selling companies that make 10,000 MRR might get up to a 5x evaluation. And the reason being is because the company has legs, but it may not have the resources, talent, information, skills, team to take it to that next level, to that million dollar company, $10 million company. So if the numbers and the information looks right, based on what we talked about today, finding a company that's willing to sell at that point is really a good opportunity. Of course you're going to cross your T's and dot your I's. But from what I've seen in my experience, taking a company from $10,000 to 20,000 to 30 to 40 to $50,000 a month is not a huge fee. You can probably get it done if you have the right skills and the right team in less than a year. It all depends on your market, your product, your user base, all that kind of stuff. But your potential for growth is pretty good.

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To wrap up today's Q and a Wednesday's question from Rob. Take a look at the things I mentioned in today's episode before you sign on that data line and buy that business. This is an investment of your money, but it's also an investment of your time and your attention for the foreseeable future. So you want to make sure that you're going to be spending your time on a winner on something that's really going to be a success, that's going to make an impact. Rob, thanks so much for asking. Today's Q and A Wednesday's question. If you have a question you want to ask, just email me over at omar100mba.net and I'll make sure to answer right here on Q and A Wednesday. If you haven't subscribed to the podcast yet, go ahead and do that right now. Subscribing is absolutely free and it makes sure that when the next episode is available, it's right on your device. It also gives you access to over 1700 business lessons in our archives. So go ahead and and hit subscribe right now. Before I go, I want to leave you with this if you're buying a business that's well documented, whether it's code, documentation systems, SOPs, then yes, you can inherit the team. But it's not necessary. You can actually hire your own team if you wish. Often, if you're buying a young company, it's still just the founders and they're willing to cash out. So it's actually in their advantage to have that documentation ready for you. You're less reliant on them to onboard you and onboard your new teammates. Thanks so much for listening and I'll check you in tomorrow's episode. I'll see you then. Take care.

ADP knows anything can change the world of work. Like what if a blocked shipping port caused a worldwide coffee shortage? Suddenly, businesses are scrambling to manage an increasingly drowsy workforce. Productivity slips 20% just due to the extended time it takes to conduct a job interview while yawning. Anything can change the world of work. From HR to payroll, ADP helps businesses take on the next anything. ADP always designing for people.