Let’s start with a question I started to dig into a few months ago, why the heck are all these “VC/YC starts ups” ending up on Acquire.com ?
And…why are they not showing up with more seasoned Online Business brokers or more alongside sophisticated M&A companies?
The last question is easy to answer and it ties into the reason these businesses are coming up for sale in the first place.
Online Business brokers always verify that a business is legitimately profitable and a good prospect for sale in the M&A marketplace. Since many of these companies can’t satisfy any of those requirements, they have to list on Marketplaces (that don’t do any investigation) like Acquire.com and Flippa.
Going back to the first question of “Why these companies are coming up for sale” in the first place is pretty simple, as it happens at the end of every tech bubble.
Once Interest rates started to rise in 2022, Venture Capital (VC) firms no longer could give free money to businesses that they did not believe were going to be successful 20x moon shots.
Venture capital firms enabled these software and SaaS businesses to acquire customers by disregarding the true acquisition costs that legitimate businesses (like we all operate) traditionally face in the marketplace
While venture capital firms provided free money to these companies to acquire customers without considering the cost of acquisition, these companies also hired additional headcount long before it was needed
Today, these businesses are very top-heavy and have no baseline understanding of what their actual customer acquisition cost legitimately would be going forward.
Since these businesses no longer get free money from venture capital firms, they either have to sell or shut the business down.
That’s why we’re seeing them on Acquire.com in 2024 and likely into 2025.
Two Challenges for Acquirers
These listings present a challenge for our acquirers like us, as well as, for the founders trying to sell those businesses.
There are two major challenges to these businesses for those of us that are interested in acquiring them.
First, they’ve over-hired the number of people they need and are hesitant to fire them.
Second, they never cared about customer acquisition cost and hired new customers as expensively as possible.
All of this makes sense in the venture capital world – being unprofitable, getting money from “Uncle-VC” to continue to unprofitably acquire customers. That’s their model and the software companies did exactly what their true customer (the VC’s) told them to do.
However, today, those customers are now run unprofitably and the business has no idea how to switch gears and profitably get new customers.
Why We Investors Aren’t Excited About These Opportunities
The problem is that now, these businesses want to sell to investors like us. To rescue them from the impending closure of an otherwise unprofitable business.
But…investors like us are looking for cash flow.
Investors like us are looking for a history of profitability.
Investors like us are looking for high profit per headcount.
That is the direct opposite of what these businesses have been doing for the lifespan of their company.
How These Companies Suddenly “Become Profitable” Before Selling
The Fed started raising US-based interest rates in March 2022. 12 months later, these businesses started to show up for sale on Acquire.com.
Ever since profitability was been forced on these startups, they really have only one way to make a business suddenly look legitimately cash flow positive…
They have to “Invent” profitability (any way they can)
The easiest way to do this is by taking those 12 months preparing for a sale and cutting out all marketing and advertising costs.
That allows them to create “phantom” profit, because they’re no longer spending any money to acquire new customers.
Boom 💥💥💥 Profit!
One thing they don’t seem to be doing is cutting headcount. And I get it, that’s a lot harder to do emotionally. Plus it highlights the company isn’t going anywhere, at least, any time soon.
That causes consternation within the company, better to try and sell it first and let the acquiring company be “the bad guy”.
When you compare the headcount of these listings with the more traditional companies that are up for sale, the profit-per-headcount difference is pretty stark. To expect the same valuation for those differences is a bit…idealistic, if you ask me.
Unfortunately, with no advertising, no marketing, and an oversized payroll, these are most likely not viable businesses going forward, especially when you consider they’ve never demonstrated the ability to acquire customers profitably in the past.
Are These Considered Turn-Arounds?
I do not know if these are technically turnarounds – because businesses that are turnarounds used to make money in the past.
If you were interested in buying one of these businesses, you would first have to figure out what all of those people are doing and likely trim headcount, because many of them are not going to be necessary, or were hired too early in the business life cycle.
The second thing you need to do is put all that advertising and marketing expense back into the budget and try to get your customer acquisition costs low enough that your customers can be profitable long term.
Additionally, anecdotally, if the team that:
- Comes up with an idea
- Pitches it to a venture capital firm
- Beats out all other pitches and gets money
- Gifted free-money to grow profitable for multiple years
If that group can’t be profitable… what in the world makes one believe that someone else can make it work?
Especially without the extra leg up that the original Founders had?
How Can I Tell Which Companies Are Ex-VC Listings?
It’s pretty easy to figure out which of these businesses have venture capital funding behind them for two reasons.
First, because they don’t pass muster with brokers, so they’re very rarely on broker websites.
Second, they usually brag about getting funded in their listing (as if we’re supposed to see that as a good thing).
They aren’t hard to spot, but even if it’s not obvious, make sure you look at MRR and profitability back a few years to see how the finances have changed since the change in interest rates in 2022-2023.
That usually can identify a sudden pivot where marketing/advertising spend drops and profit rises.
Summary
The change in interest rates is the reason you’re seeing more of these businesses for sale.
Venture capital firms are pulling money away from these businesses because they don’t meet their portfolio criteria any longer.
And the only places where they can go up for sale are on marketplaces where no one actually reviews very deeply whether the business have truly been successful the last few years.
Hopefully that gives you a little background on why these businesses for sale, what you would have to do if you were going to consider acquiring them and what many of the weaknesses are in the business.
Personally, I review them, but I need a really convincing reason to move forward with an LOI.
What do you think? Am I off my rocker? Let me know by writing back and sharing your thoughts.
