January 2024 I2Coalition Legislative Update

The i2Coalition has posted their monthly update of regulatory events for January 2024. Their legislative outlook and summary of key events regarding Section 230/Intermediary Liability among other issues make this monthly summary worth the read. Join i2 to get the more detailed briefing!

Cheval Year End Letter - 2016

Happy New Year

We want to thank our clients and colleagues for a record breaking 2016.  M&A activity in cloud, hosting and related business segments was at high levels during 2016 and we were fortunate to complete 24 M&A and 35 IPv4 block transactions.  The M&A transactions included a broad mix of sizes and types of hosting businesses and we have now completed over 370 internet services and related transactions since we first got started in the space in the mid-1990s.  

As we have done for the last few years at this time, we’d like to take a moment to highlight a few of the industry trends that caught our eye during 2016:

Industry growth in dollar terms continues to accelerate - *: The Hosting and Cloud business had another solid year in 2016. While the industry’s growth rate declined to an estimated 18.8% rate in 2016 from 20.2% in 2015, the industry’s growth in total dollars accelerated from an estimated $12.1B increase in 2015 to an estimated $13.5B increase in 2016. We believe the continued increases in dollar growth to be a more significant predictor of industry health than percentage growth at this time, particularly in the current stable/declining price environment. These increases highlight the continued expansion of demand for cloud, hosting and related services. 451 Group’s projections indicate growth in dollar terms is likely to continue to accelerate over the next few years.

As in previous years, growth across the industry continues to be uneven. This year we’ve worked with hosters growing at 30+% per year and hosters that are shrinking. We expect this unevenness to continue.

(* - 451 Research, Market Monitor 2016.)

Divergence of brains & brawn: We’ve seen increasing numbers of service providers offering service on others’ infrastructure. While not uncommon in the past, we’re now seeing it on a larger scale and among providers of higher end and more specialized services. Our expectation is that as the hyper-scalers continue to reduce prices and expand service, we will see more of these infrastructure-lite providers. We believe this separation is due in part to a declining rate of return on commodity infrastructure and in part from new opportunities the hyperscalers are creating (e.g. support, onboarding, management.)

We also believe that for the smaller providers, selling brains is likely to generate a higher risk adjusted return than commodity computing infrastructure. A key problem however, is that valuation and sale of businesses that sell hours of service like a consulting firm can be more difficult. Companies following this path need to ensure they automate and productize their service.

AWS Lightsail: Amazon Web Services (“AWS”) released a new VPS hosting product in late 2016. While the Lightsail product is not revolutionary or particularly aggressively priced, it does signal AWS’s desire to go after the unmanaged VPS market more seriously. If AWS remains true to form, we can expect price cuts, better hardware and an expanded product/service portfolio down the road. Given their size advantages, they are likely to be a formidable competitor to existing SMB hosters.

Ongoing M&A Trends: Lastly, a number of the M&A trends we highlighted last year appear to be continuing. Rather than repeat ourselves, you may find our 2015 letter https://www.chevalcap.com/blog/2016/1/11/hosting-ma-update of interest.

Best wishes for a happy and healthy 2017!

Hillary Stiff & Frank Stiff
Cheval Capital, Inc.

The M&A Process With David Snead

One of the most common questions we are asked is about the various steps involved in the buying or selling of a web hosting business.  Recently, Frank sat down with Internet industry attorney David Snead (dsnead.com) and talked through the process.

We hope this has been of interest and are happy to discuss any of these topics at your convenience.

Hillary Stiff & Frank Stiff

Disclaimer: This post is for general information purposes and is not meant to be taken as financial advice, a recommendation to buy or sell the stocks mentioned above, a comprehensive discussion of valuation or how to do the calculations discussed. Please be sure to consult your financial advisors when valuing your company, considering the sale of your business or making other financial decisions.

Authors: Hillary Stiff & Frank Stiff of Cheval Capital have been investment bankers  completing M&A transactions, arranging financing and providing financial advice for a large number of companies including The Endurance International Group, SingleHop, Rackspace, Web.Com among many others. They have completed over 270 successful web hosting, ISP and related transactions and distribute a list of hosting and related companies that are for sale.

Selling Your Hosting Company

Companies that are beginning to think about selling their business often ask us how the sale process typically works.  While it is not possible to summarize all of the possible ways to sell your business, we can give a brief outline of one way a small hoster might do it. We caution that every situation is different and the outline below may be inappropriate for your company and you should consult your financial and legal advisers before undertaking any sale.  We also want to emphasize that there are many other ways to sell your business that may be as good if not better.

Here are the basic steps the owner of a small hosting company might sell their business.

1. Get ready
2. Find prospective buyers
3. Mutual confidentiality agreement
4. Provide high level information
5. Negotiate and agree on a summary of terms
6. Complete detailed due diligence
7. Negotiate and sign the purchase agreement(s)
8. Transfer/migrate the business to the purchaser

We'll go through each of these steps below;

1. Get ready.  It is a good idea to prepare the basic information buyers will need to evaluate your business in advance of starting the process.  That way, you don't risk losing momentum by stopping things partway along while you prepare a key piece of financial or technical information. You also won't risk losing sight of your own business if you have to try and fulfill a lot of data requests.  The information to prepare in advance can vary a bit depending on your business, size and the nature of the prospective buyers.  You would be in very good shape if you could pull together (a) a written summary of your business, its ownership, its products, etc. (we have a questionnaire that we use to help sellers put this together); (b) recent financial statements for the last 12 to 18 months, quarterly if possible; (c) the number of customers and amount of revenue broken down by product line; and (d) a summary of the customer accounts added and lost for the last year.

If you don't have any of the above, it doesn't mean you can't sell, it just means you have to use other things to get the buyer what they need.  Try to keep the goal in mind - you need to help buyers understand how much cash your company will produce for them and the risks to that cash flow.  The more confidence they have in your business and its cash flow production, the more likely you can get full value for it.

2. Find prospective buyers.  Once you've got your information package ready, you need to find prospective buyers.  This isn't an issue if you work with someone like us as we already know, and have relationships with, a very large number of prospective buyers.  If you're doing it on your own, try to think of what we call the "logical" or "natural" buyers. If you lease servers or resell services of another company, they may be willing to buy you or refer you to their other customers.  They have an incentive to find someone for you so you don't get purchased and moved to another provider.  Likewise, it may make sense to talk with providers in your own geographic area or data center. Generally the goal is to talk with several prospective buyers to keep everyone competitive.

3. Mutual confidentiality agreement.  A mutual confidentiality agreement (sometimes called a non-disclosure agreement or NDA) is an agreement between you and a prospective buyer that restricts each party's use of the confidential information of the other party. Since you're going to be disclosing key information about your company, it is generally a wise idea to have and NDA signed with each prospective buyer before giving them your information package.  We strongly recommend getting a lawyer's help in putting one together (or reviewing one that you get from the internet or other sources.)

4. Provide high level information. Once you find a prospective buyer and have an NDA signed you can send over your package of material.  Oftentimes a conference call to go over technical issues and for both sides to ask questions is a good idea after the information package has been reviewed.  What is key at this step is that you want to give enough information for the prospective buyer to prepare an offer but not more.  So for example, a revenue summary of customers by product makes sense to disclose at this point but a list of customer names does not.  Also remember that you're trying to find out if they'd be a good buyer and need to find out as quickly as possible if they would be trustworthy, have the money, are a solid business, etc.

5. Negotiate and agree on a summary of terms.  Once you have answered the high level questions, you want to have the prospective buyer provide an outline of what they would pay for your company and the key terms of the transaction including an expected time-line until closing.  If the proposal is not acceptable as-is, the parties try and negotiate a mutually acceptable deal.  Oftentimes once the outline of a transaction is agreed to, a non-binding letter is signed that sets out the key terms.  Again, we strongly recommend having a lawyer advise you during this stage and help prepare or review any letter or agreement before you sign anything.
  
6. Complete detailed due diligence.  Once you've agreed to a proposal, the buyer generally begins a more detailed due diligence of your business.  They will look to confirm all the information you provided to them, see if there are any risks or liabilities that they missed and generally ensure that they have a detailed understanding of your business.  Remember, they are trying to understand/confirm the amount of cash your business is likely to produce for them and the risks to that cash flow.  You will also be looking closely at the buyer to confirm that they can fulfill their obligations and that they are trustworthy to do business with.  We believe it is in your interest to ensure the buyer knows fully what he is getting.  Surprises after closing are generally not good for either party.

7. Negotiate and sign the purchase agreement(s).  Sometimes simultaneously with the due diligence, the buyer prepares the purchase agreement(s) that is then negotiated.  Once you've reached agreement on the documents, both parties provide the information required within them and sign. We strongly recommend (yes again) having a lawyer help you with this. 

8. Transfer/migrate the business to the purchaser.  Once the purchase agreement(s) have been signed, there is sometimes a period where the buyer helps transfer the customers/assets/business to the seller.  This transfer period may also be tied to the payment of the purchase price.  For example, a certain part of the purchase price may only be paid once all of the customers are migrated onto the buyer's infrastructure.  Buyer's want provisions like this when the seller's help/expertise is critical to the migration/transfer process.

Those are the major steps for how a smaller hoster might go about selling their business.  Firms like ours help businesses navigate this process and hopefully make it go easier and faster while improving the chances for success.

As mentioned above, every business is different and this may or may not be the right method for you.  As always, we strongly urge you to consult your business, financial and legal advisers before undertaking any significant transaction.

Please feel free to let us know if you have any questions.

Cheval Capital, Inc.
March 2010

Disclaimer: This post is for general information purposes and is not meant to be taken as financial advice, a recommendation to buy or sell the stocks mentioned above, a comprehensive discussion of valuation or how to do the calculations discussed.  Please be sure to consult your financial advisers when valuing your company, considering the sale of your business or making other financial decisions.

Enterprise Value Calculation

REVISED MARCH 11, 2018: We've been asked recently about the concept of Enterprise Value and how it is calculated. Briefly, Enterprise Value attempts to calculate the value of the operating business of a firm without regard to its capital structure or (ideally) other non-operating factors like an unusually large cash balance.

Here are the two formulas we typically use for public companies.

1 - Enterprise Value = (Outstanding Shares * Current Stock Price) plus Debt (long and short term, including capital leases) less cash & marketable securities.  [UPDATE 9/8/10:  We changed our calculation to subtract off cash and marketable securities as noted. UPDATE 3/11/18: We're no longer using fully diluted shares and option exercise proceeds in the calculations.]

2 - Enterprise Value = (Outstanding Shares * Current Stock Price) less Current Assets plus Total Liabilities.  (UPDATE 3/11/18: We're no longer using fully diluted shares and option exercise proceeds in the calculations.)

While the formula many use is probably something similar to #1, we  also look at #2 as some companies have unusual balance sheet items that can distort the result of #1. #2 may also be more applicable when you are trying to look at valuations for asset purchase transactions where the bulk of current assets and total liabilities are left behind with the seller (as in hosting.)  It is also important to keep an eye on the amount of un-exercised, in the money options as these can distort valuation as well. Circumstances may dictate using a hybrid formula to ensure a logical result.

As always, if you have any questions please do not hesitate to contact us. 

Author: Hillary Stiff,  Managing Director of Cheval Capital. Hillary has been an investment banker and CFO, completing M&A transactions and arranging financing for a number of companies including NTT/Verio, The Endurance International Group and Web.Com among many others.  She has helped complete over 250 successful web hosting, ISP and related transactions and distributes a list of hosting and related companies that are for sale. 

Disclaimer: This post is for general information purposes and is not meant to be taken as financial advice, a recommendation to buy or sell the stocks mentioned above, a comprehensive discussion of valuation or how to do the calculations discussed.  Please be sure to consult your financial advisors when valuing your company, considering the sale of your business or making other financial decisions.

Price vs terms in the sale or purchase of a smaller hosting company

In the hosting and ISP worlds, we hear a lot about the multiples of revenue or EBITDA that companies are being sold for.  One thing that buyers and sellers should be aware of however, is that the non-price terms of a deal can have a major impact on the price paid.  There are two general rules of thumb that we use when evaluating terms;

(1) The more risk a party bears the more compensation they should get for taking those risks; and
(2) Money today is worth more than money tomorrow.

Here are some of the terms in a smaller hosting company purchase/sale that typically make the biggest impact on price (and how they tie to our rules of thumb);

Payment timing (1 & 2).  It is easy to understand how this could affect a purchase price.  A buyer that is willing to pay 100% of the purchase price on closing would likely pay a lower price (all other things being the same) than a buyer that paid only 20% of the purchase price on closing and the remainder over time. By paying everything upfront the buyer is taking on both more risk and they are paying with money that is worth more (today's money) than the other buyers money (tomorrow's money).

Payment and transaction certainty (1).  If there were two buyers with similar offers, the one that offered the greater certainty of being able to make the payments or complete the transaction would likely have an advantage and be able to pay a relatively lower price.  This is one reason why we encourage buyers to establish a solid track record of completing acquisitions as it reduce their costs in future acquisitions.

Churn protection (1).  Another common term that can affect purchase price is the existence of buyer churn protection.  Churn protection is when some or all of the purchase price is tied to the rate of customer retention or loss. A buyer would typically pay more for a company if a portion of the purchase price was tied to the rate of customer retention as it would reduce their risk.  For a seller, this may or may not be a good term to agree to depending on the amount of the increase in purchase price and non-renewals, the amount of risk the seller felt they were taking on.  The amount of effect this term can have of the purchase price would likely vary with the age and historic stability of the customer base.

Other legal issues.  There are a variety of legal issues in most deals that can affect the risk to either party, and as a result, the price.  One example - what happens if the buyer of your company is sued after closing, for an event that happened while you still owned it?  Is that something the new buyer is on the hook for or is that something you are obligated to reimburse them for?

We've tried to highlight an issue you should think about as you go into a buy or sell process.   For more details, please see the slides from a talk at Hostingcon 2008 with Hillary Stiff of Cheval and Joe Bardenheier of The Endurance International Group that addressed a number of these issues.

As always, if you have any questions please don't hesitate to contact us. 

BE AWARE THAT THE PURCHASE OF ASSETS OR BUSINESSES MAY BE RISKY. SMALL BUSINESSES ARE OFTEN DEVELOPMENT STAGE OPPORTUNITIES WITH SIGNIFICANT FINANCIAL, TECHNOLOGICAL AND OPERATING HURDLES TO OVERCOME AND PURCHASERS HAVE A MEANINGFUL RISK OF LOSS OF THEIR ENTIRE PURCHASE PRICE.

Disclaimer: This post is for general information purposes and is not meant to be taken as financial advice or a comprehensive discussion of this issues discussed.  Please be sure to consult your financial advisors when valuing your company, considering the sale of your business or making other financial decisions.