Unveiling the Art of SaaS Due Diligence

by | Feb 29, 2024 | Industry, Investing

In the intricate landscape of mergers and acquisitions, due diligence stands as the linchpin of informed decision-making. And when it comes to the realm of SaaS, the due diligence process requires an even more specialized lens to navigate the complexities of digital assets. Enter Mushfiq Sarker, the luminary founder and lead advisor at WebAcquisition, whose expertise has guided over 218 online business acquisitions since 2008.

Mushfiq’s journey into M&A began with a foray into the world of content websites and search engine optimization. In 2008 at just eighteen years old he built his first website, which was then acquired by Slashdot Media in 2009.

“I immediately saw the value of exiting online businesses in the open market. From 2008 to date, I’ve acquired and then exited over 218 online businesses (content sites, eCommerce, courses, SaaS, and lead generation businesses, among others). I started small in the 4-figure range and slowly ramped up to 6-figure exits.”

From these humble beginnings, he swiftly ascended, orchestrating acquisitions that spanned the spectrum of online businesses, from eCommerce to SaaS enterprises.

His trajectory culminated in the establishment of WebAcquisition.com. At the heart of WebAcquisition’s ethos lies a singular mission: to uncover red flags that others overlook.

“Acquiring businesses has always been a side gig for me while I pursued my PhD in Electrical Engineering graduating in 2016. In 2020, I left my “day job” career to focus full-time on my business portfolio.  

During this time, I’ve reviewed 1,000+ online businesses in detail. Through repetition, I’ve built up a unique skillset: technical due diligence. I’ve used this skill set to perform due diligence on my acquisitions. But, in early 2023, I launched my online business M&A firm, WebAcquisition.com.”

Driven by a passion for unraveling the intricate tapestry of each business’s data, Mushfiq’s approach to due diligence is akin to solving a multifaceted puzzle. For Mushfiq, the allure of due diligence lies in its fusion of intellectual rigor and the ever-evolving landscape of online business M&A.

SaaS Mag caught up with Mushfiq Sarker to unravel the intricacies of SaaS due diligence and explore key lessons he’s learned from his extensive experience.

About SaaS Due Diligence

What are the key components of a thorough SaaS due diligence process?

A thorough SaaS due diligence process includes looking at:

  • Marketing review: how are users finding the SaaS (e.g., SEO, social media, paid ads), are the tactics used long-term and profitable, are there any “scam” tactics being used?
  • KPI review: what are the KPIs of the business, are they sustainable and valid?
  • User profitability: On a per-user basis, is the business 
  • Seasonality: is there any seasonality in the business? If so, what’s the impact?
  • Customer risk: are any specific customers generating the majority of the revenues? Is there a key customer risk?
  • Financial review: does the P&L match up against revenues stated by payment processors? Are the costs aligned with industry averages? Is labor being taken into account (i.e., developer wages)? Are their any seller addbacks that are misaligned?

Are there any specific documents or information that businesses should have ready for due diligence?

Yes, definitely! From the seller and/or broker of the business, we need these documents and access to accounts:

  • Access to payment processor and/or dashboard where we can see revenue history of revenues and payouts to bank
  • Access to traffic analytics platform (e.g., Google Analytics) to very traffic history
  • Access as a paying member into the SaaS platform so we can check the validity of the front and back-end
  • P&L spreadsheet

How do you approach financial due diligence, and what financial metrics are critical for SaaS companies? Are there any common financial red flags that acquirers should be aware of?

We look at finances in various timeframes (last 30 days, last 3 months, last 12 months, last 3 years). We look at these components:

  • P&L review: we review each line item for each timeframe to find any misleading revenues/costs, one-time vs recurring revenues, trends, and more
  • Saas KPIs: we review new customer subscriptions against churn rates to understand how sustainable the business is. We do not on various timelines. We cross-correlate this to marketing efforts to understand which channel worked the best.
  • Costs: are the costs to maintain the platform sustainable? Were there any time periods where costs outweighed revenue? If the buyer were to keep the platform as-is to enjoy the cash flow, would that be possible?

One of the common financial red flags we have seen in the last few years has to do with sellers adding grants and government subsidies (i.e., PPP and EIDL loans) being added as revenue and thus increasing valuations. 

Grants and loans are not part of the business operations and should not be included in the P&L or valuations.

What role do market analysis and competitive landscape play in SaaS due diligence?

As marketers ourselves, we thoroughly look offer the market and competitive landscape. We look into which traffic sources are bringing users to the SaaS, is it profitable on a per-subscriber basis, and is it sustainable. 

For example, from a search engine optimization (SEO) standpoint, is the seller utilizing this channel? If they are, did they use any spammy tactics to drive up their rankings in search results (e.g., acquiring low-quality backlinks)? Did they hire an SEO agency to help with growth and if so, did they add those costs into the P&L? 

From a paid advertising perspective, is the return on ad spend (RoAS) profitable for each paid network (i.e., Google Ads, Twitter, LinkedIn, Facebook)? Is RoAS profitable across various timelines?

Competitive landscape is even more important. Where does this business fit in? Is it the most premium competitor, in the middle, or bottom of the barrel? 

A competitive landscape is important to understand what opportunities are there for growth. I personally prefer acquiring a SaaS that is in the “middle” as that gives you opportunities to grow and take market share from the premium competitor in the space.

Lessons Learned

Can you share any notable successes or challenges you’ve encountered in your experience with SaaS due diligence?

As advisors to buyers, we are only just that: advisors. 

If my firm gets hired for due diligence, our job is to get the data, analyze, and develop a report to advise the buyer. 

At times, we’ve done analysis on a business that looks amazing but when digging deep we find issues. Even with our advice to buyers to walk away, some buyers are emotionally invested and still follow through with the deal. 

We acquire businesses ourselves so fully understand the emotions when reviewing a deal. This has been a notable challenge for us to provide advice and hope the buyer is open to accepting the advice.

What advice would you give to buyers involved in SaaS acquisitions based on your experiences?       

Take your time: there is a TON of deal flow out there. Buyers have to sift through maybe 100s of deals to find the one. This can be frustrating. Some give up and just acquire the next one for the sake of it. Buying a bad deal is not the goal. You have to find the right one, not just one.

Factor in your costs: take the seller’s P&L and refactor it to include your costs if you were to acquire and operate the business. Is there enough cash flow to pay your salary? What factors of the business will you run personally? Is there enough revenue to pay a team to handle the aspects you do not have expertise doing? Buyers need to be honest with their skillsets and refactor P&L to check what the actual cash flows would be under their management.

Build your team: build your team before you get too deep into acquisition mode. If you need financing, talk to a lender, before going down the rabbit hole. If you need help with due diligence, line up a firm like WebAcquisition before reviewing deals (many M&A firms have a lead time as they review many deals so there will be wait times). The worst thing is you have the perfect deal but then are not ready with financing and the seller backs out because of delays on your end.

Market Trends and Future Outlook

Are there any emerging trends in SaaS that you find particularly interesting? Are there specific types of SaaS businesses you are evaluating more than others? 

In the past, SaaS used to be confined to those who had venture/private equity funding and could hire top-tier developers; the barrier to entry was high. As software developing has become more democratized, more and more developers are self-taught and launching their own micro-SaaS businesses. 

A micro-SaaS is exactly what it sounds like: it’s a micro version of a large-scale SaaS. For example, think of Shopify eCommerce platform as a SaaS whereas a micro SaaS would be an app extension that improves a certain feature. These micro SaaS take advantage of the existing ecosystems and build upon it.

When business acquirers are looking for acquisitions, they will come across these micro SaaS. Some generated significant cash flow, and some do not. Some are heavily dependent on a certain ecosystem (e.g., Shopify) and some are not. 

We’ve been evaluating more and more micro SaaS businesses over the last few years. They are great acquisitions for first-time acquirers as they are easier to manage. They are also great for add-ons to an existing portfolio. 

How do you see the landscape of SaaS due diligence evolving in the future?

With more and more analytics platforms, SaaS data has become democratized. In the past, M&A firms had an upper hand; they had the skillsets to extract data from not user-friendly platforms for analytics. 

Now, with the advent of Stripe payment processing, Google Analytics, and other third-party SaaS analytics platforms, it’s become much easier. 

M&A firms now are no longer paid for their data analytics skillsets but more for their industry expertise.

This is where my firm, WebAcquisition, strives. We are practitioners and operators. We can do the foundational analytics just like any other firm but then tie the numbers back to real-life operations. 

Many M&A firms are not practitioners. Buyer beware.

What’s next for WebAcquisition.com?

My goal with WebAcquisition is to be the #1 source for online business due diligence. 

Our unique proposition of utilizing business operators to perform due diligence has boded well with business buyers. They appreciate the in-depth expertise.

We have been doing due diligence on larger and larger deals up to $20M in valuation. 

Our goal is to have service offerings for all deal sizes (sub $1M to high $20M+).  We want to ensure everyone can have access to due diligence. For buyers, many of them are placing their life savings into one deal, and we want to ensure they can afford to hire us.

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