How to buy a Web Hosting Business

You have made your decision and it's official-you're going to acquire another Web hosting company. By making an acquisition, you will be able to tap into a new revenue stream, instantly grow your customer base, and leverage larger buying power to make further growth more efficient. But with an acquisition comes a host of questions and uncertainties-namely, protecting your investment from churn and financing the significant cash outlay you are suddenly forced to produce. With strategic planning and wise negotiation, you can resolve these questions and make the acquisition as advantageous as you had hoped.

The first important decision you will make comes long before you even start talking to other business owners. As business owner yourself, you need to determine whether or not any acquisition is in your best interest; increasing revenue is not the same as increasing profits and your newly added costs and liabilities may render an acquisition a poor move.

Several key factors include your ability to pay for a purchase (costly interest payments on loans could negate any gains) and whether or not your infrastructure can handle expansion. An assessment of infrastructure, for example, must take into account factors ranging from bandwidth and power usage to software licensing, office space, and staffing capacity.

Once you have completed the evaluation of your current hosting business and decided to move forward, you next need to determine how you will proceed. Consider whether an acquisition will either enhance your current business services or will be used as a gateway to introduce new services. In other words, will you be doing more of the same, or expanding into a different service area? Each case will present distinct challenges that you need to be ready to address.

The most important part of the acquisition process is evaluating prospects. There are a number of ways to find prospective companies, from cold calling, M & A listings (see WebHostingTalk.com), or through a business broker. A word about brokers-make sure you fully understand the constraints and costs associated with your broker. The common pitch that the seller pays the broker's fee is never really true, because when all is said and done, the seller will pass along this fee to you within the final price. Several reputable brokers I recommend include Cheval Capital (Hillary Stiff), Hypoint (David Mathews), and Furlow Consulting (Eric Furlow).

As you consider prospects, you should aim to develop both financial and technical guidelines that allow you to compare between companies and gain realistic insight into the operating status of each. Without a standard set of guidelines it becomes confusing to differentiate between the performance of multiple companies, thereby impairing your decision making. The key is comparing apples to apples; merely comparing revenue or costs does not tell you which company has a greater growth potential. Factors such as ARPU (average revenue per subscriber) will allow you see if most of the revenue is coming from handful large accounts (vulnerable to attrition in a bad economy!) or if the revenue is equally distributed among many accounts (a much safer investment!).

I've developed a list of 20 questions that I use to help derive the most basic facts from prospects. Keep in mind this is by no means comprehensive and should be used as only a starting point:

1. How and where is the company organized? (Partnership, LLC, Corporation [type S?], sole proprietorship, etc)?

2. Who are the principals and what is their contact information (names, addresses, phone numbers)? Furthermore, what ownership or voting rights in the company does each hold and how will it affect negotiations?

3. Is the party interested in selling the company as a whole (including the name and intellectual property) or only customers and physical assets? And if customers are sold, will the proprietors agree to sign a non-compete agreement?

4. Why is the company being sold, especially if it is performing well?

5. How many customers are there and what kind of services are being provided to them?

6. Are customers on any kind of contract or commitment? When do these expire?

7. When are customers billed? If it's yearly or quarterly, when are these cycles due to renew?

8. What is the asking price for various services-for example, how much for domain registration, for shared hosting, VPS, dedicated, etc. Break down costs per megabyte or gigabyte.

9. Would the seller be willing to accept payments over the period of a few months to ensure that everything goes smoothly? Furthermore, would the seller accept a lower price proportional to the number of customers who leave during the acquisition?

10. How does the seller accept payment from customers and will this be easily transferred in an acquisition? (If it's PayPal subscription, each could have to be re-created.)

11. What systems are used for back/frontend for customer management and billing? How will this integrate into existing systems in an acquisition? Are existing systems compatible?

12. What client control panels are in use and are they compatible with existing systems? (Plesk, cPanel, etc)

13. Are servers or other hardware owned, leased or rented?

14. What are datacenter or other infrastructure costs?

15. What are the technical specifications of the infrastructure, and is it adequate to meet existing needs?

16. How many employees are required to run the business and what are their costs? Will they need to be relocated or can they be let go?

17. Have there been any commitments made to customers that are especially unique or out of the norm? (For example, special SLAs or permission to run risky scripts or processes on servers?)

18. What is the churn rate and growth rate?

19. How does the company's public image or past performance affect its future viability in the marketplace?

20. Are there any particularly important or noteworthy details about the company that could affect an acquisition or its long term performance?

Beyond comparing metrics and the qualitative features of each company, you will undoubtedly need to consider price. In any business transaction-buying a building to buying a company-the price is always the most important and critical factor. There is only one reason a Web hosting company gets sold: price.

A final price for a Web hosting company can be a function of a combination of simple math and human emotion. In addition to the items I mentioned earlier in my list, there are a number of caveats to consider when evaluating a price:

Start with revenue. Many businesses are priced based on income. Due to the volatility of this industry, most Web hosts are priced at between 9 months and 14 months of revenue (not to be confused with profit). You will be able to make the best decision if you break down accounts into monthly, quarterly, semi-annual and annual groups. Please note that if most of the accounts are renewed annually, the traditional revenue pricing model may not apply (because you may be providing service for an entire year without gaining income). Because of annual renewals, there are several different approaches to placing a value on these types of accounts. I am going to avoid these approaches in this article, but I encourage you to investigate them as you evaluate the price.

Beyond revenue, you should also consider costs. Certain hosting services, especially those involving high-security businesses, present many costs or challenges that you may not have imagined. Additionally, some customer constituencies require vastly more technical support and staff attention, and these can add to costs. Make sure you fully understand the costs and operating liabilities you will assume in making an acquisition.

Ultimately, in weighing revenue and costs, you will be able to reach a price you believe to be fair and affordable. Set a limit for yourself and negotiate from there. Your goal must always be to minimize the price you pay and create conditions under which you can protect your investment in both the short and long term.

In negotiating, consider a few of these tips:

-When possible, it's typically in your best interest to ask the seller to present a price proposal first. The biggest negative to proposing a price yourself is that the seller can accept it. If it's accepted without negotiation, it wasn't a good price for you!

-Set limits as to what you are willing to spend for the business, and stick to them. Keep all emotion out of the negotiations; it's only a numbers game.

-Avoid impulse buys. Unless it is life and death, there is never a reason to rush a decision, especially an acquisition. Don't buy into a notion that the company must sell in 24 hours.

-Never allow yourself to get stuck in a bidding war. (Especially when the bidding war is artificially created by the seller to raise the price!)

-Be honest and foster goodwill. You will be working with the seller on a daily basis for several weeks once the acquisition is completed. Being bitter will only cause problems.

-Don't be too nice. You need to stand up for yourself and not offer the seller anything that could undermine your own investment.

-Get it in writing. Handshake agreements can turn into a disaster, especially if the acquisition goes sour.

Once you have reached a deal, you should formally submit to the seller a "Letter of Intent" (LOI). Consult with an attorney who is technologically savvy and understands your business. The LOI should spell out the sale price, what is specifically being sold, the start and end date of the servers and accounts and the proposed payment date and terms. When the seller signs and returns the LOI, you have created a firm (albeit usually nonbinding) commitment to the sale.

The second legal step of this process is to have your attorney write up a standard bill of sale finalizing all of the details of the LOI. When the payment requirements (not necessarily cash, but instead an escrow account or other safe alternative) have been completed, the seller will provide you with all administrative access you need to transfer accounts, data, domains, and more into your ownership.

At this point you may or may not notify the customers of the acquisition. Craft this announcement carefully, as an alarming letter may encourage customers to flee (taking their dollars elsewhere). Try to minimize any opportunity for the accounts to leave; perhaps you do not notify the customers of the acquisition until any necessary datacenter moves have been made.

If I may offer you just one piece of advice in closing, it's to embrace patience. Successful acquisitions take weeks if not months. It's never going to be simple, easy, or without risk. Do your diligence and never be rushed. You'll set yourself up for a positive and rewarding future, and will create the opportunities for growth in the months and years to come.

Best of luck!


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Errett CordAuthor Info: Errett Cord is a former excutive of a web hosting firm who has worked with many small- to medium-sized companies developing effective internet strategies. As part of his commitment to helping others improve their businesses, Errett has become deeply involved with Magento, WordPress, SharePoint and how to effectively set up and manage the platform. Contact Errett Cord (ecord@ecord.us)