At RSPA’s 2017 RetailNow, Jeff Riley, the former CEO of Dinerware POS, presented a session on how to value and sell your dealership. It was a thorough presentation, and thusly we will be borrowing some graphics from his slides (if you want his full presentation we suggest contacting RSPA directly).
We will be simplifying Jeff’s presentation since people in the industry have been asking for this content from our perspective. Jeff’s presentation does a great job getting into the nitty-gritty of the process of mergers and acquisitions (M&A) but this post will be focused on how to maximize your dealership now, with some concrete takeaways.
This topic has never been more relevant to the POS channel:
- Most dealers started their businesses 20+ years ago and are looking to get out
- Younger generations are coming into the channel from the payments side, not the POS side. This means handing over your dealership keys to a younger generation is not a likely option
- The dealer channel is being disintermediated with smaller merchants buying online, solely on price. Hardware and software is cheaper and more reliable, so dealers who don’t want to learn how to add value are being pushed out
The POS channel is at a crossroads. Staring down the barrel of reality, many dealers are old dogs that don’t want to learn new tricks. That’s entirely your prerogative, but we’d rather you get out of the industry as quickly as possible to make room for those willing to work to be here.
The information that follows comes from our understanding of finance and M&A, as well as empirical data provided by those who have sold or bought dealerships. The combination of the two will hopefully give readers useful information about their own dealerships and what options they may realistically have.
Firstly, businesses are purchased for any number of reasons, some of them illogical.
Sometimes it’s because a potential target has market share that would take too long to acquire organically. Other times it’s because a target has really valuable intellectual property (IP) that would be very, very difficult to replicate. In Silicon Valley acquisitions can be driven to acquire engineers; the good ones are in scarce supply.
In other cases it could be because the acquirer is clueless and fear of missing out (FOMO) grabs them by the horns as they exhibit herd mentality. In fact any honest banker would tell you most of their job involves fomenting the market this way! We estimate herd mentality is the reason for half of all M&A activity, and it most likely explains 95% of merchant spending behavior.
We say all this because some companies will be purchased for multiples that only one buyer will pay. You cannot expect nor rely on these multiples to carry over to your business. For those of us not fortunate enough to be in the right place at the right time we must deal with economic realities:
Businesses are purchased on revenue or profit (EBITDA) multiples.
So let’s talk about these revenue streams.
There are three primary revenue streams which determine most of a dealer’s valuation.
- Services (which includes payments)
Hopefully these come as no surprise.
Hardware is a one-and-done deal. Traditionally, a merchant would buy hardware once, and the dealer wouldn’t sell them new hardware for many years. This resulted in a very lumpy revenue forecast that was 100% correlated with dealer sales volume. Hardware revenues earned this way receive a 1x multiple, meaning if you expected to sell $1,000 in hardware your business would be worth $1,000. Not very impressive.
Yet some companies are getting smarter with the hardware-as-a-service (HaaS) offering. Under the HaaS model, merchants pay monthly (or annually) on an ongoing basis for their hardware. Providers do upgrade merchants to new hardware every 3-4 years, but the magic in the HaaS model is two-fold. First, it provides a recurring revenue stream. Recurring revenue businesses earn a better revenue multiple in a business valuation. Second, recurring revenue businesses can usually hide higher margins in the distributed payment structure. For example, POS software sold as-a-service (SaaS) is actually more expensive over the life of a business than an upfront POS software license. But it’s the cheaper upfront cost and ongoing software improvements that makes SaaS more desirable.
Takeaway: offer HaaS for increased margins and a higher valuation multiple on your hardware revenues!
While we touched a bit on software above, smart dealers have already figured out the recurring revenue model. Silicon Valley has popularized SaaS, and the markets love it so much they’re willing to pay a premium. SaaS receives an astounding 2x premium over licensed software models as made clear by this slide from Jeff Riley’s RetailNow presentation:
Licensed (perpetual) software companies receive a ~2.5x valuation multiple on their sales while a SaaS company doubles that to 5x sales. (Note: EBITDA is a loose word for profit, and EV is Enterprise Value, or the valuation of the whole company).
Any POS provider who doesn’t understand these financial realities should be shot in the face: SaaS is not new. Yes, there will be merchants who want a perpetual license, but you should now clearly see why you want to get them on a recurring payment. Not only will this financial arrangement benefit your dealership, it will also help the merchant receive the most updated version of their POS software, which is critical for the next component…
POS software is NOT the only software that can be sold as SaaS to the merchant. In fact, there is much MORE money to be made with bolt-on softwares than the POS software could produce itself. However, it is imperative that merchants be on the latest version of their POS software for this to happen. Remember, smart legacy POS companies are updating their software to make these opportunities possible for their channel and merchants. Therefore updating merchants to the newest software version will eventually allow for updates like this to be pushed quickly and for free, thus creating upside.
Below are categories of bolt-on software that can be sold to merchants if the POS is cloud-connected, has open and free APIs for integrations, and actively archives transactional data.
- Back office & inventory
- Labor management
- Theft avoidance
- Marketing and loyalty
- Pricing optimization
- Metadata correction (hours of operation, etc)
- Online ordering & delivery
If the POS company charges for APIs, or believes they will build all of these solutions themselves, they are not a partner for the long run. Note this is a two way street: dealers will need to actively solve merchant problems if they are to successfully place bolt-on solutions with merchants. If they are not willing or able to do this then they are implicitly defining themselves as a tax and the market seeks to avoid inefficiency: POS companies will build, sell, and support all the bolt-ons around the channel.
Takeaway: sell software as SaaS to help your business valuation. Choose a POS that provides easy and free integrations and keep the POS software updated. These are necessary ingredients to sell SaaS products on top of the POS!
Like hardware, services originated as a break-fix model: when something broke, the dealer would show up and charge an hourly repair fee. And like hardware, services models do not command much value in the market, as another of Jeff Riley’s slides makes clear:
Some organizations have transitioned the break-fix services model into a managed services model, the latter being a model with recurring monthly or annual payments regardless of support effort. So for $200 per month, a merchant will get unlimited hours of support.
Unsurprisingly, like HaaS, this model makes revenue more predictable. As POS hardware and software reliability goes up – and tools like remote diagnostics cut or prevent service time – these service revenues become higher margin. And if a dealer is wisely providing merchant value with bolt-on SaaS tools, new service revenue streams can be created. Like the managed services model, these new services can be set up on recurring monthly payments. Now a dealer is able to squeak in a higher valuation multiple for their service revenues.
The last service revenue stream – and unfortunately it’s the least valuable one commanding all the attention – is payments processing. The payments portfolio is typically worth 30x monthly net payments revenue, or 2.5x annual payments “profit”. We call this profit because a dealer does absolutely nothing to receive the ongoing residual, so there are no offsetting expenses. All dealers should have a payments portfolio because nearly every merchant needs to accept cards (i.e. there’s guaranteed demand) and it only takes about 3 brain cells to sell payments processing: it’s the lowest of the low of value-adds.
Our guess is that the 2.5x multiple reflects the fact that the average merchant goes under in 30 months, or 2.5 years, and they’re locked into the processing agreement lest they want to suffer heavy penalties. After that length of time, even if the payments contract stipulates continued payments services, all bets are off because the merchant is not likely to be solvent (it’s why we calculated the life time customer value for Toast this way too).
Takeaway: only offer managed services with recurring payments to maximize your value. Choose a POS and bolt-on providers that allow you to create new service revenues!
There are a few remaining items that we need to get across.
As mentioned above, some businesses are going to get strategic multiples and you cannot use these data points as objective reference. Cayan was recently purchased for a seemingly healthy premium, which we’ll delve into in another article, but shouldn’t be used to value your processing portfolio.
There are also intangibles that can negatively influence your business. This could be things like employing bad people; lacking automated systems for support, marketing, and deployments; and maintaining customers that are too similar and thus are exposed to the same risks.
Most parties in search of a POS dealership are looking to take advantage of the merchant base to cross-sell or upsell something else. This means having the right systems and people in place to make that happen. If you haven’t modernized your dealership it’s going to be more expensive for an acquirer to execute on this plan. That means you will be offered a significant discount over what you were expecting.