How to Sell a Software Company

Recurring revenue and how a buyer reads it

The first report a buyer wants is monthly recurring revenue, broken out by customer, by plan and by month, going back as far as the data exists. They are looking for steady growth, a stable base and a clear difference between subscriptions that renew on their own and revenue that only looks recurring. Setup fees, one-time projects and usage charges that swing from month to month get separated out, since they are valued differently. Our post on recurring revenue and contracts explains why buyers pay more for the predictable kind.

Churn follows right after. A buyer wants to know how many customers cancel each month, how much revenue leaves with them, and how much comes back through upgrades from customers who stay. A product where customers rarely leave, and where the ones who stay spend more over time, is worth a good deal more than one that has to keep replacing its base. Buyers will also look at churn by customer size and by how the customer came to you, because a cohort that leaves quickly tells them something about the product or the marketing.

Annual contracts, multi-year deals and prepayments help. Month-to-month customers can leave whenever they want, and a buyer will account for it. If you billed annually in advance, be ready to explain how the deferred revenue is handled, since the buyer takes on the obligation to serve those customers for the rest of the term.

Customers and concentration

A buyer looks at the customer list for concentration the same way a buyer of any company does. A software company with one large customer providing a big share of revenue will face questions and often a lower price or a larger holdback. Our post on customer concentration covers that in detail.

The type of customer matters too. Small businesses tend to churn more and cost less to serve. Larger customers tend to stay longer and ask for security reviews, custom terms and support commitments. A buyer will want to know how customers find you, what it costs to win each one, and how long it takes to earn that cost back. If most growth comes from one channel, such as a single marketplace or a single partner, they will ask what happens if that channel changes its rules.

The code, the infrastructure and who owns what

Technical diligence is often the longest part of the process. A buyer, or a technical advisor they hire, will look at the codebase, the architecture, the test coverage, the deployment process and the cloud setup. They want to see that the product can be maintained and extended by someone other than the founder. Documentation, a working staging environment and a reasonable record of changes all help.

Ownership of the code is the item that most often causes delay. Everyone who wrote part of it, whether employee, contractor or agency, must have signed an agreement assigning the work to the company. Freelancers who built early versions and were never asked to sign anything are a common problem. Open source components are a related question, since some licenses place conditions on how the combined product can be distributed. A buyer will ask for a list of the third party and open source components in use and will have a lawyer check the terms. Rules vary and your attorney confirms what applies to your product.

Infrastructure costs matter as well. Hosting, data storage, third party services and payment processing all affect gross margin. A buyer wants to know whether margins hold as the customer base grows, and whether any vendor, such as a database provider or an AI service, is a single point of failure for the product.

Security, data and compliance

Customers store their data in your product, and a buyer will ask how you protect it. They will want to see the security practices, the access controls, backup and recovery tests, a record of any incident, and any audit reports or certifications that customers have required. If larger customers have asked for a security questionnaire, keep the completed ones, because a buyer reads them as evidence.

Privacy matters when the product holds personal data. A buyer will ask what data you collect, where it is stored, how long it is kept, and what you have promised in your terms and privacy policy. Customers in regulated fields may have data processing agreements with you, and those carry obligations that move to the buyer. Have a list ready.

The founder and the team

Many software companies are built around one or two founders who understand every corner of the product. A buyer sees that as the largest risk after churn. If you are the only person who can fix a failure at night, or the only person who talks to key customers, the buyer will either reduce the price or ask you to stay for a longer transition. Our post on how long you stay after selling describes how that is usually structured.

Reduce the dependence before you go to market. Document the architecture and the runbooks. Give a senior engineer ownership of releases. Put a support lead in front of customers. Make sure key engineers have signed agreements, and think carefully about retention incentives, since a buyer often wants the engineering team to stay.

Deal structure and what transfers

Software companies are sold as asset deals or equity deals, and the choice affects taxes, contracts and liabilities. Our post on asset sale versus stock sale explains the trade-offs. In an asset sale, customer contracts, vendor agreements, domain names, source code repositories, app store accounts and cloud accounts must each be assigned, and some may require the other party's consent.

Payment terms often include an earnout or a holdback tied to retention of customers after closing. See earnouts, holdbacks and working capital for how those work. Buyers also use seller financing in smaller deals, and SBA lenders do finance software acquisitions, though they look carefully at assets that are mostly intangible.

What tends to sink a sale

Revenue that was reported more generously than the billing system supports. Churn that rises once the buyer looks closely. Code written by contractors with no assignment. A single customer who leaves during the process. A founder who plans to leave on closing day. Security incidents that were never written down.

Preparing the company

Reconcile the billing system, the books and the tax returns so they tell the same story. Build clean monthly reports on revenue, churn and customer cohorts. Collect the signed agreements for everyone who touched the code. Document the system. Clear out customer accounts that are unpaid or abandoned so the numbers are not inflated.

If you are thinking about selling a software company, we begin with a valuation built from your own numbers and prepare the materials a buyer and their advisors will ask for. At Business Advisors of America we work with owners from that first valuation through the closing.

This article shares our opinion and general information. It is not legal or tax advice. Always speak with a licensed attorney for legal advice, and a qualified tax professional for tax questions, before you act.