What to Ask a Founder Before Signing an LOI on Acquire.com

Hey there, Paul Kelley, VP of M&A at Acquire.com here. 

I wanted to give you and other prospective first-time buyers some advice before you dive into a deal.

After you’ve signed your non-disclosure agreement (NDA) and begun talking with a potential seller on Acquire.com, you might feel a little uncertain of what to do next. The next logical step would be to make an offer and submit a letter of intent (LOI), but that’s a big step – and you likely want to know more before taking it.

On Acquire.com, we’ve built a system that lets you search for, vet, and Acquire a business with little outside help. This can be understandably daunting if you’ve never bought a business before. 

As someone acquiring a business on a platform, you’re entering what was formerly a pretty exclusive club. Until now, most people didn’t buy and sell businesses without teams of legal advisors feeding them the right questions.

As an experienced M&A professional, I want to give you a couple of questions I always ask every tech seller before signing an LOI. 

Why Are You Selling Your Business?

While sellers may say why they are selling on Acquire.com in their bio, you want to get the news directly from them.

In a perfect world, everyone has perfect intentions, but if a business is valuable, you should understand the motivations for why someone is selling it. You don’t want to be left holding the bag with a business bleeding cash, facing changing market conditions, or up against unbeatable competition. 

How Did You Arrive at Your Valuation?

You can calculate a company’s asking price in many ways, and we provide founders with basic valuation frameworks based on revenue, profit, and startup type. But sellers don’t need to follow these rules if they can provide another good reason for their business’s valuation or asking price.

Founders may feel their business is worth more than a base revenue multiple because they’ve developed expensive tech or a very well-constructed organic lead pipeline. At the low end, many at least want to recoup the losses they took building their platform. If they’ve priced themselves outside of our recommended boundaries, ensure they can explain why.

A word to the wise: I’m usually skeptical if a seller justifies a high price by saying their business is in a field that will take off soon. 

Read our multiples reports for our pricing guidelines.

Are You Open to Different Deal Structures?

Never be afraid to ask a founder for other deal structures besides cash upfront. In many deals, buyers agree to pay X amount of money upfront and Y and Z amounts depending on certain performance standards being met (such as in an earnout). For example, a $50,000 upfront payment and then another $50,000 if MRR remains steady for two months.

A seller’s willingness to set up other deal structures speaks volumes to their confidence in their product. However, these requests are naturally more common for pricier deals.

What’s Your Role in Your Business?

You should have a very clear understanding of who the seller is. For most small businesses, the seller is likely the founder, and they’ll have all rights to transfer ownership of their business. However, you may meet sellers like agency partners wishing to transfer equity in a business or other, more complicated deals.

What’s Your Corporate Structure?

Sellers of most larger businesses (and some smaller ones) will have registered their companies in a particular country or state. Where a business is registered and pays taxes can impact what happens after you buy. You may have to pay fees to close a business and transfer funds from local bank accounts. 

In extreme cases, you may accidentally buy a business you legally can’t open in your country of residence. Check first as your seller probably doesn’t have this information.

Also, ask the seller about their employment situation. While they may not employ people full-time or regularly employ contractors, they might have one or two contractors who’ve done most of the work on the website or the CMS. Ensure you account for everybody financially and legally involved in the business as that can be a real headache come tax season.

What Is Your Total Addressable Market (TAM)?

Put simply, TAM is how much a founder calculates their potential market to be worth. TAM is especially important for sellers in large acquisitions, and it should be a specific number. If a seller gives you a vague answer like, “Our TAM is in the millions,” you should challenge that.

Where Are You Getting Customers? What’s Your Churn?

Customer acquisition data may look great on paper, but even the most complete metrics only show you part of the picture.

For example, if the founder markets from their popular social media account, all that great monthly acquisition data may mean nothing. For many early-stage startups, much of their organic traffic may come from one post on a forum like Reddit. If that post somehow gets archived or deleted, it may shut down substantial customer acquisition.

Also, ask about churn, or the number of customers leaving the platform. Having a million customers is great, but if they all leave the next day, that isn’t recurring revenue. How can your seller guarantee they’ll be around tomorrow? 

Trailing twelve-month (TTM) revenue can be a challenging metric. One million lifetime subscriptions can give great TTM, but it isn’t recurring revenue.

Are You Tracking ROI on Marketing Expenditures?

It’s easy for any business to fall into the trap of throwing money at a marketing campaign and expecting an equal ROI. Google ad campaigns can be highly effective but those leads will immediately drop off if you’re forced to cancel the campaign due to high costs.

Before you send the seller an LOI, ask one or two specific questions about their marketing expenditures. 

For example:

  • What types of marketing have you done in the past? 
  • What has produced the most return per expenditure?

What’s Your Codebase?

When buying any tech product, clarify the codebase they use both for their website and tools.

This information should be readily available on most seller accounts you see on Acquire.com, but if not, ask, as any discrepancy could cost you. It’s much harder to find a Ruby-on-Rails developer than a Java one. Naturally, the fewer different codebases you have to work with, the easier it will be to build a development team and hire contractors.

What CMS Do You Use?

Besides code, most websites with blogs will have a content management system (CMS) that lets even non-coders update the site. Usually, a CMS is built on a platform like WordPress with standard templates. If a website uses a custom template or an uncommon CMS, it may be much more difficult to update and find people who can modify it.

Do You Use Any Subscription Tools?

Today there’s a SaaS for just about everything. Most startups commonly subscribe to tools like Hubspot for tracking sales and Mailchimp for email campaigns. While these should be listed on sellers’ profiles already, ensure there aren’t more subscriptions on the sidelines draining revenue.

Do You Have Any Other Assets?

Businesses may also own tangential assets to their business that may or may not weigh into a seller’s final valuation.

For example, a seller may have a repository of email addresses that you could use as potential leads. They may even have large media assets like a blog or newsletter. Media assets have strong marketing value as they can attract large numbers of customers on the cheap due to the power of search engine optimization (SEO).

Final Thoughts

These questions are merely qualifiers to make sure you want to progress to the much more in-depth due diligence stage. Therefore, you want most of them to be quick and easy for sellers to answer.

Another note: I always hop on a phone call with a seller before signing an LOI, no matter how much the business costs. Willingness to chat says a lot about the likely validity of a sale.

And though all of these questions are good to ask any seller on Acquire, tailor what you ask to startup size. In my experience, you want to ask about tech stack and churn for lower-priced early-stage startups. On the high end, most of your questions should be about market position and if their business is defensible from competition.

When you’re asking questions and a seller cannot give a satisfactory answer, frequently that’s all the answer you need. And remember, you don’t have to do everything alone. Any buyer or seller can use our M&A advisor directory for help with any part of their deal.

We also have two other articles you may want to look at if you’re just getting started as a buyer:

For the love of startups!