At Constellation, where multiple companies are acquired every month, we have extensive experience with M&A due diligence on recurring revenue businesses. We would be happy to share that deep expertise with you. Our MRR Churn application was purpose-built not just as a recurring revenue management platform, but also as an M&A consulting toolbox.
Our M&A due diligence pricing is very straightforward. We charge a 10% contingency fee on any proven valuation gaps vs. what the target company (i.e., vendor of the business) is representing. The contingency fee includes all of our consulting services to do the relevant due diligence for you. This means that there will be no charge for our due diligence consulting hours, regardless of whether we find any valuation gaps or not. The contingency fee also includes full and free access to all the MRR Churn analytics and dashboards for your M&A team over an extendable trial period, which would normally cover the entire M&A due diligence timeframe. The only potential additional charges would be for travel time hours or travel expenses if you requested one or more of us to be on site during the due diligence process. The current valuation gap components that we provide due diligence services on are as follows:
- Customer Lifetime Value (LTV): The LTV valuation gap will fluctuate based on the difference between the proven customer attrition rates vs. the vendor’s represented attrition rates. LTV will be calculated using the most conservative, accurate and broadly recognized LTV calculation per David Skok (see here: https://www.forentrepreneurs.com/ltv/ ), which incorporates not just the customer or ARR attrition rate, but also the cash flow discount rate, the gross margin %, and the future ARR growth rates for retained customers. The discount rate will be based on whatever discount rate the acquiring company is using in its valuation/pricing model, subject to a 30% cap; the gross margin % will be based on any reasonable average of one or more prior years; and the future ARR growth/expansion rate within the retained customer base will be based on whatever rate the acquiring company is using in its valuation/pricing model, subject to a floor of 0%.
- Deferred Recurring Revenue (DRR): This valuation gap will be based on a detailed recalculation of DRR vs. the DRR represented by the target company / vendor. It will incorporate daily and/or monthly revenue recognition (your choice, in advance), as well as accurate FX rates in translating originating currency (“OC”) amounts to the purchase price reporting currency (“RC”). So, as an example, if an M&A target / vendor represents that DRR is $100k lower than it demonstrably is, the contingency fee would be $10k, since the valuation gap artificially raises the net tangible assets (and hence the purchase price) by $100k. If a negative valuation gap is found, then no contingency fee would be applicable, as would be the case for all valuation gap components.
- Unbilled AR and Future AR: These valuation gaps will be based on a detailed recalculation of these balances on an invoice-by-invoice, line-by-line basis vs. the amounts that have been represented by the target company / vendor. Like for DRR, the calculations will incorporate daily and/or monthly revenue recognition (your choice, in advance), as well as accurate FX rates in translating originating currency (“OC”) amounts to the purchase price reporting currency (“RC”).
- Sales Tax: Currently in development, this valuation gap will be based on a detailed recalculation of unpaid sales tax liabilities for every legal entity and tax jurisdiction on an invoice-by-invoice basis using the shipping postal code of each invoice. It will also recalculate the sales tax on a line-by-line basis on every invoice based on legal entity nexus and the taxability of every product in every relevant jurisdiction (which is generally at the state or federal level). The taxability by legal entity, jurisdiction and product can also be optionally configured to change over time to account for changes in tax laws or legal entity nexus over many years and months of sales tax recalculation. Finally, the tax rates themselves can be optionally stored for every month, so sales tax can also fluctuate due to rate changes too.
Keep in mind that sales tax audit liabilities often extend 7 or 10 years into the past, and sometimes indefinitely if a legal entity has not properly filed or registered in a state. This can add up to a very large hidden tax liability for acquiring companies to find out about after the fact. Even worse, this hidden liability is often discovered well after it can be recouped from customers or the target company / vendor.
- Accounts Receivable (AR): We will perform a detailed recalculation of all AR balances based on the daily invoicing and cash receipts per the ERP system, including how every invoice and payment has been applied. Any validated Future AR adjustment will also be deducted from AR if it has not been already. We will also optionally send out AR confirmations on any invoices > 90 days old that the target company / vendor is representing are still collectible. In addition, we will document our follow-up to those AR confirmations to support whether those invoices are indeed collectible or not. The total valuation gap here is obvious: the AR that we can prove does not exist or is not collectible.
Please contact firstname.lastname@example.org for more information.