Article Preparing for an acquisition – the deferred revenue pothole!

Congratulations! Your SaaS company is being acquired for a nice sum—YEAH!!

BUT WAIT, don’t pop the champagne just yet. Before you celebrate, there's a crucial aspect of your financials that needs your immediate attention—deferred revenue. Often overlooked, deferred revenue can play a pivotal role in the final acquisition price, potentially leading to substantial NEGATIVE adjustments that could hit where it hurts the most: your final payout. SaaS acquisitions can fall through for many reasons, but dont let it be for reasons within your control.

Why Deferred Revenue Matters

At its most basic, deferred revenue is cash received from customers for services to be delivered in the future. In accounting terms, it's a liability, not an asset. This is because it represents a future obligation on your part to deliver value to the customer. For SaaS companies, where subscription models are king, deferred revenue is a common line item.

Incorrect Deferred Revenue:

• Hurts your valuation
• Could delay the transaction
• Provides an opportunity for the acquiror to re-negotiate
• Generate uncertainty about your books to an acquirer

How Deferred Revenue Affects Acquisition

1. Purchase Price Adjustments: During the acquisition process, deferred revenue often leads to adjustments in the purchase price. Buyers typically argue that deferred revenue is a liability which they will have to fulfill post-acquisition, and therefore it should be subtracted from the overall valuation of the company. If you sell large annual or multi-year deals, then this could become a very material adjustment to the expected purchase price.
2. Revenue Recognition: For SaaS companies, the timing and recognition of revenue can be complex due to the subscription-based business model. Accurate revenue recognition practices are critical to ensure that the financial statements reflect true economic reality. Any inaccuracies can be a red flag for potential buyers, leading to lower valuation multiples or additional indemnity clauses. Inaccurate revenue recognized will also have a direct impact on deferred revenue.
3. Compliance and Reporting: Accurate deferred revenue reporting ensures compliance with financial reporting standards such as ASC 606 and IFRS 15, which dictate the accounting for contracts with customers. Having a clean and compliant set of books helps boost the confidence of prospective buyers in the robustness of your financial operations.

Tips for Managing Deferred Revenue Before an Acquisition

• Stay Compliant: Are your books based on accrual accounting? Are they clean? If not, then don't wait until due diligence begins to get this started.
• Use Robust Systems: There are many great solutions that can accurately track and manage deferred revenue. This is where SaaS platforms with strong subscription management tools come into play.
• Transparency: Be transparent with potential acquirers about your accounting policies and those around deferred revenue and how it's calculated. This will help build trust and smooth out negotiations.
• Prepare Early: If you anticipate a sale, begin preparing your financials, particularly deferred revenue, well in advance, usually this means months. This preparation will help you navigate blind spots and command a better price as well as facilitate a smoother transaction.

Conclusion

While it might be tempting to focus only on the immediate benefits of an acquisition, savvy SaaS founders know the importance of detailed attention to deferred revenue. By ensuring accurate tracking and reporting of deferred revenue, you not only safeguard your company's valuation but also pave the way for a successful transition to new ownership. Don't be THAT company that overlooks this crucial element—instead, be the one that goes to market fully prepared, with every financial detail buttoned up.

As you move closer to closing the deal, keep these considerations in mind to ensure that your big payday is as big as it should be. And then, once all is in order, go ahead and pop that champagne!