In our sell-side M&A activities, I frequently run across small software companies that are market leaders in their niche. At first look, this seems to be an attractive affirmation of the quality of the technology and business model. Buyers like to own market leading companies and the associated benefits of strong brand recognition, a large user base, and good recurring revenue. However, if you are small, and we see many $10-25 million revenue companies that lead their sectors, it raises the question about the overall size of the market.

If you are reporting $10 million in revenue in your vertical market sector, and your three competitors combined only generate another $20 million in revenue, math says the sector is currently limited to only about $30 million in total revenue. For some buyers, this may be attractive, especially if they can visualize how leveraging their brand, distribution and expertise can significantly grow the business or if you have a technology that can fill a hole in their overall product suite. All too often, though, buyers are looking for very large expansion opportunities, those that offer the potential of $100 million or more in future revenue, or acquisitions that can be the foundation for a new business division. So, it is important for you to know and understand the dynamics of your market space. When working with buyers on an M&A transaction, make sure you can articulate the market opportunity and back it up with solid industry stats if available.

In the dynamic software industry, things can change for the worse as well as the better, so be prepared to defend your sector, and to go it alone if a buyer does not surface. If no large buyer takes the deal, maybe its time to look at expanding into new markets through partnerships, joint ventures and other distribution channels. Doors can close quickly on small vertical markets. Your business with its current products and business model may not make it through the next five years unless something changes. You may need to be the change agent to survive.

 

A version of this article originally appeared in Soft•letter and Software Success.

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