My friends and I bought five software businesses last year, on the thesis that:

1. despite the recent uptick of interest in the space, it was still a fairly undervalued class of asset;
2. it would be kind of fun and neat.

We purchased these businesses after around eight months of sourcing and searching; we've been operating them for a little less than half a year.

A lot of people have asked a lot of questions about almost every part of the process: sourcing, negotiating, closing, operating. Rather than actually be useful and write a two-thousand word screed on our tactics in finding and closing deals that we liked, I thought it would be more interesting to jot down a list of answers to the following question:

What do we know now that you didn't know a year ago?

• There are no perfect businesses.
• There might be a perfect business for you, but that mostly depends on your definition of perfect. It's important to figure out what your level of time and resource commitment is, and you can walk that back into deal size and operational threshold.
• When a seller says "this takes me one or two hours a day to deal with", it means it will take three times that amount for you; even if they're being genuine, they've got a lot of time and experience and muscle memory that you don't.
• Every business is going to have some sort of looming existential risk: maybe it's platform risk, maybe it's well-financed competitors, maybe it's passwords stored in plaintext. Your goal is not to find a business without risk; your goal is to find one whose risk profile matches your appetite. (If you don't have any appetite for risk, you should not buy a software business — or any business.) If any of these businesses passed every single heuristic on a Berkshire-style checklist, it probably wouldn’t be for sale.
• You should have at least one compelling thesis as to how you can improve the business relative to the current owners.
• Assuming the business is otherwise in solid health, the failure case for your acquisition is much less likely to be "something fundamentally broke this business and it zeroes overnight" and more likely to be "I no longer want to run or operate this business and it either dies slowly or I sell for a loss."
• You should adjust up/down a company's acquisition and retention numbers based on your rough estimate of their hustle: an otherwise unsticky business might have great churn numbers not due to the underlying asset but because the owner is particularly good at hustling. (The inverse can be true; some owners are so checked out of the business that you can meaningfully bend its trajectory by answering emails within two business days.)
• Letters of intent are cheap, especially on free-for-all platforms like Acquire. (In general, the online two-sided marketplaces have a supply problem; they're good to browse and to develop some muscles around high-level characteristics, but brokerages like Quietlight and FE International have a much better signal-to-noise ratio.)
• There is a tremendous amount of signal in the reason why sellers are selling their business.
• Similarly, if a business has been sitting out on the market soliciting offers for more than a few months at what looks like a reasonable valuation — there’s a reason why.
• Financial engineering gets a bad rep, and is a good way to defray risks. Worried about significant platform risk? Add a two-year seller note! Think the business has a huge amount of knowledge transfer required? Add a twelve-month consulting retainer!
• Ask for usage data — as much of it as you can get. Try and get a pretty solid number for "what percentage of revenue is actually using this product?"
• Ask for pricing strategy, and in particular how much potential energy there is in the business for pricing experimentation. Some owners haven't touched prices in a decade; others have slyly moved up prices recently in an effort to make the business more attractive.
• First-time buyers and first-time sellers alike underestimate the value of legible financial systems and a clean set of books. A fractured set of accounting statements might not sink a deal, but they can make it much harder to quickly close.
• Sourcing is really tough, and "tough" shifts from "there's a whole lot of volume and a whole lot of data and I'm not sure how to make decisions about what is or isn't interesting" to "there's absolutely no deal flow for the shape of business that I'm interested in". The market for these businesses is still fairly illiquid, and it can take many months to find businesses that are worth putting serious effort into.
• Sellers keep tons of information in their head: abandoned marketing ideas, undocumented operational issues, one-off lifetime deals, problematic customers, launched-but-underused features, incoming annual renewals, basic support steps, basic customer relationships. Get as much of this into a durable artifact (Loom recording, plaintext, whatever) as you can.
• Price is downstream of deal quality, not vice-versa. A business that may be in many respects "bad" (no obvious marketing channels, relatively high churn) could still be a worthwhile acquisition at 2.3X EBITDA, and we never regretted being forthright with our reasons for valuing a business the way we did when pitching sellers on a low valuation.
• The activation energy required to do anything in the first few months post-close is much higher than you expect.
• In general, it's easier to do work on the marketing, ops, and pricing side of an acquired business than on the product side. Accordingly, be wary of businesses that purport to require a lot of product work to maintain their current position.
• Platform risk is also, for lack of a more clever phrase, platform reward. Having a growing platform to take care of GTM for you can make up for a lot of deficiencies.
• Cold sourcing potential businesses sounds like searching for needles in a haystack (and it is), but any potential sellers you come across will have much less competition than ones who are selling through a brokerage or marketplace.
• Contractors who you trust and like are worth their weight in gold, and much harder to find than you might otherwise imagine.
• There are few better ways to spend time and energy during diligence than dog-fooding the product for a few hours.
• Not all payment providers are created equal.
• At the end of the day, you’re buying a job (even if it’s one with low hours!) — so make sure that you’re buying a job that you find either fun or worthwhile.

(Thank you to Colin and Harrison for — well, for many things, but in particular for reading and improving this essay.)

If you have any questions — or are interested in selling us your software business — feel free to reach out at hi@thirdsouth.capital.