The three years before you sell

Thirteen years ago Omar Mohout wrote Lean Pricing, and today he does M&A and finance for tech companies at Deloitte, so when I sat down with him for Tentacles of Pricing, I wanted to know what changed along the way. Surprisingly, pricing was the number one issue he saw back then, and still is on top of his mind today. Not because he stayed in the subject, he moved on to growth and deals years ago, but because every road he took kept leading back to the same lever.

The morning of our conversation he had been in Waregem, at a company that reached ten million after ten years of bootstrapping, and one of the first things he put on the table there was what about pricing. For Omar that question is a given, wherever he has a conversation with a founder.

Why founders struggle

Omar’s explanation for why pricing gets so little attention is the fact that pricing is intangible. Building a product is tangible, running a marketing campaign is somehow tangible, but pricing is a number you cannot calculate, and that is exactly what throws off technical founders, the people who love numbers most. In his words “they’re pretty much lost”, which makes pricing one of the few areas where guidance really matters.

The deeper problem sits a layer up. Everybody focuses on value creation, the best product, the polished go-to-market, while value capturing gets almost nothing, even though it decides what you keep. Omar names other ways a company can capture value, data for instance, or reviews, but his conclusion leaves no room for doubt: “the number one, by far, for capturing value is pricing.”

The exit math

Here is where his M&A work sharpens the point. A valuation is a multiple on the EBITDA of your last three years, which means that if you ever want to sell in the next three to five years, you are already in your measurement period, whether you planned it or not.

Omar quotes Warren Buffett on this: “if a company cannot increase the price by 10%, it has no market power.” In other words, there will be no investment. That single test tells a potential buyer of your company more than a shiny slide deck.

And then comes the multiplication. A typical multiple sits between four and eight, sometimes ten, so every euro you add to your result in those three years gets multiplied by that factor at exit. Take the old mantra that one percent of price improvement gives you ten percent on the bottom line, put a multiple on top of it, and you understand his reaction: “to me, it’s really like magic.” He knows no other way to create that much value in that little time.

The contract trap

The counterintuitive part of our conversation was about contracts. Recurring revenue is the dream, forward-looking and stable, exactly what company buyers pay premiums for, but a long contract is also a lock, and what you trade away is pricing power in exchange for a certainty that mostly benefits the other side of the table.

Omar’s alternative is to prove the loyalty instead of enforcing it. Lifetime value and churn show whether customers stay, even without a fixed contract, and a company whose customers stay for the long term out of choice, with an open field to work on pricing, is worth more to him than one that chained itself to fixed long-term contracts. Breaking open long contracts three years before an exit sounds radical, and he agrees that it is, but in his words “it has to be on the table for discussion” when considering an exit. The outcome can be no, and that is fine, because not discussing it is the real mistake.

We’re doing all fine

Why does nobody act on this? Because software forgives you. Founders tell Omar they have a gross margin of ninety-five percent, the kind of margin no other legal business gets you, as he puts it, and a compound annual growth rate of thirty to thirty-five percent, and they are right, it works today, the money comes in, so why change anything. “We’re doing all fine,” they say.

His answer is that you might be leaving money on the table, and that in three years you might really regret it. From his experience, what changes behaviour is rarely insight, it is a fixed point in time, and an exit process creates exactly that: the clock starts today, the pressure is real, and the pressure delivers outcomes. The sentence he hears most from founders who went through it says everything about the ones who have not: “if only we did that much earlier.”

Selling your company alone

The second half of our conversation was about whether you should sell your company yourself or hire support. Omar sees the reasoning, an advisor costs roughly three percent, like the agent who sells your house, but the real cost of going alone is opportunity cost. A sale process takes around nine months and eats your bandwidth, which is why founders who run it themselves routinely miss their own year-one forecast, ten million promised and eight million delivered. And in his words: “whatever you do, anything beyond year one is fantasy, if you miss your first year.”

He told me about a founder, experienced but doing his first transaction, who ran his own deal with a single party. The buyer got distracted by a bigger file, the process went to sleep, and the deal died before closing. A structured process exists to prevent exactly that, with a process letter, several parties and options that stay open, because as Omar puts it, “you only sell once.”

There is a pattern behind it, and it separates the beginners from the veterans. The difference between a first-time founder and a second-time founder is the attention they give to legal from day one. Or in Omar’s words: “all the things that second-time founders do right, learned the hard way, are exactly the things that first-time founders don’t like.”

Bragging about funding valuations

On funding, Omar is more relaxed than you would expect. Raising a hundred thousand, half a million or a million and a half is something you do yourself, here is the list of angels, here is the list of VCs, go and contact them. At ten million the game changes, and so does the need for support.

The trap at that level is the number everyone optimises for. Thirty million pre-money sounds better than twenty, but if the thirty comes with liquidation preferences of factor three and a set of warrants, you can fast forward three years and find yourself, in Omar’s words, “screwed.” The investor gets paid three times over before it is your turn, which means the clean twenty would have made you richer.

You eat, sleep and drink pricing

At that point Omar turned the argument on me. “You’re an expert, Maarten. It’s like you doing pricing. You eat, you sleep, you drink pricing. When I talk to you, you know what you’re talking about.” Then came his question: “do you really think, as an entrepreneur, talking to investors who are every day talking to entrepreneurs and negotiating, that you are better than them? They know what they’re doing.”

The same asymmetry sits on the other side of the table in M&A. The buyer has a different profile but it is the same process, and the party across from you does nothing else, “it’s a machine” in Omar’s words, while you are doing this for the first time in your life. Valuation is one parameter, the conditions decide what you actually take home, and the side that negotiates for a living knows exactly which of the two matters.

The detail that stayed with me most: Omar sees term sheets pass every week, that is his job, and still, if he sold his own company tomorrow, he would make sure the right team helps him, legal, tax, the whole list. If the professional surrounds himself with professionals, the first-timer going in alone has little left to argue.

The three years start today

You do not need an exit plan to think like a seller, because the measurement period is always running and pricing is the one lever that pays most. Thirteen years after Lean Pricing, Omar’s conclusion has only hardened: “value capturing is always underestimated. Until the day it’s not, because you have to work on that.”

The full conversation with Omar Mohout is on YouTube, in the Tentacles of Pricing series. Voortschrijdend inzicht included, as we say around here.