As technology mergers and acquisitions (M&A) activity continues, optimism is growing around exciting opportunities in the technology and technology-enabled sectors. Taking a tech company to market is a significant milestone in a founder's journey—often a once-in-a-lifetime opportunity. With proper planning and successful execution, it can provide financial security, open doors to new ventures, and validate years of hard work. However, to achieve this outcome, founders must avoid critical pitfalls that can diminish valuation, delay closing or even cause deals to fall apart altogether. Here are some of the most common pitfalls founders should watch for when preparing to take a tech company to market.
Overreliance on the founder
Many lower- and middle-market tech companies are heavily dependent on their founders for operations, decision-making and customer relationships. Buyers see this as a "Key Person Risk" because they worry about business continuity once the founder transitions out of the company.
To mitigate this issue, founders should begin assigning and delegating responsibilities well before going to market. Building a strong leadership team, establishing and documenting standard operating procedures (SOPs), cross-training personnel in key areas and diversifying responsibilities ensures that no single person is indispensable to daily operations. The goal is to demonstrate that the company can not only function smoothly but also thrive without the founder's direct involvement. That said, a willingness to stay onboard for some form of a transitional period, typically 1-2 years, is often expected by buyers, as it helps facilitate continuity and a smoother handover.
Overlooking contingent considerations
Earnouts are a form of contingent payments made to the seller based on the target's future performance. They are often tied to revenue, earnings before interest, taxes, depreciation, and amortization (EBITDA), or user growth milestones over a specified period. These contingencies are common in tech M&A, and if not negotiated properly before the exit, they can lead to disputes and misalignment post-closing.
Before going to market, it is important to consistently track key performance indicators (KPIs) and growth drivers so that the appropriate metrics triggering earnout payments are negotiated before signing a Letter of Intent (LOI) and are clearly defined before finalizing the Purchase and Sale Agreement. Avoid earnout structures that tie payments to post-sale management decisions that you have no control over, or that may yield different results based on potential changes to post-close accounting methodologies. If possible, push for more cash upfront rather than relying on future contingencies, which may not ever materialize.
Customer concentration risks
In many technology mergers and acquisitions, a high customer concentration is viewed as a red flag. When a significant portion of revenue comes from a small number of customers, buyers see this as a risk. Losing one or two key customers could dramatically impact revenue, making the business a riskier acquisition.
Implement strategies to diversify the customer base before going to market. Securing multi-year contracts can help ensure recurring revenue and foster customer retention post-close. If your business has high customer concentration, prepare a clear narrative, value proposition, and relevant customer KPIs, such as churn analysis and customer lifetime value in advance to explain why those relationships are secure and unlikely to churn post-acquisition. In cases of high concentration, you may be requested to introduce the buyer to the key customer. However, this introduction should only happen once the deal is fairly imminent to avoid unnecessary disruptions or risks to the relationship.
The cost of inaccurate financials in tech M&A
Many tech startups do not prioritize robust accounting and finance functions, leaving this crucial area neglected. Without an internal accountant or controller, companies often have disorganized and inconsistent financials, non-GAAP (Generally Accepted Accounting Principles) accounting practices, and incomplete records. These issues slow down due diligence and cause buyers to lose confidence in the deal, which at minimum could lead to a lower valuation.
Before going to market, hire a controller or external accounting professional to maintain clean, GAAP-compliant monthly financials with clear documentation of revenue recognition, expenses, appropriate accruals, and tax compliance. Many of our clients engage us to prepare a sell-side Quality of Earnings report, which includes thorough due diligence, key reconciliations, necessary EBITDA adjustments, and pro-forma financials to ensure they are investor-ready when going to market.
IP and compliance issues
Intellectual property (IP) is often a tech company's most valuable asset. Any ownership disputes, missing documentation, or regulatory non-compliance can raise red flags for buyers.
Conduct an internal audit of your IP portfolio. Make sure that all code, trademarks, and patents are properly documented and owned by the company, not individual employees or contractors. Address any outstanding compliance issues related to data privacy regulations, such as the General Data Protection Regulation (GDPR) or Consumer Privacy Act (CPA). If necessary, consult with an M&A attorney to make sure everything is in order before initiating the sale process.
Unrealistic valuation expectations
A common issue is founders holding an emotional attachment to their company and overestimating its value. Some also compare their valuation expectations to a personal connection's past sale, assuming they will achieve similar results. These unrealistic expectations can lead to failed negotiations and time wasted. Additionally, unlike other industries, tech businesses are not always valued based on EBITDA. Many tech companies that sell may be pre-revenue, making traditional valuation methods less applicable.
Letting go of the emotional attachment that comes with founding and growing a successful business can be challenging. However, soliciting a professional valuation from an M&A advisor can help establish realistic expectations based on current market benchmarks. An M&A advisor can research recent comparable deals in your sector while structuring deals to maximize both upfront liquidity and long-term upside. They can also help determine the most appropriate valuation methodology based on your company's financial profile, growth potential and market position.
Delaying tax and estate planning
Many founders do not consider the tax implications of a sale until it is too late. Performing estate and tax (E&T) planning too close to signing an LOI significantly reduces the benefits available, leaving sellers with fewer options to optimize after-tax proceeds. Poor tax structuring can also lead to unnecessary liabilities and lost value.
Engaging in tax and estate planning well ahead of a sale can help you retain more of your sale proceeds. Further, strategic tax structuring as well as gross-up calculations can save sellers significant amounts in after-tax proceeds. Working with experienced tax advisors early in the process can help you leverage the most effective strategies to minimize tax burdens and preserve wealth post-transaction.
Key Takeaways
- Start exit planning early by delegating responsibilities and ensuring operational independence.
- Structure earnouts carefully to avoid post-sale disputes.
- Diversify the customer base to minimize revenue concentration risks.
- Keep financials clean, organized, and GAAP-compliant.
- Secure intellectual property rights and ensure regulatory compliance before going to market.
- Set realistic valuation expectations based on current industry benchmarks.
Work with an experienced M&A advisor
A well-prepared tech founder may significantly increase the chances of a successful exit by avoiding these common pitfalls. Proactively addressing these risks may not only make your company more attractive to buyers but also can help you walk away with the best possible terms.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
