The Role of Due Diligence in Selling a Software Company
In the sale of a software company, due diligence is not just a procedural step — it is the crucible through which the deal is tested, validated, and ultimately shaped. For founders and CEOs, understanding the role of due diligence is essential to both maximizing valuation and ensuring a smooth transaction. Done right, it builds trust, uncovers risks before they become deal-breakers, and positions the company as a credible, acquisition-ready asset.
This article explores the strategic importance of due diligence in software M&A, what buyers are really looking for, and how sellers can prepare to navigate this critical phase with confidence.
Why Due Diligence Matters in Software M&A
Due diligence is the buyer’s opportunity to verify the claims made by the seller — from financial performance and customer contracts to intellectual property and codebase integrity. But for sellers, it’s also a chance to demonstrate operational maturity, reduce perceived risk, and justify premium valuation multiples.
In software transactions, where intangible assets dominate and recurring revenue models are common, the due diligence process often goes deeper than in traditional industries. Buyers — whether private equity firms, strategic acquirers, or growth investors — are not just buying code. They’re buying future cash flows, customer relationships, and scalable infrastructure.
Legal: IP ownership, customer and vendor contracts, employment agreements, and compliance
Technology: Code quality, scalability, technical debt, and third-party dependencies
Operational: Team structure, key person risk, and internal systems/processes
Pre-LOI vs. Post-LOI Due Diligence
While most due diligence occurs after a Letter of Intent (LOI) is signed, savvy sellers increasingly conduct internal diligence before going to market. This pre-LOI preparation — sometimes called “reverse diligence” — allows sellers to identify and address red flags proactively, reducing the risk of retrading or deal collapse later.
As discussed in Completing Due Diligence Before the LOI, this early effort can also accelerate the deal timeline and increase buyer confidence. For example, a seller who can provide clean, GAAP-compliant financials and a clear IP chain of title will stand out in a crowded market.
What Buyers Are Really Looking For
Buyers approach due diligence with a dual lens: validation and risk mitigation. They want to confirm that the business is performing as advertised — and that there are no hidden liabilities that could impair future value.
In software deals, common buyer concerns include:
IP Ownership: Were all developers (including contractors) under proper IP assignment agreements?
Revenue Quality: Are revenues recurring, diversified, and contractually secure?
Customer Concentration: Is the business overly reliant on a few key accounts?
Technical Risk: Is the codebase maintainable, secure, and free of open-source licensing issues?
Compliance: Are data privacy policies (e.g., GDPR, SOC 2) in place and enforced?
Failing to address these areas can lead to valuation discounts, escrow holdbacks, or even deal termination. Conversely, demonstrating strength in these areas can justify a higher multiple and more favorable terms.
How Sellers Can Prepare
Preparation is the seller’s best defense — and offense — in due diligence. At iMerge, we often advise clients to begin preparing 6–12 months before going to market. This allows time to clean up financials, resolve legal gaps, and document key processes.
Key steps include:
Audit Financials: Ensure revenue recognition aligns with GAAP and that key metrics (ARR, churn, CAC) are clearly defined and defensible.
Secure IP: Confirm that all code contributors have signed IP assignment agreements. Address any legacy contractor issues.
Organize Contracts: Centralize customer, vendor, and employee agreements. Flag any change-of-control clauses.
Document Tech Stack: Provide a clear architecture overview, third-party dependencies, and any known technical debt.
Prepare a Data Room: Create a secure, well-organized virtual data room with indexed folders and version-controlled documents.
In some cases, sellers may also commission a Quality of Earnings (QoE) report to preempt buyer concerns and streamline financial diligence.
Strategic Value of a Well-Run Diligence Process
Beyond risk mitigation, due diligence is a signaling mechanism. A well-prepared seller signals professionalism, transparency, and operational discipline — all of which increase buyer confidence and reduce perceived risk. This, in turn, can lead to:
Higher valuation multiples
Faster deal timelines
Fewer post-closing disputes
More favorable earn-out or rollover terms
Firms like iMerge specialize in helping software founders navigate this process — not just by managing the data room, but by anticipating buyer concerns, crafting the narrative, and ensuring that diligence supports the valuation story.
Case in Point: A SaaS Exit with Preemptive Diligence
Consider a mid-market SaaS company with $8M ARR and 90% gross margins. Before going to market, the founder worked with iMerge to conduct a pre-sale diligence review. This uncovered several issues: a contractor who hadn’t signed an IP assignment, inconsistent revenue recognition practices, and a customer contract with a problematic change-of-control clause.
By addressing these issues before engaging buyers, the company avoided late-stage surprises. The result? A competitive process with multiple offers, a 9.5x ARR exit, and a clean closing with minimal escrow.
Conclusion
Due diligence is not a hurdle to clear — it’s a strategic phase that can make or break a software M&A transaction. For founders, it’s an opportunity to showcase the strength of the business, reduce buyer uncertainty, and command a premium valuation.
Whether you’re preparing for a full exit or exploring strategic options, early diligence preparation is one of the highest-ROI investments you can make.
Founders navigating valuation or deal structuring decisions can benefit from iMerge’s experience in software and tech exits — reach out for guidance tailored to your situation.
How to Handle Earn-Outs in the Sale of Your Software Business
For many software founders, the sale of their company is the culmination of years—sometimes decades—of innovation, risk-taking, and relentless execution. But when it comes time to negotiate the final terms, one element often introduces both opportunity and uncertainty: the earn-out.
Earn-outs are a common feature in software M&A transactions, especially when there’s a gap between the seller’s valuation expectations and the buyer’s risk tolerance. Handled well, they can bridge that gap and unlock additional value. Handled poorly, they can lead to misaligned incentives, post-closing disputes, and missed payouts.
This article explores how to structure, negotiate, and manage earn-outs effectively in the sale of a software business—drawing on insights from real-world transactions and the advisory experience of firms like iMerge, which specializes in software and technology M&A.
What Is an Earn-Out?
An earn-out is a contractual provision in which a portion of the purchase price is contingent on the business achieving certain post-closing performance targets. These targets are typically tied to financial metrics such as:
Revenue (e.g., ARR or MRR growth)
EBITDA or net income
Customer retention or expansion
Product milestones or integration goals
Earn-outs are especially prevalent in software deals where future growth potential is high but not yet fully realized—such as early-stage SaaS companies with strong KPIs but limited operating history.
Why Earn-Outs Are Common in Software M&A
Software businesses, particularly SaaS companies, often command high valuation multiples based on forward-looking metrics. Buyers—whether private equity firms or strategic acquirers—may be hesitant to pay a full premium upfront without some assurance that projected growth will materialize.
Earn-outs offer a compromise: the seller receives a base purchase price at closing, with the potential to earn additional consideration if the business performs as expected. This structure can help close valuation gaps, align incentives, and reduce buyer risk.
However, as we’ve seen in numerous transactions, the devil is in the details.
Key Considerations When Structuring an Earn-Out
1. Define Clear, Objective Metrics
Ambiguity is the enemy of a successful earn-out. Metrics should be:
Quantifiable — e.g., “$10M in ARR by Year 2”
Auditable — based on GAAP-compliant financials or agreed-upon accounting methods
Within the seller’s influence — avoid tying payouts to metrics the seller can’t control post-closing
For example, tying an earn-out to EBITDA may seem straightforward, but if the buyer integrates the business and changes cost structures, the seller may lose visibility or control. In such cases, revenue-based earn-outs may be more appropriate.
2. Align Time Horizons
Earn-outs typically span 12 to 36 months. Shorter periods reduce uncertainty but may not capture the full value of long-term initiatives. Longer periods increase risk for the seller, especially if they’re no longer involved in day-to-day operations.
In founder-led businesses, buyers often request that the founder stay on during the earn-out period. If that’s the case, negotiate compensation, reporting lines, and decision-making authority upfront.
3. Anticipate Post-Closing Changes
One of the most common earn-out disputes arises when the buyer makes operational changes that affect performance. To mitigate this risk, sellers should negotiate covenants that:
Require the buyer to operate the business in the ordinary course
Restrict major changes to sales strategy, pricing, or staffing
Provide the seller with ongoing access to performance data
Some sellers also negotiate “catch-up” provisions—so if a target is missed one year but exceeded the next, the earn-out can still be partially or fully earned.
4. Cap and Floor the Earn-Out
Earn-outs should include a maximum payout (cap) and, in some cases, a minimum threshold (floor). This helps both parties model the financial impact and reduces the risk of open-ended obligations.
For instance, a $20 million deal might include $15 million at closing and up to $5 million in earn-out payments over two years, contingent on hitting revenue milestones. The cap ensures the buyer’s exposure is limited, while the seller knows the upside potential.
Additionally, earn-outs should be clearly documented in the purchase agreement, with dispute resolution mechanisms (e.g., arbitration) in case of disagreement.
Case Study: A SaaS Exit with a Tiered Earn-Out
Consider a mid-market SaaS company with $8M in ARR and strong YoY growth. The founder received multiple offers, but the highest valuation—$40M—came with a $25M upfront payment and a $15M earn-out tied to hitting $12M ARR within 24 months.
With guidance from iMerge, the founder negotiated:
A tiered earn-out: $5M at $10M ARR, $10M at $12M ARR
Monthly reporting access and a seat on the integration steering committee
A clause preventing the acquirer from reallocating key sales resources without consent
The result: the company hit $11.5M ARR in 18 months, triggering a $7.5M payout—more than the founder would have received in a flat $35M offer with no earn-out.
When to Push Back on an Earn-Out
Not all earn-outs are worth accepting. Founders should be cautious if:
The earn-out comprises more than 40% of total consideration
The buyer refuses to provide operational transparency
The metrics are vague or subject to manipulation
The seller has no post-closing role or influence
In such cases, it may be better to negotiate a lower upfront price with fewer contingencies—or walk away entirely.
Final Thoughts
Earn-outs can be a powerful tool in software M&A, but they require careful structuring, clear communication, and experienced negotiation. Founders should approach them not as a gamble, but as a strategic component of the deal—one that can unlock additional value if aligned properly.
Firms like iMerge help software founders navigate these complexities, from exit planning strategy to post-closing integration. With the right guidance, earn-outs can become a win-win for both buyer and seller.
Founders navigating valuation or deal structuring decisions can benefit from iMerge’s experience in software and tech exits — reach out for guidance tailored to your situation.
Software Company Valuations in 2025: Trends, Multiples, and Strategic Implications
As we move into 2025, software company valuations are entering a new phase—one shaped by macroeconomic recalibration, AI-driven disruption, and a more disciplined capital environment. For founders, CEOs, and investors, understanding the evolving valuation landscape is not just a matter of pricing—it’s a strategic imperative that informs everything from capital raises to exit timing.
This article explores the key trends shaping software company valuations in 2025, with a focus on SaaS, AI-enabled platforms, and vertical software businesses. We’ll also examine how buyers—both strategic and financial—are recalibrating their models, and what that means for deal structuring and exit planning.
1. Valuation Multiples Are Stabilizing—But Below 2021 Highs
After the correction that began in late 2022, software valuation multiples have largely stabilized in 2024 and are expected to remain steady into 2025. However, they are doing so at a “new normal” level—typically 20–40% below the frothy peaks of 2021.
Public SaaS multiples are averaging 6–8x forward revenue, down from 15–20x in 2021, according to SaaS Capital.
Private SaaS deals are seeing 3–6x ARR multiples, with premium valuations reserved for companies with strong net retention, efficient growth, and vertical market dominance.
EBITDA-based valuations for mature software firms are trending between 8–12x, depending on growth, margins, and customer concentration. See our deeper dive in EBITDA Multiples Continue to Trend Lower.
While the market has cooled from its speculative highs, this recalibration is not necessarily bad news. Buyers are still active—especially private equity firms executing roll-up strategies—and disciplined operators are commanding healthy premiums.
2. AI-Enabled Software Is Creating a Two-Tier Market
One of the most significant valuation bifurcations in 2025 is between traditional SaaS and AI-native or AI-augmented platforms. Buyers are increasingly willing to pay a premium for companies that have successfully embedded AI into their core workflows—especially if it drives measurable efficiency or customer stickiness.
However, not all AI is valued equally. Acquirers are scrutinizing:
Gone are the days when growth-at-all-costs was the dominant narrative. In 2025, buyers are laser-focused on efficiency metrics such as:
Rule of 40 (growth rate + EBITDA margin)
Net revenue retention (NRR)
Customer acquisition cost (CAC) payback
Gross margin consistency
Companies that exceed the Rule of 40, maintain NRR above 120%, and show CAC payback under 12 months are consistently achieving top-quartile valuations. For founders preparing for a sale, aligning internal metrics with these benchmarks is critical. Our article on SaaS Key Performance Metrics and Valuation Multiples offers a detailed breakdown of how these KPIs influence deal outcomes.
4. Vertical SaaS and Mission-Critical Tools Are in High Demand
In a more selective market, acquirers are gravitating toward software companies that serve niche verticals with high switching costs. These businesses often enjoy:
Lower churn due to industry-specific workflows
Pricing power from deep domain expertise
Defensible moats through integrations and compliance features
As a result, vertical SaaS companies—especially in healthcare, legal tech, logistics, and construction—are commanding higher revenue multiples than horizontal tools with broader but shallower adoption.
5. Private Equity Remains a Dominant Buyer Class
Private equity firms continue to be the most active acquirers in the software space, particularly in the lower middle market ($5M–$50M ARR). Their playbook often includes:
Platform acquisitions at 4–6x ARR
Follow-on tuck-ins at 2–4x ARR
Operational improvements to drive EBITDA expansion
For founders, this means that even if your company isn’t a unicorn, it may still be highly attractive as a strategic bolt-on. Firms like iMerge often help sellers position their business as a valuable puzzle piece in a larger roll-up strategy—especially when preparing for exit planning or evaluating unsolicited offers.
6. Deal Structuring Is More Nuanced
With buyers more cautious and capital more expensive, deal structures in 2025 are increasingly complex. Earn-outs, seller financing, and equity rollovers are more common—especially in deals where valuation expectations exceed what buyers are willing to pay upfront.
Founders should be prepared to negotiate:
Performance-based earn-outs tied to revenue or EBITDA milestones
Equity rollovers into the acquiring entity or PE platform
Working capital adjustments and escrow holdbacks
Understanding these mechanisms—and how they affect your net proceeds—is essential. Our guide on earn-outs in software M&A offers practical advice for navigating these negotiations.
Conclusion: Strategic Positioning Matters More Than Ever
In 2025, software company valuations are no longer driven by hype—they’re driven by fundamentals, differentiation, and strategic fit. Founders who can articulate a clear value proposition, demonstrate efficient growth, and prepare for buyer scrutiny will be best positioned to command premium outcomes.
Whether you’re considering a full exit, recapitalization, or growth equity round, the key is preparation. That means aligning your metrics, cleaning up your financials, and understanding how buyers will view your business through their lens.
Founders navigating valuation or deal structuring decisions can benefit from iMerge’s experience in software and tech exits — reach out for guidance tailored to your situation.
How to Maximize the Value of Your Software Company Before Selling
For software founders, the decision to sell is rarely just about timing — it’s about readiness. Not just your own, but your company’s. Whether you’re considering a full exit, recapitalization, or strategic acquisition, the months (or years) leading up to a sale are critical for value creation. The difference between a 4x and 8x EBITDA multiple often lies in the groundwork laid well before the first buyer conversation.
This article outlines the key levers that drive valuation in software M&A and how to position your company to command a premium.
1. Understand What Drives Valuation in Software M&A
Buyers — whether private equity firms, strategic acquirers, or growth investors — evaluate software companies through a consistent lens. The most influential factors include:
Recurring revenue quality (e.g., ARR/MRR, churn, net revenue retention)
Profitability and margin profile (especially EBITDA margins)
Scalability of the platform (cloud-native, multi-tenant, API-first)
Customer concentration and contract terms
Growth trajectory and TAM (Total Addressable Market)
Team depth and key person risk
Each of these factors contributes to the perceived risk and upside of your business. A company with 90% gross margins, 120% net revenue retention, and a diversified customer base will command a higher multiple than one with similar revenue but weaker fundamentals.
One of the most common value-destroyers in M&A is poor financial hygiene. Buyers want to see GAAP-compliant financials, clear revenue recognition policies, and a clean chart of accounts. If your books are cash-based or lack accrual adjustments, now is the time to upgrade.
Consider preparing a Quality of Earnings (QoE) report — even before going to market. A QoE, typically prepared by a third-party accounting firm, validates your revenue, EBITDA, and working capital. It also helps you identify and adjust for one-time expenses or owner-related costs that may be added back to normalized earnings.
As we noted in What Is My Website Worth?, discretionary earnings and normalized EBITDA are often the foundation of valuation discussions. Presenting these clearly can materially impact your outcome.
3. Optimize Revenue Mix and Retention
Not all revenue is created equal. Buyers place a premium on:
If your business includes a mix of one-time services and recurring revenue, consider shifting the model toward subscriptions or bundling services into annual contracts. Improving customer retention and reducing churn — even by a few percentage points — can significantly increase your valuation multiple.
For SaaS companies, understanding the key performance metrics (KPIs) that buyers track is essential. Metrics like CAC payback period, LTV/CAC ratio, and gross margin by cohort can tell a compelling growth story — or raise red flags.
4. Address Key Person Risk and Build a Scalable Team
Many founder-led software companies suffer from a common issue: the founder is too central to operations, sales, or product development. This creates “key person risk,” which can spook buyers or lead to earn-out-heavy deal structures.
To mitigate this:
Document processes and delegate responsibilities
Build a second layer of leadership (e.g., VP of Engineering, Head of Sales)
Incentivize key employees with retention bonuses or equity
Buyers want to know the business can thrive without the founder. The more autonomous your team, the more transferable — and valuable — your company becomes.
5. Prepare for Diligence Before the LOI
Due diligence is no longer a post-LOI exercise. Sophisticated buyers now expect a high degree of transparency and readiness even during initial conversations. That means having your legal, financial, and operational documentation in order well in advance.
Privacy policies and compliance documentation (e.g., GDPR, SOC 2)
Firms like iMerge often work with founders months before a formal sale process to identify and resolve diligence red flags early — a step that can prevent deal erosion later.
6. Position Strategically for the Right Buyer
Maximizing value isn’t just about cleaning up your business — it’s about telling the right story to the right buyer. A strategic acquirer may value your product roadmap or customer base more than your EBITDA. A private equity firm may focus on your growth levers and margin expansion potential.
Tailor your positioning accordingly. For example:
Highlight cross-sell opportunities for strategic buyers
Show scalability and operational leverage for PE firms
Emphasize defensible IP and data assets for AI-focused acquirers
Finally, one of the most effective ways to maximize value is to work with an experienced M&A advisor who understands the software landscape. A firm like iMerge can help you:
Benchmark your valuation against recent comps
Craft a compelling Confidential Information Memorandum (CIM)
Run a competitive process to attract multiple offers
Negotiate deal terms, including earn-outs, escrows, and rollover equity
In many cases, the advisor’s fee is more than offset by the increase in deal value and improved terms they help secure. As we’ve seen in 8 Ways Top M&A Advisors Increase Value During the Transaction, the right advisor can be a force multiplier.
Conclusion
Maximizing the value of your software company before a sale is not about last-minute window dressing — it’s about building a business that buyers want to own. That means strong financials, recurring revenue, a scalable team, and a clear growth story. With the right preparation and guidance, you can shift the conversation from “what’s your asking price?” to “how do we win this deal?”
Founders navigating valuation or deal structuring decisions can benefit from iMerge’s experience in software and tech exits — reach out for guidance tailored to your situation.
Strategic vs. Financial Buyers: What Software Founders Need to Know Before Selling
When a founder begins exploring an exit, one of the most consequential decisions is choosing the right type of buyer. While both strategic buyers and financial buyers can offer compelling valuations, their motivations, deal structures, and post-acquisition expectations differ significantly. Understanding these differences is essential for software and technology founders seeking not just liquidity, but the right long-term outcome for their business, team, and legacy.
This article breaks down the key distinctions between strategic and financial buyers, with a focus on how these dynamics play out in the software and SaaS M&A landscape.
Defining the Buyer Types
Strategic Buyers
Strategic buyers are typically operating companies—often competitors, partners, or firms in adjacent markets—looking to acquire businesses that complement or enhance their existing operations. Their goal is to create synergies, expand market share, or accelerate product development.
Examples include:
A cybersecurity firm acquiring a threat intelligence startup to expand its product suite
A large enterprise software company buying a vertical SaaS provider to enter a new industry
A global tech conglomerate acquiring a regional player to gain geographic access
Financial Buyers
Financial buyers, such as private equity (PE) firms, family offices, or venture capitalists, are primarily focused on generating a return on investment. They typically acquire companies with the intent to grow them over a 3–7 year horizon and exit at a higher valuation.
These buyers may pursue:
Platform investments (buying a company to serve as the foundation for future add-ons)
Roll-up strategies (acquiring multiple similar businesses to create scale)
Recapitalizations (providing liquidity to founders while retaining them for continued growth)
Key Differences That Matter to Founders
1. Motivation and Valuation Drivers
Strategic buyers often value synergies—cost savings, cross-selling opportunities, or accelerated product development. This can lead to higher valuations, especially if the target fills a critical gap in the acquirer’s roadmap.
Financial buyers, by contrast, base valuations on financial fundamentals: EBITDA, revenue growth, retention metrics, and scalability. They may offer lower headline multiples but more flexible deal structures, such as earn-outs or equity rollovers.
As we noted in EBITDA Multiples Continue to Trend Lower, financial buyers are increasingly disciplined in pricing, especially in a rising interest rate environment. Strategic buyers, however, may still pay a premium if the acquisition is mission-critical.
2. Deal Structure and Terms
Strategic buyers often prefer outright acquisitions—typically stock or asset purchases—with a clean break. They may require the founder to stay on for a short transition period, but long-term involvement is less common unless the founder plays a key technical or customer-facing role.
Financial buyers, on the other hand, frequently structure deals to keep founders involved. This could include:
Equity rollovers (retaining a minority stake)
Earn-outs tied to future performance
Board participation or operational leadership roles
For founders seeking partial liquidity while continuing to grow the business, a financial buyer may be the better fit. For those ready to exit entirely, a strategic buyer may offer a cleaner path.
3. Post-Acquisition Integration
Strategic buyers often integrate the acquired company into their existing operations. This can mean changes to branding, systems, culture, and even personnel. While this may unlock synergies, it can also disrupt the acquired company’s identity and autonomy.
Financial buyers typically maintain the company as a standalone entity, at least initially. They may bring in new leadership or operational resources, but they often preserve the brand and team to maintain continuity and performance.
As we explored in Sell Website: Success After The Closing, the post-close experience can vary dramatically depending on the buyer type. Founders should consider not just the deal terms, but what life looks like after the ink dries.
4. Speed and Complexity of the Deal Process
Strategic buyers may move more slowly, especially if the deal requires board approval, regulatory review, or integration planning. However, they may also be more flexible on diligence if they already know the market or the team.
Financial buyers are often more process-driven. They conduct rigorous due diligence, including quality of earnings (QoE) reports, customer churn analysis, and legal reviews. While this can extend timelines, it also creates a more predictable process.
Firms like iMerge help founders navigate these complexities by preparing detailed financial packages, managing buyer communications, and anticipating diligence hurdles—especially when selling to institutional investors.
Which Buyer Is Right for You?
There’s no one-size-fits-all answer. The right buyer depends on your goals, your company’s profile, and your appetite for continued involvement.
Consider the following scenarios:
You want to retire or exit completely: A strategic buyer may offer a cleaner break.
You want to de-risk but stay involved: A financial buyer can provide partial liquidity and growth capital.
Your company fills a critical gap in a larger player’s strategy: A strategic buyer may pay a premium.
Your business has strong recurring revenue and growth potential: A financial buyer may see it as a platform investment.
In some cases, founders may receive offers from both types of buyers. In these situations, the decision often comes down to more than just price—it’s about alignment, vision, and trust.
Final Thoughts
Whether you’re fielding inbound interest or preparing for a formal sale process, understanding the differences between strategic and financial buyers is essential. Each brings unique advantages—and trade-offs—that can shape the future of your company and your personal journey.
At iMerge, we help software and technology founders evaluate buyer types, structure deals that align with their goals, and maximize value throughout the M&A process. From exit planning to pre-LOI diligence, our team brings deep experience and founder-first perspective to every transaction.
Founders navigating valuation or deal structuring decisions can benefit from iMerge’s experience in software and tech exits — reach out for guidance tailored to your situation.
