This story appeared in the December 2005 issue of Web Host Industry Review magazine. Click here to subscribe for free.
February 10, 2005 -- (WEB HOST INDUSTRY REVIEW) -- In this section, Internet lawyer David Snead helps answer some common questions sumitted by Web hosts.
How Much is my Hosting Company Worth?
While this isn't a purely legal question, I hear it almost as often as any other. Though there is certainly a legal aspect to this calculation, I turned to Dean Mann at DH Capital LLC for the type of information clients usually seek.
At base, says Dean, valuation is founded almost entirely on a strict cash flow analysis. Even though acquisitions appear to be picking up steam in 2004, there doesn't appear to be any type of return to the "cash flow plus intangibles" calculations prevalent during the Internet bubble. Any acquisition is going to be valued almost entirely on business fundamentals: Your cash flow, its sustainability, and continued growth. Any additions would be based on a "one-off" situation, beyond the scope of a valuation estimate.
So other than maximizing your cash flow, how can you increase the valuation of your business? In general, you should look at the operating characteristics that define it. What differentiates you operationally from other hosting providers? How will that compliment the buyer's business? According to Dean, a common denominator of the one-off acquisitions — which involve a valuation higher than merely cash flow — appears to be the company type, and the company's customer base.
Companies that appear to be attracting interest, and in some cases higher valuations, are those at the low end of the SME market — ranging from two guys and a server to companies with 10 to 20 employees. Large established players don't appear to be as attractive, in general. A company that can show customer base that has a particular characteristic desired by the acquiring company may be in a position to demand a higher valuation multiple. While these characteristics will necessarily vary from company to company, some trends seem to be appearing. These include customers in a particular niche — for example, those heavily involved in online transactions — and companies with a particular technical expertise in a discrete area missing from the buyer's knowledge base — for example provisioning systems.
Once you've done your cash flow evaluation, you'll want to find intangibles that you believe should result in a higher valuation for your business. It would be wise to use the most conservative estimate of those intangibles' worth. It is important to consider that you will likely receive a higher valuation from a buyer outside your industry than one inside. Buyers inside the hosting business are likely only looking to expand their customer base and will focus on your cash flow.
Dean believes the most accurate way to discover this valuation is through an auction process. While an auction can be done in a formal manner, it can also be an informal process run discreetly by a capital firm. The auction process should not be entered into lightly however. At a minimum you should have your corporate organization completely scrubbed down, all disputes or controversies settled or monetized, and files readied for due diligence.
How was The FBI Able to Seize Servers in the UK?
The 9th Circuit Court of Appeals recently handed a victory to copyright holders, and by extension, recipients of their notice and take down letters. In Rossi vs. MPAA, the court upheld a lower court determination that the "good faith" provision of the DMCA does not require the copyright owner to actually know that copyright infringement is taking place. This particular requirement is set out at 17 U.S.C. § 512(c)(3)(A)(v).
The facts in the Rossi case are pretty straightforward. The dispute was based on the fact that the site at issue was not actually engaged in copyright infringement. However, the MPAA did not verify this fact by trying to download bootleg movies. Rather, the MPAA determined that in its view the site contained infringing material.
The court determined that the standard for evaluating good faith is from the perspective of the provider of the notice, or a subjective belief, rather than an objective belief. So, the question became, why did the MPAA send the notice? Was the notice sent because the MPAA was engaged in a systematic attempt to track down copyright infringers, and did so based on an analysis of infringing sites; or, did the MPAA send the notice with the knowledge that the site did not contain infringing material? The court engaged in a pretty detailed analysis of the statute. However, it appears the court was largely persuaded by the fact that § 512(f) contains a penalty for entities who knowingly send false notice.
This decision is important for hosting companies because it reinforces the theory that these companies are merely conduits — they do not need to get into the business of determining whether a site is actually infringing. Rather, they may act on the good faith representation made by the notice provider. It also seems to provide additional protection for hosting companies, which often face allegations that their actions, upon receipt of a notice and take down letter, somehow injured the entity whose Web site was shut down.
This discussion is intended merely as a general summary of the relevant law for background purposes. Legal decisions must be based on your unique situation. Please consult with your attorney before making decisions based on this summary.
