API (Application Programming Interface)

What is an API?

API (application programming interface) refers to a defined interface through which one software system uses the data or functions of another system without knowing its internal structure. It determines which requests are permitted, in which format they are made and which response comes back. It is comparable to the order counter of a large kitchen: whoever orders does not need to know how the cooking is done, only which dishes are offered and how to place an order.

Through programming interfaces, companies connect payment processing, shipping or accounting and open their own products to customers and partners. In financing rounds and company sales, the API is of interest from two directions. Third-party interfaces are dependencies that investors and buyers examine in technical due diligence, that is, in the examination of technology, contracts and operations before the transaction. A company's own interface, by contrast, is a gateway to the customer that makes it harder to switch providers. Its use is governed by the provider's terms of use and licence or service agreements.

How it works

The requesting system sends a message to a defined address of the provider, usually over the internet. The provider checks authorisation, usually by means of an access key (API key, a kind of password for software), and returns the result in an agreed format. The interface description (documentation) is the actual agreement between the systems. If the provider changes it without a transition period, connected systems stop working. Versioning is therefore usual: a changed interface is introduced as a new version, and the old one continues to run for an announced transition period.

A distinction is made between internal interfaces between the components of one's own product, partner interfaces for selected companies and public interfaces that anyone can use after registering. Ecosystems of extensions and integrations arise around public interfaces.

The interface as a business model

For some companies, the interface is itself the product. Customers pay for access to payment processing, identity verification, geodata or data queries. Billing is often per call or per transaction, frequently combined with a base fee and volume tiers. Revenue then grows with the customers' business but also fluctuates with it. Investors therefore examine how stable usage is and how strongly it is concentrated among a few large customers.

More often, the interface is part of a software product through which customers connect it with their accounting, their sales system or their own applications. Each such integration, that is, each permanent technical connection with a customer's system, anchors the product more deeply in the customer's processes and increases the effort of switching providers. This lock-in effect is an argument for valuation as soon as usage data supports it. Interfaces also make product-led growth (PLG) easier, because developers can connect and test the product without a sales conversation.

Dependence on third-party providers and terms of use

Third-party interfaces shorten development time and tie up less capital than in-house development but create dependencies. Anyone who runs a core process through the service of a single provider bears that provider's price changes, outages and strategic decisions. In the terms of use, the following points deserve attention:

• the provider's rights to change prices and scope of service unilaterally or to discontinue the service,
• usage limits, such as maximum numbers of calls or bans on caching data or using it for competing products,
• commitments on availability and response times in a service level agreement (SLA) and the provider's limitation of liability,
• termination rights on a change of control (change of control) and restrictions on assigning the contract,
• the processing of personal data, which may require a data processing agreement under Article 28 of the General Data Protection Regulation (GDPR, in German DSGVO), because the provider processes the data on behalf of the company.

Review in due diligence

Buyers and investors ask for a list of all integrated third-party interfaces with their importance for revenue and operations, the costs in relation to revenue and the alternatives available if a provider is changed. If the target company itself offers an interface, four questions come to the fore:

• whether the documentation is complete and whether old versions are discontinued under a fixed rule and with advance notice,
• how access is protected, for example by access keys, permission assignment and a limit on calls per customer,
• how many customers actively use the interface and how much revenue is attributable to them,
• whether security incidents or longer outages have occurred and how they were resolved.

The value of a company's own interface lies less in its technical design than in the service behind it, in the data and in the customers' existing integrations.

Worked example

A software company generates annual revenue of EUR 4 million. For each customer transaction it calls a third-party provider's interface for identity verification, billed at EUR 0.40 per call, with 1.5 million calls a year. The other direct costs for operations and customer service are EUR 400,000. The provider raises the price by 50%, which its contract allows with three months' notice.

• Costs so far: 1.5 million × EUR 0.40 = EUR 600,000
• Gross margin so far (revenue after direct costs in relation to revenue): (4,000,000 minus 600,000 minus 400,000) divided by 4,000,000 = 75%
• New price: EUR 0.40 × 1.5 = EUR 0.60 per call, new costs: 1.5 million × EUR 0.60 = EUR 900,000
• New gross margin: (4,000,000 minus 900,000 minus 400,000) divided by 4,000,000 = 67.5%
• Reduction in earnings if the additional costs cannot be passed on to customers: 900,000 minus 600,000 = EUR 300,000 a year
• On a valuation at ten times EBITDA (earnings before interest, taxes, depreciation and amortisation, EBITDA multiple): 300,000 × 10 = EUR 3 million less enterprise value

A price clause in a supplier's contract here changes the enterprise value by EUR 3 million. A buyer who recognises this dependence demands a contractual price commitment, a second provider or a discount on the purchase price.

Distinction from related terms

• SDK (software development kit): a toolkit of program libraries, examples and documentation for a particular programming language. The API sets the rules; the SDK is built into the customer's software and implements these rules there.
• Tech stack: the entirety of the technologies used. Integrated third-party interfaces are part of it.
• SLA: the contractual commitment on how reliably an interface is available and how quickly faults are fixed. The API describes what can be queried, the SLA the quality at which.

Common mistakes

• No versioning. Anyone who changes their own interface without continuing to operate the previous version for a transition period interrupts their customers' systems.
• Incomplete documentation. Interfaces that developers cannot understand without asking questions are rarely connected, and the hoped-for lock-in effect does not materialise.
• A single critical provider. If a core process depends on a service with no alternative, that provider co-determines prices and terms.
• Terms of use not checked. Bans on caching or on particular purposes often come to light only in due diligence, when the product is already built on them.

Frequently asked questions

Does an in-house API increase enterprise value?

Not through its existence alone. It becomes valuable when customers actually use it and as a result stay longer or buy more. This can be evidenced by the share of customers with an active integration and a comparison of their attrition (churn) with the rest of the customer base.

Should a company offer its interface publicly?

That depends on the business model. A public interface is worthwhile if partners build extensions on it and the product is thereby anchored more firmly in customers' processes. Against this stand the effort of support and protection against misuse, and easier data access for competitors.

Does using a third-party API need a written contract?

No. The contract usually comes about with registration and agreement to the terms of use. These general terms and conditions often contain reservations of change in the provider's favour. For business-critical services, an individually negotiated contract with fixed prices and term is preferable.

What does switching to another interface provider cost?

That depends on how deeply the service is built in. If the integration has been bundled in a separate, clearly delimited part of the software, switching is often limited to a few weeks of development work. If the service is spread across the entire product, switching can take several months.

The Roemer Capital view

For software companies that Roemer Capital supports in a financing round or sale, it records early which third-party interfaces the business relies on and what they cost in relation to revenue. Contract terms, price adjustment rights and alternatives belong in the data room, the organised collection of documents for investors and buyers, before a buyer asks about them. The legal review of the terms of use rests with the company's law firm.

Roemer Capital uses a client's own interface in the equity story, that is, in the presentation of why an investment in the company is economically convincing. What must support it here is the numerical basis: the share of customers with an active integration, their attrition in comparison and the revenue that runs through connected customers. Without such usage data, an API remains a technical feature and not an argument for valuation.