Business Valuation Blog | Understanding Buying / Selling a Company

When you want to sell your software company or need a better understanding of the value for business you have worked so hard to build, you need to consider an appraisal. The software industry differs from most others, so how does this factor into a business valuation? Understanding the methodologies involved with the appraisal of your software business can help you make sense of the current market and your place within it.

There are two main approaches to value within the business appraisal world: the income approach and the market approach. Both can be used to value a software company, and a business appraiser will select the best method depending on the reasons for appraisal and the data available for analysis.

For the income approach, an appraiser focuses on the current and future benefits of your business in terms of revenue and expenses. They will utilize this information and discount it in present terms. This is referred to as a discounted cash flow (DCF) of your business.

This approach is appropriate for companies that bring in an unstable amount of earnings from one year to the next, or companies that are not growing at a consistent rate. Since many software companies do not grow at a steady pace, and commonly see material fluctuations for revenue and expenses, an income approach makes sense.

A market approach can also be used for taking the valuation of a company in the software industry. This is more specifically referred to as the multiples of revenues and earnings market approach. In this method, an appraiser looks at the software company's historic financial statements to determine values. The appraiser then compares the software company's values to its peers.

Factors That Affect the Value of a Software Company

Factors that may affect the value of the software company include among others, tangible assets owned, the replacement cost of the software itself, the value of similar businesses (possibly competitors), customer acquisition cost, and measurable advantages to your products

Since there are many factors that affect the value of your software company, you should know what method an appraiser will use, the factors they consider, and how they put this data together to arrive at your company's overall value. Talk with the appraiser during the valuation engagement to better understand what the appraised value really means.

Does your business involve creating software for your clients or developing solutions to get their systems and programs working together seamlessly? If so, you need to know that valuing a software company is a vital part of your disaster recovery plan. Why? Though it can seem like simply replacing your computers is not a major investment for your business, having your company valued ahead of time can help you get back to work more quickly. Here's a quick look at what happened when one software firm faced an office flood and how having a valuation in place would have made the recovery process go much more smoothly.

Interesting Issues in Valuing a Software Company

Some years ago, Qlue Consulting in the Research Triangle area of Raleigh, North Carolina provided a range of software services for their clients. Because they specialized in integrating a wide range of aging equipment and developing creative solutions for their clients, their office housed a number of systems that were difficult to replace, from aging mainframes to computer banks that housed dozens of different operating systems and software programs. This allowed them to quickly test their solutions in-office and deliver a completed, tested solution for their clients.

Housed in a multi-purpose structure, the business was on the ground floor with several apartments in the levels above it. The business had insurance to cover any disasters that may happen to the company, but assumed that their insurance company could react quickly to a claim. For that reason, they hadn't had a business valuation performed.

The apartment renter on the third floor above their office was out of town at a conference for a week when a pipe burst in their bathroom. The leasee on the second floor was in Spain for a month, so the first sign of trouble for Qlue was when the maintenance tech for the complex discovered the leak and, knowing there were a lot of computers in the rooms directly below, ran into the office, yelled that there was a flood and to shut everything down.

The company was in the middle of restoring their computers from a lightning strike earlier in the week and had their backup loading from external media. Acting quickly, one employee hit the main power breaker - which cut power for a moment, until the triple-redundancy power supplies kicked in and supplied power to the office. This happened just as water began streaming in from the ceiling, causing arcing and major damage to most of the company's computer lab.

In moments, they'd lost weeks of data, hundreds of thousands of dollars of electrical equipment and similar assets. The insurance company couldn't understand that it had taken years to find aging systems to test the software on and wanted to simply replace the old machinery with newer, less expensive equipment. The company's CTO had to spend a lot of time tracking down replacements for the aging equipment.

Though the company did eventually recover from this disaster, it took months of back and forth with the insurance company to finish recovering the entire loss the company faced during the disaster, time that the company could have invested into growth instead. Valuing a software company is vital to your business' bottom line, especially when dealing with insurance claims, securing financing for expansion, selling or buying a company or many other situations.