There is quite some differences between selling a software business and a normal business. So what is different about a Software Business?
In reality two extremes occur in the sale of a software company: Future potential of perceived and future realisable value. Or established recurring revenue from a strong customer base.
In London over 250 software companies have been set up since January 2014. The majority of these are thriving on innovation. While nowhere near the halcyon days of the dot.com boom, many investment banks, VC’s and larger companies are beginning to make offers based purely on the IPR (intellectual Property Rights). Is this typical of the industry? No.
The majority of software companies fall into four categories: (My global estimates)
In category 1 there may be distortions of value as already discussed but the reality is that for most of these companies they have no value but cost !!! Category 4 are public and operate within the confines of a traded marketplace. So let me focus on the majority of the global software industry which is categories 2 and 3.
The process of selling a company is described very often. There is the technical part as well as the human side of a business sale. In our practice, with European business sales, cross border aspects are important. If you want to read more about the actual steps please go to the process and steps in how to sell a business.
A topic dear to most owner’s hearts is how much is the business worth? To answer that question it is important to understand that your business is to lesser or greater degree a part of the global technology industry and mirrors the drivers that influence value in different regions of the world. Clearly the technology markets themselves are diverse and there are many subcategories that can enjoy a range of valuations. At the moment in the United Kingdom (UK) market we are seeing multipliers in the software industries ranging from 90% to 150% of turnover or multipliers of 4 to 12 times discounted future profits.
Of course it is relatively straightforward to monitor publicly quoted companies so how does this affect you and your privately owned company? As a rule of thumb you should allow a 20% discount on the prevailing multipliers pertinent to your sector. However, please bear in mind this is only a guide. As we all know from buying a house there can be an enormous difference between valuation and selling price. You may also get professional advice from accounting firms who may use all types of formulae. They are indicators. The only way you will know what you are worth is when you have offers on the table. At the end of the day, as the old saying goes ” beauty is in the eye of the beholder”.
Technology companies and in particular software companies, have had to learn that they are not outside the metrics and measurement criteria that are applied to other industries. This has been driven not only by the dot.com crash but also by the fact that customers have become more sophisticated and demanding. Customers want value and return on investment. In short many markets are now mainstream. There are a few things that mainly determine the value of a software company:
These main drivers of value for software companies are described more in detail here below.
If there has been one area which has changed it is unquestionably in the valuation of IPR. In the dot.com boom days it was mainly the IPR that created most of the value. Not anymore. The only exceptions would be if the technology contained highly complex algorithms or had patents or patents pending. Regrettably, the cost of development does not correspond to value. Indeed the creation of low cost development centres in India and China has had a major impact on development costs in general and in the value of IPR in particular. The reality today is that IPR on its own has little value if any at the moment when you want to sell your software company. Hence, it should be considered a cost rather than asset. The value of IPR can only be realised through usage. The value of IPR then increases with acceptance in the marketplace as more and more customers utilise the technology of the IPR. If you are looking to sell just the IPR that has cost you a £1million to develop then you might get £60,000 if it is still state of the art !!
The area of the greatest debate today when you sell your software business is how do you value the Intellectual capital of the company. Clearly if your company is biased towards services rather than products then many would argue that this indeed is the major asset of your company. Conservative accountants will argue that Intellectual capital of a software company does not appear on the balance sheet. The trend at the moment for software business sales is assessing value based more on the balance sheet than before. However, we have also seen that most buyers prefer earn outs and that key staff are “golden handcuffed” so that the intellectual capital does not walk out of the door once the buy transaction has been concluded.
As stated earlier the value of IPR is incrementally linked to usage. In today’s market buyers of software companies are very keen on acquiring a customer base when an owner sells a software business. The reasons are as follows:
As the buyer community sees software and services as commodities, capturing new customers has become increasingly expensive. The cost of creating new business is usually ten times the cost of maintaining an existing customer, in some cases that cost is nearer 15.
Recurring revenues of software companies for sale. Annuities, in the form of maintenance and additional service revenue, are predictable and generate significant cash and a very high margin. Hence the value of SaaS based models will eventually increase valuations.
Customers tend to be amenable to buying from preferred suppliers rather than new ones. The opportunity exists to sell more products to existing customers.
Would Yahoo or Google be as valuable by any other name? Along with goodwill the intangible assets of your company such as branding and visibility can dramatically affect value when you sell your software business. Many years ago we conducted Market Research on the CRM market in the United Kingdom (UK) for a service management client. At that time the actual market was worth £32 million and Siebel were twelfth in actual market share in the United Kingdom. However, their PR machine told the world that they WERE the market leader in the UK. The market believed them.
The ‘cloud’ is still a pretty vague term and can refer to many things. However, since online storage and hosting is available more and more software solutions can be provided and approached online. This increases the influence of software and the effect it will have on software to be applied in business processes. SaaS based models will eventually increase valuations as it is more easy to add new customers and revenue. As gaining new clients is becoming more important the influence of cloud based models will increase valuations of software companies that go for a business sale.
Software is improving the processes in many different industries. We see specific applications for a wide array of industries. Especially in the services industries the output can be improved by using software solutions. The financial services industries like insurances, investments, pensions are very much suited to use software as a tool to optimize processes and make them more efficient. However, in production environments software has also the opportunity to add value and help in modernizing companies. If you want to get feedback regarding the possibilities of a sale of a software company in your industry please get in touch.
We have people with a software background living across many countries in Europe. This article has mainly been written by Keith Elliot, our software expert in the United Kingdom. However, we also have software M&A experts in countries like the Netherlands, Germany, Ireland, France, Italy and many other countries in Europe To get feedback regarding a business sale of a software company and the opportunities that exist please get in touch with Keith Elliot.
Mo Gamei | Wednesday 5 April 2017 | website: efdcs.com
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