Join us » cknowledge this aspect of buyer v

Achieving Strategic Value in the Sale of a Software Company Computers Articles | January 1 Cheap Leonard Williams Jersey , 2013

One of the most challenging aspects of selling a software or information technology company is coming up with a business valuation. Sometimes the valuations provided by the market defy the valuation logic that typically dictates a selling price for a manufacturing company, for example. This article discusses how an investment banker can properly position your company to the right buyer in order to achieve a strategic transaction value.



One of the most challenging aspects of selling an information technology company is coming up with a business valuation. Sometimes the valuations provided by the market (translation - a completed transaction) defy all logic. In other industry segments there are some pretty handy rules of thumb for valuation metrics. In one industry it may be 1 X Revenue, in another it could be 5 X EBITDA or cash flow.


Since it is critical to our business to help our information technology clients maximize their business selling price, I have given this considerable thought. Why are some of these software company valuations so high?


It is because of the profitability leverage a technology company can generate. A simple example is what is Microsoft's incremental cost to produce the next copy of Office Professional? It is probably $1.20 for three CD's and 80 cents for packaging. Let's say the license cost is $400. The gross margin is north of 99%. That does not happen in manufacturing or services or retail or most other industries.


One problem in selling a small technology company is that they do not have any of the brand name Cheap Darron Lee Jersey , distribution, or standards leverage that the big companies possess. So, on their own, they cannot create this profitability leverage. The acquiring company Cheap Jamal Adams Jersey , however, does not want to compensate the small seller for the post acquisition results that are directly attributable to the buyer's market presence. This what we refer to as the valuation gap.


What we attempt to do is to help the buyer justify paying a much higher price than a pre-acquisition financial valuation of the target company. In other words, we want to get strategic value for our seller. Below are the factors that we use in positioning our software business for maximum selling price:


1. Cost for the buyer to write the code internally - Many years ago, Barry Boehm Cheap Nathan Shepherd Jersey , in his book, Software Engineering Economics, developed a constructive cost model for projecting the programming costs for writing computer code. He called it the COCOMO model. It was quite detailed and complex, but I have boiled it down and simplified it for our purposes. We have the advantage of estimating the "projects" retrospectively because we already know the number of lines of code comprising our client's products. This information is designed to help us understand what it might cost the buyer to develop it internally so that he starts his own build versus buy analysis.


2. Most acquirers could write the code themselves Cheap Sam Darnold Jersey , but we suggest they analyze the cost of their time to market delay. Believe me, with first mover advantage from a competitor or, worse, customer defections Cheap Le'Veon Bell Jersey , there is a very real cost of not having your product today. We were able to convince one buyer that they would be able to justify our seller's entire purchase price based on the number of client defections their acquisition would prevent.


3. Another arrow in our valuation driving quiver for our sellers is we restate historical financials using the pricing power of the brand name acquirer. We had one client that was a small IT company that had developed a fine piece of software that compared favorably with a large, publicly traded company's solution. Our product had the same functionality, ease of use, and open systems platform Cheap C.J. Mosley Jersey , but there was one very important difference. The end-user customer's perception of risk was far greater with the little IT company that could be "out of business tomorrow."


We were literally able to double the financial performance of our client on paper and present a compelling argument to the big company buyer that those economics would be immediately available to him post acquisition. It certainly was not GAP Accounting, but it was effective as a tool to drive transaction value.


4. Financials are important so we have to acknowledge this aspect of buyer valuation as well. We generally like to build in a baseline value (before we start adding the strategic value components) of 2 X contractually recurring revenue during the current year. So, for example, if the company has monthly maintenance contracts of $100 Cheap Curtis Martin Jersey ,000 times 12 months = $1.2 million X 2 = $2.4 million as a baseline company value component. Again, this financial analysis is to establish a baseline, before we pile on the strategic value components.


5. We try to ass