Determining the value of your business early on is imperative to a smooth sale. Setting a reasonable valuation is the first step to successfully negotiating all “must haves” during a sale process. However, valuation methodologies are unique and typically dependent on the various characteristics of a given business.
Just as a business owner is likely to have a unique measurement of valuation, different types of acquirers will also assign their valuations based on a unique set of criteria. Below are four common valuation methodologies used to evaluate software businesses by acquirers:
A revenue multiple is a quick valuation strategy that estimates a business’ value, based on revenue generated. Measuring valuation based on revenue multiple will involve assessing revenues from the last fiscal year, trailing twelve months and forecasts. This valuation method is not used for businesses where revenues are in decline or have historically shown volatility.
Recurring (Maintenance) Revenue Multiple
Recurring Revenue Multiple is another common valuation methodology, especially when valuing a Software-as-a-Service (SaaS) businesses. Some acquirers prefer this valuation approach because recurring revenue is more predictable than net new or incremental up-sell revenues. Recurring revenues also tend to show greater stability during economic downturns, and thus, they are typically indicative of a businesses’ sustainability.
Internal Rate of Return (IRR) Method
Also known as the Discounted Cash Flow method, the IRR approach is used to understand how desirable an investment is based on the rate of return on the invested capital. For this method to be used, the business will need to have shown profits over a number of years, or the financial modeling has to show future profitability.
This valuation methodology is the least systematic of the four. It relies on the value that has been put on companies with similar characteristics. The difficulty with this is that no two companies are the same, and in the case of private companies reliable data is often difficult to come by. This method should be treated as a rule of thumb. However, on the other hand, it offers a point of comparison and “sanity check” to the other methodologies used.
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