Valuation Methods
There are many generally recognized ways to value a software business, although not all will be appropriate for your particular company, and a weighting of the various selected methods should be used. Each of these methods is briefly described below.
1. Sales Multiple
A quick and easy way to estimate the value of a software company is by applying a multiple to your annual revenue.
For companies with significant direct costs of sale such as purchased hardware, applying the multiple to gross profit is more appropriate. There is some latitude in valuations based upon the growth of the company, using trailing (last 12 months), actual (fiscal year projections) and forecasted (next twelve months or fiscal year) revenue. The sales multiple method is not often used when revenues are highly volatile or declining. Sales of software companies typically occur in the 1 to 2 times revenue range, although sales at higher and lower multiples do occur.
2. Book Value Method
Book value is the amount of assets on the books in excess of the liabilities on the books. Book value for a software company may be influenced heavily by the company’s policy with respect to capitalizing software development costs. Book value is often multiplied by a multiple of 2 or 3, then used as a sanity check against other methods.
There is a formula can be adjusted for unusual swings in sales or earnings. A rapidly growing company may use next year's numbers with a present value discount. Since this is the "public" price, you need to adjust by 20% - 50% downward to reflect the normal discount for stock of privately held companies.
- This formula developed by "David Dunn-Rankin":
[(net profit margin / 5%) + (growth rate / 10%)] divided by 2 = multiple of revenue valuation
3. Price Earnings Ratio
4.Internal Rate of Return Method
5. Free Cash Flow Model
6.Replacement Value
7.Liquidition /Salvage Value
8.Recent Internal Transaction Price
