Software Company
 Valuation

Software Company Valuation

Many methods and ideas for valuing a software company float around the internet and in the business press. As a business broker who’s sold a few of these types of companies, I’ll share with you how I have been valuing tech companies in order to attract qualified buyers like a public saas company or a private equity fund. It is important to remember that a software valuation for the purposes of an exit is different than a valuation intended to attract ongoing investors to the company.

Here are five common ways to perform a software company valuation.

Multiple of Recurring Revenue

For a SaaS valuation, a quick and easy way to arrive at a valuation is to apply a multiple to the annual recurring revenue. This revenue multiple approach would be used by a strategic acquirer, like a public company or a private equity fund, seeking to add incremental recurring revenue to their existing company. For companies with revenue under $10m, a typical valuation multiple will range from 1-5x. The factors used to determine where in the range of 1-5 a likely transaction would occur.

  • Revenue Growth – Faster growth results in a higher multiple.
  • Recurring Revenue Percentage – The higher percentage of recurring revenue the higher multiple.
  • Customer Churn – The lower the customer churn, the higher the multiple.
  • Customer Acquisition Cost (CAC) – The lower the customer acquisition cost, the higher the multiple.
  • Cash FlowPositive cash flow, high gross margin and strong revenue growth indicate the company has nailed the product market fit and deserves a higher valuation.

Multiple of Discretionary Earnings

This business valuation method of a software company is similar to the EBITDA multiple used for larger companies. In smaller companies, without a complete level of management, business valuation by a multiple of the economic value received by the business owner is most common with low and moderate revenue growth. This method applies a multiple of 3-6x to the total reported income of the owner.

Multiple of EBITDA

In this method, typically used for larger companies with a management team and external investors, a multiple is applied to the Earnings before Interest, Taxes, Depreciation and Amortization (EBITDA). The multiples can range from 3-15x with revenue growth being the most important factor in determining wherein the range of multiples are used.

Payback Period

This method seeks to look at the annual revenue minus the operating expenses and determine a maximum enterprise value of a SaaS business based on the number of years to payback the investors the purchase price. This back of the envelope method seeks to quantify how much a company valuation would change with a 3-5 year payback period. While this is a rough estimate, it is helpful to estimate the strategic value of companies with quickly growing annual recurring revenue.

Income Approach

This method, commonly used with commercial real estate valuations is a quick method to determine business value based on the cost of capital. It takes the annual cash flow and divides it by the cost of the capital expressed as a percentage. So if the SaaS business is generating $1m/year in cash flow and the cost of capital is 20%, then the business is worth $5m ($1m / .20 = $5m).

Software Company Valuation Summary

An estimate of a company’s value is helpful in the planning phase of bringing a company to market.  Once you’re in the market and start attracting offers from qualified buyers you learn the true value of your company.

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David Jacobs
David Jacobs

David Jacobs is a Licensed California Business Broker for Software and B2B Service Companies — Predictable, transparent and orderly exits for business owners across the USA.