Valuation of a software company

“How much is my software company really worth?” This question becomes particularly explosive if you want to attract an investor for the next round of capital or determine the optimal sales price for your company. In this blog post, you will learn which value drivers, in addition to sales and profits, influence the value of a software company.

Basic valuation

A simple and common method for calculating the business value is the multiplier method (also called the multiple method), in which the business value is calculated by multiplying the adjusted EBIT by an industry-standard multiple.

The basis of the valuation is more or less identical for all types of companies. The Nimbo Guide to Business Value provides you with useful background information and everything you need to know about this topic.

General value drivers

It is not only the profitability and size of a company that determine its value. A number of internal value drivers also impact the selling price – both positively and negatively. Based on the base valuation, the value can increase or decrease by up to 25%. The most important value drivers here are:

• Independence from the owner :
  – How does an unexpected absence of the owner affect the company?
  – Does the customer expect the owner to personally handle the business transaction?
  – Is the management of the company independent of the owner, or could a management team be set up internally?
  
  For a buyer, the question arises whether the success would continue without the current owner. The less the company depends on the activities and relationships of the owner, the higher the average bids are.
  
• Growth prospects and potential:
  – What are the growth prospects for the next three years?
  – If the company were to grow, how easy would it be to recruit employees?
  Investors are interested in the future prospects of a company. Questions that are important here: Is the main market growing? What percentage growth do I forecast for my company over the next three years? Is there potential within the core competence that could be exploited profitably? Is there a shortage of skilled workers or is it easy to recruit new employees? Is there sufficient cash flow for replacement and expansion investments?
  
• Market position:
  The catchment area and the company’s pricing policy are taken into account here. Companies that operate not only regionally and companies that can enforce prices that are above the market average receive, on average, significantly higher purchase offers.
  
• Balance:
  How dependent is the company on individual customers or business partners (e.g. suppliers)? Companies without large concentration risks receive, on average, higher purchase offers.
  
• Employees:
  One motivation for purchasing companies can be access to new qualified employees who are difficult to find on the labor market. Companies that can attract and retain sought-after employees receive, on average, significantly higher purchase offers.

Industry-specific value factors for software companies

• Switching costs for customers: "Does the customer incur costs if he switches to the competition?"
  
  High switching costs create a kind of “wall” that prevents customers from switching to the competition. For software companies, switching costs are often high because switching can involve extensive data migration, training and adaptation to new systems. Companies that achieve strong integration of their software into their customers’ business processes receive higher ratings because their customers are less inclined to switch to another provider. High switching costs therefore mean a more stable customer base and thus a more stable sales forecast.
  
• Marginal profit: "How does the company’s profit change as sales increase?"
  
  The term “marginal profit” refers to the additional profit made by selling one more unit of a product or service. In the software industry, marginal costs – the costs associated with producing an additional software license or subscription – are typically extremely low. This is because software development costs are predominantly fixed costs. Once the software is developed, distribution to additional users is minimal. This characteristic leads to high marginal returns, which is an attractive feature for investors. A company that is able to distribute its software to a large number of customers without incurring significant additional costs can increase its profits disproportionately. Such business models are usually valued higher because they have enormous growth potential.
  
• Contractually recurring revenues: "Is a portion of revenue generated from contractually secured, recurring revenue?"
  
  They are another key factor in evaluating a software company. They consist of recurring revenue that a company regularly generates through subscription models, maintenance contracts or other long-term agreements. This type of revenue is often viewed as particularly valuable by investors because it offers a high level of predictability and stability. Unlike one-time sales, recurring revenue provides a solid foundation for future growth. Companies with a high proportion of recurring revenues can plan better in the long term, make investments more strategically and are less vulnerable to short-term market changes. In terms of valuation, this means that companies with a high proportion of contractually secured, recurring revenues are generally valued higher because they have lower risk and more stable cash flows.

Nimbo company valuation for software companies

In addition to figures such as sales and profits, the Nimbo company valuation also takes into account the general and industry-specific value drivers mentioned above. Free version available!