Valuation of a Software Company

“How much is my software company really worth?” This question becomes particularly pressing when you want to attract an investor for the next round of funding or determine the optimal selling price for your company. In this blog post, you’ll learn which value drivers, besides revenue and profit, additionally influence the value of a software company.

Basic Valuation

A simple and common method for calculating the company value is the multiple method (also called the multiplier method), where the company 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 Company Value Guide provides you with useful background information and everything worth knowing on this topic.

General value drivers

Not only the profitability and size of a company determine its value. A series of internal value drivers also affects the selling price – both positively and negatively. Based on the basic 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 business transactions?
  – Is the company’s management independent of the owner, or could an internal management team be built up?
  
  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 purchase offers observed on average.
  
• 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 a company’s future prospects. Questions that are important here: Is the main market growing? What percentage growth do I forecast for my company for the next three years? Is there potential within the core competency that could be profitably tapped? Is there a shortage of skilled workers or is the recruitment of new employees easily possible? Is there sufficient cash flow for replacement and expansion investments?
  
• Market Position:
  This considers the company’s catchment area and pricing policy. Companies that are not only regionally active and companies that can enforce prices above the market average receive significantly higher purchase offers on average.
  
• Balance:
  How dependent is the company on individual customers or business partners (e.g., suppliers)? Companies without large cluster risks receive higher purchase offers on average.
  
• Employees:
  One motivation for buying companies can be access to new qualified employees who are difficult to find on the job market. Companies that can attract and retain desirable employees receive significantly higher purchase offers on average.

Industry-Specific Value Factors for Software Companies

• Switching Costs for Customers: “Do customers incur costs when switching to the competition?”
  
  High switching costs create a kind of “wall” that prevents customers from switching to competitors. For software companies, switching costs are often high, as switching can involve extensive data migrations, training, and adaptations to new systems. Companies that achieve strong integration of their software into their customers’ business processes receive higher valuations, as 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 revenue forecast.
  
• Marginal Profit: “How does the company’s profit change with increasing revenue?”
  
  The term ‘marginal profit’ refers to the additional profit gained from selling one more unit of a product or service. In the software industry, the marginal costs – that is, 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, distributing it to additional users involves minimal costs. This characteristic leads to high marginal profits, 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 generally valued higher as they show enormous growth potential.
  
• Contractually recurring revenues: “Is a portion of revenue generated from contractually secured, recurring revenues?”
  
  They are another key factor in valuing a software company. They consist of recurring income that a company regularly generates through subscription models, maintenance contracts, or other long-term agreements. This type of revenue is often considered particularly valuable by investors as it offers high predictability and stability. Unlike one-time sales, recurring revenues provide 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 susceptible to short-term market changes. For valuation, this means that companies with a high proportion of contractually secured, recurring revenues are typically valued higher as they present lower risk and more stable cash flows.

Nimbo Company Valuation for Software Companies

The Nimbo company valuation considers, in addition to figures such as revenue and profit, the above-mentioned general and industry-specific value drivers. Free version available!