Company valuation is part art and part science. Over-bloated software valuations have unfortunately pushed valuations to the “art” side of the spectrum. Luckily the market is self-correcting. What a buyer pays for the willing seller is determined by so many factors including urgency, other alternatives and internal/external motives. Several factors play into the process on the hard-line monetary valuation of a software company.
Recent benchmark comparables can come from several public and private sources. Sometimes it can be wise and helpful to use a site like VentureWire. Because the categorical buckets the business may be placed in can be nebulous and highly subjective, it is beneficial to ask a number of helpful questions in determining public and private comps. In determining pre-money valuations for software companies, venture capitalists will often use benchmark data to determine future hypotheticals.
It is important to keep in mind that recent deals are the most relevant benchmark, keeping in mind that buying low and selling high is the ultimate name of the game. Any business valuation will include normal growth projections along with greater-than-normal discounts. Unlike using standard weighted-average-cost-of-capital (WACC) for discounts, such private VC deals will include much larger discount metrics in the range of 25%+.
Recent deal valuations may have the biggest sway on current company valuations, but VCs will also take a close look at the performance of recent deals and adjust accordingly. As an example, if a company beats projections made during the initial valuation, it may be worth much more than it could have initially been worth. If this is the case, other similar deals may see a small bump in price as well.
Other “Buy-Side” Factors For Software M&A
- Buy vs. Build. Buyers seeking targets always consider speed and money considerations. With delay considerations for a competing offering, target comparables can often balloon if they remain a strategic key for a much larger acquirer.
- Buyer’s valuation. Sometimes a buyer’s valuation is 20 to 40x earnings based on public market prices. In theory this means the target’s multiple should be 20 to 40x as well. Unfortunately, other factors including dilution issues (paying too much for your earnings) on the acquirer’s stock will certainly push the targets value down, but still up relative to a stand-alone valuation.
- Strategic goals. Acquirers will often pay more for a company when certain strategic parameters fit like IP, competitor-blocking technology, access to specific customers/markets, margin improvement and complimentary product access.
- Earnings management. Acquisitions can allow the buyer to beat quarterly targets by simply buying into the target. This is a generally helpful, but often strategic move.