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I'm in the middle of negotiating an exit of a software startup company. My partner is interested in buying me out. We're negotiating on the valuation. Obviously a detailed analysis requires a lot of accounting and such but I just wanted to get a ballpark first.

The company in its first year had the revenue of 3M with a profit of 1.5M. In the coming year, it is projected to have around 8M of revenue. What kind of multiples are we looking at and what's the range?

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3 Answers

up vote 12 down vote

Congradulations on your successful start-up!

How about between $10-12 million? That is based loosely on a multiplier of the annualized profit after the first quarter.

There are so many variables to consider here that the number above is worth as much as the pixels that were rearranged to convey it to you. Even a little more information about the nature of the past revenue contracts, the assumptions behind the projected 2011 revenue, the value of the market segment that your software is in, the viability of the scalability of 50% profit margin, season adjustments for annualizing first quarter revenue will all provide greater details which will determine what a good multiplier would be, and for whether it should be on profit/revenue or a mixture of both.

Different Models

There are lots of different models for valuation. Which do you and your partner think best reflects that business model?

  • Capitalized Earning Approach
  • Excess Earning Method
  • Cash Flow Method
  • Tangible Assets (Balance Sheet) Method
  • Costs to Create Approach
  • Value of Specific Intangible Assets

Most people will probably agree upon some mixture of these -- that mixture will be unique to your business, market and customers.

Get Support

There is a entire software catagory of business valuation software. There is an entire industry of professionals that appraise businesses. They even have their own specialized accredidation. Doesn't everyone? :)

I know you were just looking for a ballpark figure right now, but I strongly recommended leveraging an agreed upon third party for the actual valuation.

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How did you come up with the 10-12 number? You are using a multiple between 1-1.5? – erotsppa Apr 12 '11 at 17:36
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I divided your projected 8M revenue by 4 to reflect this first quarter ($2M) to get where revenue would be right now. Then I decreased that a little assuming that you projected to grow over the course of the year and that 8M didn't happen right away. ($1.5M). Then I multiplied that by four to reflect that actual annualized revenue right now ($6M). Then I assumed that you would maintain the impressive 50% profit margin ($3M profit) and then I multiplied by a value of 3 for a moderate risk business in a high value space ($12M). Then because I am conservative I backed off by about 15%. – Joseph Barisonzi Apr 12 '11 at 17:51
Isn't 3x multiple on earnings a bit low? I thought it's quite common practise to value on 6-8x earnings and 2-3 revenue? – erotsppa Apr 12 '11 at 17:59
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@erotsppa -- perhaps, perhaps not. Depends on the market. Depends on the nature of your revenue. Depends on the nature of your relationship with your customers. Depends on the nature of your product. Depends on the size of your market. There are too many "depends" for anyone to make a good thumbnail amount based on the information provided. Which is the point of my answer. – Joseph Barisonzi Apr 12 '11 at 18:04
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If you believe that your market segment commands 6-8x earnings or 2-3x revenue -- then there was no need to ask the question. Yet you did. And I threw out a number based on one set of assumptions. Anyone could throw out another set of numbers based on another set of assumptions. None of them are right. None of them are wrong. The bottom line is the value is what your partner is willing to pay you for the company and what you are willing to sell it for. No more. No less. – Joseph Barisonzi Apr 12 '11 at 18:05
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up vote 5 down vote

Roughly, it's worth about what someone will pay for it :)

Is your first year number sustainable? Do you think growth would be flat, increasing, or decreasing?

If the company is healthy and there is a clear growth plan, then $10-$12MM valuation is probably a defensible number. If growth is flat, then a $1-$2MM valuation is probably closer to reality. I'm supposing at this stage growth isn't expected to drop off, or else none of these conversations would be happening.

Also, kind of like lottery tickets the value can sometimes depend on how you want to take the money. If you want one big check, and then will completely wash your hands of it, it might be an $8MM deal. If you plan to stay involved in some way (board of directors or advisors, consultant, etc.) and take a payout over 5 years, then a $15-$20MM number (earned over X years) could be plausible.

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I find it a little hard to justify that a company that will make 8MM this year with 4MM earning is only valued 10-12MM. Can you elaborate more on your thoughts? :) – erotsppa Apr 13 '11 at 5:52
Your original post didn't say 4MM earning. The way most companies scale at early stages, it's not a fair assumption to think that the revenue:profit ratio is going to stay constant. You also didn't answer my question: Is the first year number sustainable? To give more detailed analysis, it would be helpful to have more details. Otherwise we're just guessing, you could be selling vuvuzela sheet music for all I know... – Brian Karas Apr 13 '11 at 10:46
The margin isn't going to change a single bit. In our software business it scales completely. If anything, actually the margin will likely increase. The only increase in cost is in hiring, which isn't even necessary to reach the 8MM target. It's only done for further R&D work for future projects. Regarding the first year number, yes it's sustainable. Again, not only sustainable but it is going to grow significantly because the market is expanding. Hence the increase from 3->8MM from first to second year. Would you revise your evaluation? – erotsppa Apr 13 '11 at 14:41
If that is the case, then yes, you'd probably be more like 2x the numbers I mentioned above. But, it also will depend on how you want to get paid. – Brian Karas Apr 13 '11 at 17:25
up vote 2 down vote

As a ballpark, I would say the company is worth around 15 million using a P/E ratio of 10. However, I would calculate the company's value based on actual, not theoretical earnings. To the extent a company has high projected growth, that could justify a higher P/E ratio, but the company is a very illiquid asset and has to be discounted accordingly.

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