Software & IT Services

Software and information technology companies present unique valuation difficulties. Often, very similar companies command very different prices. In other sectors, there are standard valuation mechanics that are used repeatedly. However, in the information technology sectors, analyzing data from completed transactions does not yield consistent patterns or reliable estimates.

Maximizing the profit our sellers receive is one of Orion Capital Group’s primary functions, so understanding the differences in valuation models is essential. What explains the widely disparate selling prices among similar software companies? The simple answer is that the ultimate price depends on how effectively each individual component of the business was marketed. In other words, the goal is to perform a detailed analysis of the business model that justifies paying a significantly larger amount than a mere pre-acquisition valuation.

This process inherently increases the chances that a strategic buyer will be interested. At Orion Capital Group our emphasis is placed on finding strategic buyers before turning to plain vanilla equity buyers. Strategic buyers are aware that the same opportunity is being presented to other buyers and are motivated by the fact that competitors might reach the opportunity and capitalize on it first.   Therefore, it is imperative to develop justifications that convince the board of directors that the business is worth a valuation of 8 or 9 X revenue.

Orion Capital Group develops valuations based on a variety of factors. One begins with the cost of development, which can be estimated depending on the number of lines of code. This number helps strategic acquirers perform what is known as a “Build vs Buy” analysis in which they compare the relative costs of developing the product internally or buying it.

Another factor in the valuation is the applicable discounts that must be applied, although such discounts can generally be offset by the number of existing customers using such software. For example, the valuation of a legacy system standing alone might be discounted in the range of 80-90%. However, the very characteristics that make the code itself less valuable can actually increase the price of the company.   Customers using legacy systems are often reluctant to ditch legacy systems. The costs of redesigning the system can be large, or the system might require close to 100% availability making it impossible to take out of service, the way the system works might not be well understood if the system is not fully documented, or the employees administering the system may have left.

The above factors might lead to a lower valuation for the actual software itself, but potential buyers see value in the many existing client accounts.   A large, stable customer base can offset legacy discounts. Recently, there seems to be some movement away from such deep discounts as more companies are developing new user and application interfaces to existing code. In these situations (referred to as “legacy modernization” and “legacy transformation”) companies reuse and refactor existing code by simply adding applicable interfaces as they are needed.

Yet another factor that Orion Capital Group considers is the position the software occupies in relation to other products. If the software has potential to re-define the marketplace and become the “standard” then the company is much more likely to command a larger valuation and the attention of strategic buyers.

There is a vast array of other complex considerations other than the ones mentioned above. Please call Orion Capital Group today for a consultation on selling your business and its valuation.

Recent M&A Trends

The lower middle-market (deals under $100 million) has weathered the credit freeze and "Great Recession" better than the upper middle market has. The deal landscape for the middle market has changed as Wall Street has struggled, but so far, deals are getting done.

The biggest change has been in the deals has been valuations, reliance on debt and reliance on the seller to finance part of the deal. We have seen an increased use of earn-outs, which are typically used in periods where interest rates are high or credit is tight. Thus, PE groups have not stopped investing, and in fact are aggressively trying to deploy their capital into middle-market companies.

As profits are returning, many strategic buyers are more willing to use their cash reserves to purchase various technologies or intangibles that are of synergistic value to them.

Depending on your situation, now could be a good time to seek an exit or even plan for an exit several years down the road. For those that want top dollar for their company and know it will achieve strong, consistent growth for many years, now is definitely not the right time to sell. While valuations may be down, there are many creative ways of structuring deals that may not affect your end proceeds much.

Therefore, if you are a business owner looking to sell, do not avoid doing so due to market conditions. While current market conditions might require a more nuanced approach, the directors at Orion Capital Group have the experience to help you weather these current changes.

If you would like to learn more about Orion Capital Group, please contact us by your prefered means. Any mode of communication is held strictly confidential.

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