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The first step in the valuation process for software companies is to analyze the company’s going concern. If you missed our introduction to the valuation of software companies you can read it here.
A going concern asks whether a company will be able to continue operating for the foreseeable future. For software companies, this is often more difficult to establish given the inherent risks within this industry (for a further discussion on these risks see our post here).
A factor to consider is whether there is proof that a market exists. Sales of a competing software company may be considered evidence that a market does exist. Other factors include whether there is prior evidence and success in software development by the developers, or if the software is their first project. Stronger evidence can include demonstrated market acceptance of the product or service and, at the very least, whether there is proof that the product has technological and commercial potential (e.g., favourable reviews or signs that an external party would be interested in the product or service offered).
If the software company is determined not to be a going concern, the valuation is typically performed using an asset-based approach via the liquidation method, or in simplest terms, the fair market value of the assets in the company net of the fair market value of the liabilities less costs to sell and tax arising from the sale.
Once the valuator has concluded that the software company in question is a going concern, the valuation is typically performed by one of the following approaches:
The Composite Approach is an alternative approach that uses a combination of two or more of the above.
Stay tuned for next week’s post where we will briefly explain each approach in the valuation of a software company.
CPA, CA, CBV
Partner - Advisory Services
Mike has over 25 years of experience providing accounting and business advisory services, with a focus on the Canadian insurance industry.
CPA, CA, CBV
Alex Wong is a partner at Smythe Advisory and is focused on being a trusted business advisor to his clients.
CPA, CA, CBV
Director of Valuation Services
Paul Woodhouse focuses on providing financial advisory and litigation support services to clients.
Gagandeep specializes in M&A advisory engagements, as well as business valuations in the contexts of management buyouts and succession planning.
Arthur’s mandate is to assist Smythe clients in Western Canada in preparing for and executing business divestitures or acquisitions.