Application software companies are a large industry sector, classified under SIC code 7372 and NAICS 511210, and composed of firms engaged in the development, production and marketing of specialized software products.
In this day and age virtually all industries rely on some form of business software to power their operations. As a result the application software sector continues to grow. As of 2011, some 8,200 US players have chalked up a grand total of over $135B in annual revenues. The industry employs some 386,900 with an average of 47 staff per firm.
While the application software industry is well know for its multi-billion dollar industry titans, most software firms are small to mid-size businesses. In fact, the average application software development company generates close to $16.3M in annual revenues. About 92% of the companies employ less than 25 people and contribute $19.8B in annual sales to the sector’s total.
Business valuation of application software firms
Given the growth rates often achieved by software firms along with their profitability potential, emerging companies are frequent acquisition targets. Market-based valuation methods are quite common when valuing businesses in this industry.
Valuation multiples relating the enterprise values of comparable firms to their financial performance are the typical tools to appraise a business in this industry. The most common valuation multiples used are these:
- Enterprise value (EV) to revenues (net sales)
- EV to EBITDA
- EV to Property, Plant and Equipment (PPE) assets
- EV to total business assets
- EV to book value of owners’ equity
Example: Using valuation multiples to value an application software company
To demonstrate the application of multiples, we pick a sample software company with the following annual financials:
- Revenue: $10,000,000
- EBITDA: $1,800,000
- Total business assets: $14,300,000
Applying the valuation multiples to each financial measure basis, we calculate the business value as shown in the table below:
|Multiple||Multiple value||Business value|
|EV to net sales||0.7171||$7,170,626|
|EV to EBITDA||4.1042||$7,387,570|
|EV to total assets||0.6097||$8,719,222|
|Average Business Value||$7,759,139|
In this example the business value estimates across all valuation multiples fall pretty close together. The spread of valuation results can be considerably greater depending on how well the subject business performs against a specific financial measure compared to industry peers.