Companies developing security software applications fall within the custom software industry sector. It is classified under SIC code 7371 and NAICS 541512.
Information systems security concerns in companies large and small are a major reason this sector of the software industry has experienced rapid growth in recent years. In 2011, over 49,000 US based firms have been responsible for over $65.4B in total annual revenues. The industry as a whole employs well over 555,000 professional and administrative staff.
Yet the vast majority of security software companies are considered small to mid-size businesses. The average firm produces about $1,500,000 in annual sales with a staff of just 12.
Business valuation of security software development companies
As with any software business, you have a number of well known valuation methods to value security application development firms. These companies are common acquisition targets so you can use the recent business sales as a guideline to estimate the value of a company in this industry.
These sales comparables are an important source of valuation multiples that you can use in calculating the business value in relation to a range of financial performance factors. Here is our short list of valuation multiples to consider:
- Enterprise value (EV) to gross revenues or net sales
- EV to seller’s discretionary cash flow
- EV to EBIT or EBITDA
- EV to hard assets such as Property, Plant and Equipment (PPE)
- EV to total business assets
- EV to book value of owners’ equity
Example: Using valuation multiples for security software company appraisals
Let’s pick a typical firm in this industry with the following financials to demonstrate the technique:
- Revenue: $1,500,000
- EBITDA: $250,000
- Total business assets: $1,200,000
We next apply the valuation multiples to the corresponding financial performance bases to calculate the business value:
|Multiple||Multiple value||Business value|
|EV to net sales||1.3293||$2,000,421|
|EV to EBITDA||8.5194||$2,129,858|
|EV to total assets||2.6392||$3,182,529|
|Average Business Value||$2,440,603|
As the above table shows, the calculated values can differ quite a bit. This depends on how our example business financials compare to its industry sector peers. For example, this company appears to be relatively asset rich for its level of revenues and profitability.