Image by Paco Cameo
Some of the very difficult features of selling a health care information technology firm is coming up with a business valuation. Occasionally the valuations furnished by the marketplace (translation – a finished trade) defy all sense. In other business sections there are some rather useful rules of thumb for valuation metrics. In a single sector it can be 1 X Sales, in another it might be 7.5 X EBITDA.
Since it’s essential to our company to help our health care information technology customers optimize their company selling price, I’ve given this considerable thought. Are some of these software company valuations high? It’s due to the profitableness influence of technology. An easy example is what’s the incremental cost of Microsoft to make the next copy of Office Professional? It’s likely $ 1.20 for three CD’s and 80 cents for packaging. Let us say the permit price is $ 400. The gross margin is north of 99%. That doesn’t really happen in services or production or retail or the majority of other businesses.
One difficulty in selling a modest health care technology firm is they would not have some of the brand name, supply, or standards influence the large firms have. On their own, they can’t create this profitableness influence. The acquiring firm, nevertheless, will not need to compensate the modest seller for the post acquisition results which are directly attributable to the market presence of the buyer. This really is that which we refer to as the valuation difference.
What we try to do would be to assist the purchaser warrant paying a higher cost when compared to a pre-acquisition monetary valuation of the target company. To put it differently, we should get our seller tactical value. Here are the variables that we use in our evaluation:
1. Cost for the purchaser to write the code – Many years back, Barry Boehm, Software Engineering Economics, in his book, developed a constructive cost model for writing computer code for projecting the programming prices. He called it the COCOMO model. It was complicated and fairly comprehensive, but I’ve boiled it down and simplified it for our goals. We’ve got the advantage of estimating the “jobs” retrospectively because we already understand how many lines of code constituting our customer’s products. Generally terms he projected that it takes 3.6 individual months to compose one thousand SLOC (source lines of code). Therefore, if you looked at a senior software engineer at a $ 70,000 completely packed settlement package writing an application with 15,000 SLOC, your computation is as follows – 15 X 3.6 = 54 individual months X $ 5,800 per month = $ 313,200 split by 15,000 = $ 20.88/SLOC.
Before you guys with 1,000,000 million lines of code get overly excited about your $ 20.88 million business value, there are several caveats. Sadly the marketplace WOn’t pay for what it cost you to develop your merchandise and will not care. Second, this info was created to help us comprehend what it may cost the purchaser so he begins his own build versus buy analysis to develop it. We must use reductions to this investigation in the event the program is legacy code that is three generations old, for instance. If so, 90% discount it. You’re a technology sale with high profitability influence. They’re basically getting your customer base as well as the valuation is not going to be that exciting.
If, nevertheless, your program is a completely new program that’s legs, begin sizing your yacht. Examples of this may be Pay Pal, a click fraud program, or Internet Telephony. The next high worth platform would be where your applications technology “leap frogs” a popular heritage program. An example of this is when we sold a business that had entirely rewritten their heritage management platform in Microsoft .Net. They leap frogged the dominant player in that space that was supporting multiple second generation options. Our customer became a tactical acquisition that was powerful. Fast forward and I hear the acquirer is selling one of these $ 100,000 systems per week. Now that’s leverage
2. Most acquirers could write the code themselves, but we propose they examine the expense of their time to market postponement. Believe me, with first mover advantage from customer defections, a competition or, worse, there’s a very actual expense of not having your merchandise now. We could convince one buyer they would have the ability to warrant our seller’s whole purchase price on the basis of the amount of customer defections their acquisition would prevent. As it turned out, the buyer through multiple previous acquisitions was keeping six disparate applications platforms to provide basically the same functionality and had a tremendous install base.
This was quite expensive to keep and they passed those costs on to their dissatisfied install foundation. The buyer had been swearing upgrades for several years, but nothing was delivered. Customers were starting to sign on with their leading competition. Our pitch to the buyer was to make this acquisition, present to your customer base that you’re actually providing an upgrade path and give notice of support withdrawal for 5 or 4 of the other platforms. The acquisition was finished and, they didn’t desert either, even though their customers which were considering leaving didn’t instantly update. Seemingly the demon that you just know is much better compared to the devil you do not in the universe of health care information technology.
3. Another arrow in our valuation driving quiver for our sellers is we restate historic financials utilizing the pricing power of the brand name acquirer. We had one customer which was a little health care IT firm that had developed a great piece of applications that compared with a big, publicly traded firm’s option. Our merchandise had open systems platform, simplicity of use, and the same functionality, however there was one crucial difference. The end user customer’s understanding of threat was much greater with the small IT firm which could be “out of business tomorrow.” We were able to double the fiscal performance of our customer on paper and present the large business buyer with a persuasive argument that those economics would be instantly accessible to him post acquisition. It definitely wasn’t DIFFERENCE Accounting, but it was not ineffective as a tool to drive trade value.
4. Financials are significant so we need to recognize this facet of buyer valuation too. We usually prefer to construct in a baseline worth (before we begin adding the tactical value elements) of 2 X contractually recurring sales during the present year. So, as an example, in the event the firm has monthly care contracts of $ 100,000 times 12 months = $ 1.2 million X 2 = $ 2.4 million as a baseline business worth element. Another element we add is for any contracts that go beyond one year. We assign a 5 X multiple to that and take an estimation of the gross margin made in the firm contract years beyond year one and mark down it to present value.
Let Us use an example where they had 4 years staying on a services contract and the last 3 years were $ 200,000 per year in sales with about 50% gross margin. We’d take a to the last tree years of $ 100,000 yearly gross margin and present value it at 5% discount rate resulting in This would be added to the 2 X revenant year 1 earnings from previously. Again, before we stack on the tactical value elements, this fiscal evaluation will be to set a baseline.
5. We attempt to put values for miscellaneous assets the seller is supplying to the buyer. Do not overlook the tactical worth of Blue Chip Accounts. Those accounts become a platform for the purchaser’s whole product package being sold post acquisition into an “installed account.” It’s much more easy to sell add on merchandises and programs into an existent account than it’s to open up that new account. These tactical accounts can have tremendous value to a buyer.
6. Eventually, we make use of a customer acquisition price version to drive value in the eyes of an expected buyer. Let us say your sales person internet new accounts. 5 at 100% of Quota brings in fees and overall wages of $ 125,000 and sells That will mean your base customer acquisition price per account was $ 25,000. Add a
20% business overhead for the 85 accounts, for instance, as well as the firm worth, using this methodology would be $ 2,550,000.
7. Our closing valuation element is that which we call the defensive variable. This really is really actual in the health care information technology area. What’s the value to a big company of enhancing their competitive status in the market and preventing his opponent from getting your technology. One of our customers had nurse staffing applications algorithm and an outcomes database. The owner had business credibility and was the accepted specialist in this area. This was a little add on program to two big business players’ incorporated hospital programs package. This module was viewed as supplying the organization that could incorporate it with their primary systems with a minimal characteristics edge. The selling price for one of these leading software systems to a hospital chain was frequently more than $ 50 million. The fiscal operation of our customer, but by the competitive advantage they could supply post acquisition not established, the worth paid for our customer. Our customer did on her business sale.
After reading this you might be saying to yourself, come on, this is somewhat far fetched. These parts do have actual worth, but that value is open to a broad interpretation by the market. We’re trying to assign metrics to an extremely subjective group of parts. The buyers are intelligent, and experienced in the M&A procedure and quite frankly, they attempt to deflect these arty strategies to driving up their monetary outlay. The most effective influence point we’ve is that those buyers understand they do not understand which part or components of value that we’ve presented will resonate with their opposition and that we’re presenting the exact same evaluation to their opponents. In the final analysis, we’re only attempting to supply some sensible explanation for their board of directors to warrant paying 8 X sales for an acquisition to the buyers.
Dave Kauppi (firstname.lastname@example.org) is the editor of The Departure Strategist Newsletter, a Merger and Acquisition Advisor and President of MidMarket Capital, representing owners in the selling health care and technoloby based companies. Wall Street design investment banking services to lower mid market businesses at a size suitable fee construction is provided by us.
Associated Information Technology, Business Technology Posts