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Product Valuation

Can anyone provide some insight or links to help determine the fair market value of a product.  I'm not talking about selling a product to a consumer, rather to a company that would like to purchase the code base and all rights to further develop and market said product.  I've found discussions ranging from 3 - 10 years of average annual sales.
-Rob
Sunday, December 24, 2006
 
 
The 10 years of sales is considered 'classic' valuation, but of established and matured businesses.

In fact there is no real number you should use.

Many had proposed the 2 years of profits for a software product. I myself think 3 years profits is the right number.

But if you think about it, no company is like that. Few examples:

Ryan Carson tries to sell DropSend for $1mil. The service which amouonts to over 10 years the projections for sales. (overpriced imho).

Kiko sold for $250K. No profits. If it had sold for $50K the founders would be happy. Valuation in this case = luck.

Ford cost a mere %16 bil because of its great losses (compare this with $200 bil for Toyoya).

Google has more than half the valuation of Microsoft although it has much less profits.

And so on.

The price of your company is based solely on what people are willing to pay for it. If it is a private one, luck plays way too big role in this.
Boris Yankov Send private email
Sunday, December 24, 2006
 
 
Financial buyers sometimes use EBITDA multiples, usually in the range of 5 - 7.

There are many ways to do this, and no single correct answer.  Valuation is a very complex subject.  Think of the response above as a single piece of a 500 piece jigsaw puzzle.

Background:

EBITDA means Earnings Before Interest Taxes Depreciation and Amortization.  Calculate this number for one year of your operations.  Multiple by 5.  The result is a decent guess at what a financial buyer /might/ think your company is worth.
Eric Sink Send private email
Sunday, December 24, 2006
 
 
As other posters have stated, the true value of anything is what you can get for it.  Some people have a knack for using charisma and personality to get a lot of money for nothing special.

However, for most people, it is easier to use a method that has some rational basis for both the seller and buyer.  One way to do this is to use a method called "Net Present Value".  This has been put forward as one of Warren Buffett's favorite methods.  What this method does is to discount all future profit to today based on a desired return.  In order to come to a mutually acceptable sales price with this method there are only three variables that the buyer and seller must agree on - rate of return, and the number of years to discount and amount of profit per year. Here is an example (based on a story in "Buffettology" by Mary Buffett p. 57).

Warren puts a pinball machine in a barber shop. Let's say this pinball machine produces $8 in profit each day, and that the barbershop is open 365 days a year (Sarge, the barber is a little weird). This yields $2,920 a year.  If he was selling you the pinball machine as a business he would in effect be selling you the right to collect $2,920 a year.  He believes that he could continue to operate the pinball machine for ten years with the same profit.

Further, if he deposited the profits in a bank account each month that earned 8% (it's a really good bank), at the end of 10 years he would have about $44,516.  From the buyers perspective the question becomes "How much would I have to invest today at 8% to have $44,516 in 10 years?".  You can find any of number of web pages with "Net Present Value" (NPV) instructions, and there are functions in most spreadsheets to do this.  The answer is that you would have to invest a lump sum of about $20,619 at 8% compounded APR.  So would you buy the pinball business for $20,619?

Probably not, since we assume that if Warren could get 8% in a bank account, you could too.  So there would be less risk in just putting $20,619 into the bank.

This is where the subjective part of the negotiation comes in.  The buyer now has the question "What return am I willing to accept based on my perception of the risk".  There are 2 basic elements of risk.  1) The profit stream will continue for 10 years.  2) The profit stream will remain the same or greater for all 10 years.

Let's say you think that a 10% return is adequate, and that you believe that the business will indeed last 10 years.  This would yield an NPV of $17,163.  That means if you gave Warren $17,163 today, that in 10 years you would have earned back that $17,163 plus an additional $27,353 in earnings giving you a 10% annual compounding rate of return.

So if you are selling a product line, one way you could set a price is to do the following.

1) Determine the profit per unit sold.
2) Determine number of units sold per year
3) Determine how many years the units will sell
4) Determine what you think a fair Annual Compounding Rate of Return should be
5) Calculate the NPV.

With this price you can show a perspective buyer exactly how you determined it, and then the discussion centers on the Rate of Return and how realistic the #years and # of units are.  Also, if you look on the web, you can see the methods to calculate the NPV if the number of units sold changes every year.  This would let you estimate a gradual drop-off or increase in sales.

There are still shortcomings with this method, but it is just another way you can view the problem.  Also, it provides a rational framework for negotiations.

Anyways - sorry for the length of the post.  Hope it helps. 

Best of Luck!!
Loren Charnley Send private email
Sunday, December 24, 2006
 
 
You can have a CPA do a business line valuation.  This is a document that computes (or attempts to) compute a fair market value for the buisness of owning/selling your code.

This sort of valuation is expensive (about 20K), mainly because this sort of thing is often litigated over, and the accountant can be later forced to testify about their work.

You don't want to get a cheap valuation either, it won't stand up in court or with the IRS, which can cause huge problems.

If you are thinking of selling a line of business, get an attorney involved early and often, as you are exposing yourself and your company to all sorts of liabilities if you don't dot all your i's and cross all the t's

Tuesday, December 26, 2006
 
 

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