More services businesses are adding a software layer and expecting a software multiple. Here is what a buyer actually credits, and what gets discounted.
Over the last two years we have seen more services businesses come to market with a piece of software attached. A client portal, a dashboard, a subscription tool, a set of workflows the clients log into. The pitch that comes with it is usually the same. We are not only a services business anymore, we are a platform, so value us like one.
We understand why. A services business tends to trade on a multiple of profit, often somewhere in the mid-single digits, and sometimes a low multiple of revenue. Software trades much higher when the revenue is recurring and the margins are good. So the gap between the two is large, and the pull toward the higher number is obvious. The problem is that a buyer does not pay for the label. A buyer pays for what the software actually does to the business underneath it. This week we want to set out what that is, because getting it right before you go to market is worth real money, and getting it wrong wastes the first month of every conversation.
Is the software actually earning?
The first thing a buyer looks at is how much revenue the software is really generating on its own. Not the services the software supports, the software itself. If the subscription line is a small fraction of total revenue, then what you have is a feature that helps you sell and deliver services, not a software business. That can still be valuable, but it is valued as part of the services business, not as a separate thing at a separate multiple. When the subscription revenue is large, standing on its own, and growing, the conversation changes, because now there is a real second revenue stream to value. Most of the time the honest answer sits in the middle, and the seller who can show exactly where it sits is ahead of the one who cannot.
Does it lower the cost of delivering the service?
This is where a software layer earns its keep for most services businesses. If the platform lets you serve more clients without adding staff in proportion, that shows up as margin, and margin is something a buyer can see and underwrite. A firm that has held headcount flat while revenue climbed because the software absorbed the work has a real story, and the numbers back it. A buyer will credit operating leverage that has already happened. A buyer will not pay much for an effect that has not shown up yet. The difference between those two is whether the effect is already in your financials or still in your deck.
Does it keep clients longer?
Software that clients use every week is harder to leave than a service delivered by email. If the platform has raised retention, or lengthened the average client life, that de-risks the recurring base, and a more durable recurring base is worth a higher multiple on its own. Buyers pay for retention because retention is what makes the forward revenue believable. So the retention data, split between clients who use the platform and clients who do not, is one of the more persuasive things you can put in front of a buyer. If the users stay longer, say so and prove it.
Who owns the code and the data?
A platform is only an asset if it transfers cleanly. We have seen so-called platforms that turned out to be a thin layer built on top of third-party tools, or software written by a contractor who still owns the code, or a system where the client data is tangled up with a provider the buyer cannot easily replace. Every one of those lowers what a buyer will pay, because the buyer is now taking on a dependency rather than acquiring an asset. Clean ownership of the code and the underlying data is not glamorous, but it is the thing that lets a buyer treat the software as something they are buying outright.
Is anyone using it?
A platform that clients logged into once and then forgot is worse than no platform, because now it is a cost with no return, and a buyer sees that quickly. Active usage across the client base is the evidence that the software is doing something. How often clients actually use it, and what share of the base touches it at all, matters more than the feature list. A short feature list that clients use every day beats a long one that sits idle.
So how does a buyer actually price it?
Here is the part sellers most often get wrong. A buyer does not usually blend a services business and a software layer into one big software multiple. What a buyer tends to do is value the services business as a services business, then add a premium for the software where the software has earned it, through the margin effect and the retention effect and the standalone subscription revenue we have just described. The stronger and more provable those effects, the larger the premium. When they are real, the uplift can add real money to the final number. When they are only asserted, the premium is close to nothing, and the seller who led with the software story ends up negotiating back down to the services multiple anyway, having lost credibility on the way.
What to do before you go to market
If you have built a software layer and you are thinking about a sale, the work to do first is straightforward. Separate the software revenue so it can be seen on its own. Pull the numbers that show what the platform did to your margins and your retention. Confirm you own the code and the data outright. And be ready to show that clients actually use it. Do that, and the platform becomes a reason a buyer pays more. Skip it, and the platform becomes a claim a buyer discounts.
We spend a lot of our time helping owners work out which of these they can actually prove, because the answer sets the asking price. If you are weighing a sale and you are not sure how a buyer will treat your software, that is a conversation worth having before the data room opens rather than during it.