Computer Software Valuation: Don't Be Led Astray by a Quick Approach

By Millon, Tom | The National Public Accountant, September 1992 | Go to article overview

Computer Software Valuation: Don't Be Led Astray by a Quick Approach


Millon, Tom, The National Public Accountant


Computer software is a valuable business tool for your client, and for many different reasons for. It can be held as nontypical loan collateral, enhance the purchase price in buy-sell negotiations and be used to transfer wealth intergenerationally. Frequently, unsophisticated analysts apply broad brush formulas or rules of thumb to the valuation of computer software. These quick approaches can lead to misleading results as to the relative value of what can be an important intangible asset to a business enterprise. Therefore, a current, accurate determination of the value of a company's computer software is often critical to the firm's current owners, potential buyers, management, lenders or other interested parties.

The first part of this article will present some of the reasons why the valuation of computer software can be important. The second part will present some generally accepted valuation approaches. Finally, an example of the most common approach will be offered to illustrate the key variables that are necessary for conducting such an appraisal.

Reasons for a Software Appraisal

A myriad of reasons exists for quantifying the value of a firm's computer software. Some of these reasons are financial-related, others are tax-related motivations.

Acquisition Financing

In many business acquisitions, the value of computer software is an important consideration in collateralizing either cash flow-based or asset-based financing. The valuation of computer software may directly impact the refinancing or recapitalization of an established business, outside the realm of an acquisition or transaction.

Business Sale/Purchase

As with the value of any business asset, the specific value of computer software plays an important role in the overall valuation of a business enterprise. Obviously, an overall business valuation is an important consideration in the determination and negotiation of a business purchase or sale price. Because computer software is typically a depreciable asset for federal income tax purposes, its value may have a greater impact on the overall business value than other assets which may not generate tax amortization benefits, such as going concern value of goodwill.

Buy/Sell Agreements

Buy/sell agreements are used for both ownership succession as well as estate tax planning purposes. In many instances where computer software is an important operational asset of the firm, the value of the computer software may be contemplated by the buy/sell agreement valuation formula.

Management Stewardship

The valuation of computer software and its impact on the overall business valuation, may be an important consideration on the periodic assessment of the effectiveness of management's stewardship of business assets.

In addition, the valuation of internally-developed computer software may directly impact the measurement of the performance of the firm's data processing management.

Intercompany Transfer Pricing

In many firms, computer software is developed by a centralized headquarters staff, but these internally developed systems are used by the various divisions and subsidiaries. The appropriate intercompany transfer price for the use of software should be a direct function of that asset's value. Depending on the relative locations of the firm's branches and subsidiary operations, the transfer price for the use of internally developed computer software can have both Federal and state income tax implications.

Intergenerational Wealth Transfer

Many family business owners look for ways to transfer wealth and income to second and third generation heirs. This wealth transfer provides for the heirs and helps manage the value of the business owner's estate. Since many business owners are reluctant to transfer direct equity interests to family members, they may choose to transfer direct or beneficial interest in the firm's computer software. …

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