In a consulting business it is common practice in situations where there is a standalone software product to separate the ‘value’ associated with the product and the ‘value’ associated with the service that is supplied using the product. The question in this situation is just how standalone is the software product and what is the size of the market for the product alone? Questions that need to be answered are:
- Could the product be sold separately and used by a third party without the consultancy services?
- Is the product fully documented?
- Is the source code owned fully by you?
- Can you estimate the market size for the sale of the standalone product and what data would underpin this estimate?
If the answer to these and other questions is yes, then there is sometimes a case for separating the product from the consulting business and valuing it separately. The reason you would separate the product from the business is that once developed, a software product has very high gross margins and thus intrinsically high value. The reason why it might not make sense is that there may not be too large a market for this type of product as a standalone and it might be difficult to persuade a buyer of the product of the potential revenue stream from the product alone.
In 9 out of 10 situations like this, it makes more sense to bundle the product in with the consultancy sale. Usually the net margins of the consulting firm are significantly enhanced by using such a product and this is then reflected in the price of the firm.
Clearly the specifics of any situation need to be investigated to see if there was a case for valuing the product separately or as part of the whole business.
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