Deferred Revenue treatment in Software M&A deals

Many software companies have a lot of recurring revenue from the 20 percent (or so) annual maintenance tail that they have from their previous perpetual license sales.

 

This can be very valuable revenue that requires special treatment with buyers.

 

Sellers must assess the liability associated with this deferred revenue to determine value. Normally expenses are help desk costs and some portion of R&D expenses as they are required (effectively) to produce new product features as part of the contract. The cost of that revenue is maybe 30% (?) which would mean that the GPM on the recurring revenue is 70% - not bad. If sellers can increase this margin through contract adjustments and reducing help desk costs this is a great way to build more value.

 

However if the total margins of the company are much less than that, this means that the rest of the operations are losing money.

 

If the buyer plans to shut down the growth engine, layoff most staff and milk the recurring revenue until it dries up (and some do this), then the argument to overweight the value of deferred revenue is very sound.

 

In most cases, the company is being sold as a going concern so the total cost of running the business has to be factored in so the EBITDA number (GAAP) is the real tell-tale of cash flow.

Posted by , Vice President on 13 July 2011
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