Software LBO - capex, A/R, A/P, D&A, intangible acquisition assumptions
Hey guys,
Could you please help me to wrap my head around LBO of growth software company.
I created a basic LBO and noticed (revenue and margins forecasts const) that my assumptions about capex-depreciation, intangible acquisition-amortisation and NWC can change the price dramatically. So how do I arrive at reasonable valuation?
Capex-depreciation: should I just assume Capex=Depreciation? They cancel out, but depreciation influences tax I pay, lowering my FCF. Also - should I drive them as historical % of sales? It's a growth biz so sales skyrocket - not sure company would invest in PP&E with same speed, especially given it's software business
Intangibles -amortisation: now this is a problem as i have never seen anyone accounting for intangibles purchase in LBO (typically it's EBITDA less tax, less interest, less capex and less change in NWC) - but my company invests a lot in this stuff and also amortises a lot. Also - should I just drive as historic % of sales?
NWC: How should I project these? I understand in software biz receivables are important as typically prepaid services. So makes sense to drive as % of sales. Also - what is the difference between deferred revenue and receivables?
But what should I do with payables? It sounds a bit dumb dumd just to assume same % COGS as last historic year. Companies can try to manage NWC better in future...should I attempt to assume it, or play safe and stick to historicals? Maybe in growth businesses receivables are lower than payables, but as business matures we see reversion - company collects more with less costs to suppliers manifesting in payables...?
Would appreciate inteligent advice about logic about drivers of these items, different ways to argue. Because as you see - my approach is quite simplistic and unsophisticated. I might get these things wrong in my model, but want to make sure I give good reasons why.
Million thanks!
For capex, some software firms capitalize their software development costs. That's generally most of the capex, as you are not likely to be spending on physical equipment aside from computers. I generally keep it as a % of revenue unless you have more info. This gets amortized.
If you are doing an LBO, you often either write up or write down the intangibles based on your excess purchase price calc, so the amortization will be based on that.
On NWC, deferred revenue is cash you've collected prior to completing the service, so revenue is not yet recognized. This happens when you have software firms with subscription models, so they collect cash at the start of the year and it gets recognized as revenue monthly throughout the balance of the year. Accounts receivable is the opposite. You've recognized the revenue already but are waiting for the cash to come in (like with credit cards).
Generally speaking, you can use the traditional ratios (days receivable, deferred revenue as % of revenue, etc.) to project, but deferred revenue can change if your software company is changing their license terms. If they are increasing the length of the license (3-year to 5-year license) you will have deferred revenues increasing as % of revenue since you are collecting 5 years of cash for the subscription as opposed to 3 years. This can be a granular build based on the mix of your license terms, but if you don't have that visibility, you can generally stick with % of revenue. For payables and current liabilities, I wouldn't overthink it. Just use the ratios.
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