Computing Valuation of Custom Software

I've recently been approached by a potential partner to buy a piece of custom software that I have written, and I'm struggling with a way to value the software. They would like to buy the source code outright, and then also pay royalties on what they have sold. I'm OK with this, but they have also asked me to provide my expectations around price and royalty percentage. They also hope to hire me as a consultant to add functionality to the application, so there will be more income as more features are put in.

Another challenge is that we are going to be changing the pricing model from a perpetual (flat) price to a monthly license fee price, and we're not sure how to price it. We hope to enter an agreement and then approach their customers to come up with a price. I've asked them for some projectioons on number of users, and let's assume that we can put together a rough estimate of monthly revenue. (I don't have this rough number yet, still waiting on details from the partner)

So, I've come up with this plan of attack, and I was hoping for insight here or suggestions to a better way.

I know it took me so many hours to develop the software, and that price is $XX based on my rate to hire me to do it again. I think I can assume if they wanted to build this it would take them 1.5 to 2 times as long, because I have expertise in the area. So, we're 2 * $XX for a valuation.

Now, if I figured a 5x muliplier is reasonable (maybe a little high, but let's go for it). So, we're at 10 * $XX as a valuation.

I would expect to recover this amount through the purchase price and royalties. I'd like to recover this over 2 years, so I thought it would make sense to structure price and royalties over 2 years to match this. So, upfront price would be whatever is left unpaid to me after I have received project royalties. Now, if these numbers don't align in the end sensibly, we'll need to restructure, or my valuation is too high or low

Am I nuts? Any better suggestions?!

Thanks all!

Matthew, you're not nuts, but more does come into consideration. 10 * $XX might be what it's worth, but does the potential client have the investment ready to cover that and still the necessary start-up fees for the modified business you are proposing? If so, and the return promises to be high, your buyer might be able to afford more than 10x.

I think you are taking the right direction by getting a fair value on your investment in time, and keeping some potential share of the success if your investor can bring you to a new level.

One thing I would caution on is what the buyer expects you to support and what they will pay you to maintain. Be sure to work with a lawyer over the contract and what your expectations are if you do not own the source code anymore.