Valuing a business based on time spent

We are a small online business that has been running for a couple of years.

We have an annual turnover of around £35,000, profit on which is around £10,000. We haven't spent much time or effort on marketing. We realise this is a weakness and have been looking for partners to help.

We have been approached by a company who are interested in taking our technology and coupling it with their marketing expertise (and technology) to deliver something new and interesting. They would like to setup a new company, transfer the IP and technology into that and allocate us shares in this new company. We are also looking for some kind of initial payment - i.e. a cash + shares deal.

We have "spent" around £300,000 in time building and developing the software. We have calculated this figure based on our source control logs and market rates for the tasks undertaken.

My questions are:

1. Does this seem like a fair way to value our business?

2. Are we potentially under or over valuing our business?

3. Are we missing anything important, or some fundamental issue?

 

(converted my comment to an answer)

Valuations are normally a multiple of current/potential earnings or potentially raw revenue. It doesn't matter what you "spent" to get there. Therefore your method is pretty far off.. and entirely in your favor.

Consider these things:

• First, that money never existed. You're assuming there's a missed opportunity cost.
• Second, it's based on your billing rate which may or may not be reasonable.
• Finally, if you really "spent" 300k to make 10k/year, that's a payback period of 30 years.. There's something wrong in there.

The potential acquirers have no reason to value what you "spent" to get there, only what you actually have.. which is earnings.

Does this seem like a fair way to value our business?

No.

Traditionally there are two ways to value an asset: what it cost to acquire or what its market value is.

The cost approach is straight forward with tangible property such as a factory. With software however it's a grey area. How do we know that your 10 hours are as productive as my 10 hours? What language was it built in (and could it have been built more cheaply in another language)?

The fair value approach makes more sense in your situation. In which case you need to look at your software product's earning potential.

Are we potentially under or over valuing our business?

That all depends on how well your business model will scale. Don't worry about the fact that your profit is currently only 10k per annum, because 35k revenue per annum with 10k profit is a great profit margin.

Are we missing anything important, or some fundamental issue?

I'd talk some more with your potential buyer to gauge their motives. Perhaps they have a pile of cash that's currently earning little to no interest in their bank and they're looking for a better return? Or perhaps they're looking to expand they're portfolio of products? Or perhaps they see you as a long-term threat and are looking to eliminate that risk by buying you out?

Personally, I'd go back to my initial question above - how well does your model scale? Your margins are really good, so assuming you aren't in a rush to earn more, it might be best to hold on to your business for now, and hire a couple of interns to do some affordable marketing for you.