Technology & SaaS
Revenue recognition on multi-year implementations
The most common quality of earnings adjustment in software is also among the most avoidable. The cost of discovering it late is not the adjustment itself.
Where a software contract combines licence, implementation and ongoing support, the allocation of revenue across those elements and across accounting periods involves judgment. The judgment made for management reporting is frequently not the one an acquirer’s accountants will accept, and the gap between them can be material.
How it happens
It is rarely aggressive accounting. A founder-led business signs a contract worth a fixed sum, delivers an implementation over several months, and recognises revenue on a basis that made sense when the contracts were simple. The contracts become more complex, the basis does not change, and nobody revisits it because the business is not audited to a standard that would force the question.
Long implementations amplify it. A twelve month deployment straddling two financial years, with milestone payments that do not track the delivery of value, produces a revenue curve that depends entirely on the allocation method chosen.
The real cost
The adjustment arrives in month four or five of a process, when the buyer’s accountants complete their quality of earnings work. The revenue curve is restated, usually flattened, and sometimes the growth rate that justified the valuation is materially reduced.
At that point leverage has moved. The seller has been in exclusivity or close to it, alternative buyers have been released, and the transaction has developed momentum that makes walking away expensive. A reduction proposed at that stage is very difficult to resist, which is why some buyers are content to let it emerge.
What a sell-side review actually buys
Commissioning a quality of earnings review before going to market does not make the adjustment disappear. The accounting is what it is.
What it does is convert a discovered adjustment into a known one. A restatement presented by the seller on day one, with the methodology explained and the revised figures used consistently throughout the materials, is a fact the market prices from the beginning. The same restatement discovered by a buyer in month five is a negotiating instrument.
That difference is most of the negotiation, and it is available for the cost of a diligence engagement.
The same logic applies to deferred revenue balances, capitalised development costs and contract acquisition costs. None of these usually change what the business is worth. All of them change the conversation if the other side raises them first.
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Thirty minutes, without materials or obligation. We will give you a considered view of value, of what is currently constraining it, and of whether this is the right point at which to act.
Where our view is that you should wait, we will say so.
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