We have a high-margin proprietary software tool built inside our traditional services company. Should we carve out the software into a separate legal subsidiary before an exit to command a tech multiple?

Question

Tyler Smith · Accepted Answer

Embedding proprietary technology inside a services company is common, but it creates a valuation trap. Buyers will treat the combined entity as a services business, applying a modest services multiple to your entire cash flow rather than valuing your software at software-as-a-service rates.

Carving the software into a distinct legal subsidiary can unlock enterprise value, but only if the technology can stand on its own feet. Buyers will scrutinize whether third parties actually pay for the tool, or if it is merely an internal operational efficiency feature that your services team uses.

To capture a dual multiple, separate the entities operationally and legally at least twelve months before going to market. Establish distinct corporate entities, assign all intellectual property and developer contracts to the software subsidiary, and create formal intercompany Master Service Agreements. Your services business should pay market-rate license fees to the software entity under the same terms as external customers.

Build distinct Accountability Charts for each entity. If your services Integrator or engineers are splitting time between client billable hours and writing code, buyers will argue that corporate overhead is commingled and discount your margins. The software entity must demonstrate standalone financials, clear recurring revenue, and separate customer contracts.

If you cannot prove standalone third-party revenue, do not waste money on an expensive pre-deal corporate separation. Instead, present the software as a proprietary moat that drives superior gross margins and customer retention for your core company. That efficiency still drives multiple expansion within your industry category.