MBA Mondays - Business 101 for startups by Fred Wilson

Venture Investing: Determining Valuation Multiples

Last time on MBA Mondays, I talked about valuing an internet marketplace business. In that post, I talked about using 1x gross marketplace transactions and 20x EBITDA as multiples to determine value. In the comments, I was asked about multiples for other sectors. That's a good question so I figured I'd show how to calculate multiples for various sectors.

For this exercise we will focus on the software as a services (SAAS) sector. The first thing you need to do is find a universe of publicly traded companies to use for your model. 

The next thing you do is create a spreadsheet with a bunch of companies on it. I decided to use five SAAS companies in my model; Salesforce, NetSuite, Constant Contact, Taleo, and RightNow. 

Please don't get too caught up in the numbers in the spreadsheet. I believe they are accurate but I did this work in about twenty minutes this morning and there could well be errors in it. The point is to show you how to do this work, not to build the absolutely most accurate valuation model.

For each company, I collected revenues and EBITDA for 2011 and 2012 and current values for market cap, cash and debt. I used two free services to get these numbers. I used Google Finance to get market caps and current cash and debt levels. To get revenues and EBITDA, I used a combination of Google Finance and Yahoo Analyst Estimates. 

I then put all the numbers down and used formulas in the spreadsheet to calculate enterprise value which is market value minus cash plus debt. This normalizes the market caps for companies with high cash levels or high debt levels. Then I divided enterprise value by revenues to get to enterprise value/revenue multiples for 2011 and 2012. And I divided enterprise value by EBITDA to get enterprise value/EBITDA multiples for 2011 and 2012. 

The results of this exercise are as follows:

SAAS Price/Rev 2011: 4.8x

SAAS Price/Rev 2012: 3.9x

SAAS Price/EBITDA 2011: 66x

SAAS Price/EBITDA 2012: 31x

The EBITDA multiples are based on a smaller sample size (the 2011 sample size is one!) so they should be understood in that context. It is also true that most of the companies in this sample seem to be investing heavily in sales and marketing to grow revenues at the expense of profits and the public markets seem to be accepting of that approach (given the valuations they are carrying).

The price/revenue multiples seem about right given my cursory understanding of the SAAS world. If you have a SAAS business, then your company's valuation should roughly be 5x this year's revenues and 4x next year's revenues. These are for public companies. Investors will typically take a 20-25% discount for private company valuations because private company investments are not liquid. So maybe 4x this year's revenues and 3x next year's revenues is an appropriate multiple for a privately held SAAS business.

We led a follow-on in one of our most mature portfolio companies last month. It is a SAAS business and these multiples are almost exactly what we paid. That makes me feel good. It means we got a fair deal and so did the company. And that is why this kind of exercise is valuable.

From the Comments

Mike Altschul added:

My former Corporate Finance and Valuations professor posts data sets every year with most of this data (even multiples) compiled. Useful for folks to double-check your work (note: EV/Sales = EV/Revenue). 

@Serkan , you should be able to find some comparisons in the Europe / Emerging Markets data sets. But, less developed financial markets (particularly those with limited regulation) will yield less reliable information so take any findings with a grain of salt.

Then William Mougayar asked:

I'm still grappling with how to apply this to an emerging start-up situation. Especially when you transition from being valued based on the future potential/prospects to actual revenue multiple, i.e. when your revenues are small but starting to pick-up but a pure revenue X doesn't make sense.

Example: company did a Series A at 8M with no revenues a year ago, then is now tracking $100K rev/month. At 1.2mil/year and even at X5 that's $6 million valuation which doesn't make sense.

To which fredwilson replied:

that's the problem with revenues. they can reduce your valuation. going from hopes and dreams to a real business often exposes the difference between what someone thought the business was worth and what it is worth. best thing to do is get the existing investors to fund you through this phase and go back to market once your valuation based on metrics is well north of the last round price