The Beauty and Limitations of Multiples
OK, so let's talk multiples. I know that this is so exciting to some of you that you can hardly wait. In all seriousness though, multiples are one of the funnest parts of entrepreneurship, VC, and private equity. Multiples are put simply numbers that you can multiple against the operating metrics of a company (like revenue, EBITDA, cash flow, downloads, monthly unique visitors on a site, etc) that yield a rough valuation estimate for that company. We use multiples as the basis of our valuation work at http://www.venturereturns.com/. We kind of consider ourselves multiples junkies. So what is so exciting about multiples? Lots of things, so I will go into more detail here.
Simple to use. One of the coolest things about multiples is that they are simply to use. It is often very hard to find the right multiples, but once you find them, they make valuing a company easy. VR makes finding them easy for you (http://www.venturereturns.com/company_komp_builder.php?newFlag=N&pType=5). Now, for example, let's assume you are interested in the value of a particular Saas (software as a service, like Salesforce.com) company. Saas multiples are really high right now--generally between 6-8x revenue and 30-40x EBITDA. This means that if you have a Saas company doing $5M in revenue, it could be worth up to $30-40M.
Multiples yield business insight. Multiples can actually teach you a lot about different businesses. For example, they can basically tell you what the value of $1 of revenue in one kind of business is worth versus the same amount of revenue in another business. Again, let's take Saas as an example. Let's compare Saas to hardware companies. Hardware companies are lucky if they can get 0.8-1.5x revenue multiples. The revenue multiples teach us that $1 of revenue in a Saas business is worth about $6-8 of hardware business. This can be instructive as entrepreneurs are considering business opportunities, as VC and PE investors are looking at deals, and as businesses are making investment decisions. I can promise you that any investor worth his or her salt will think carefully about multiples. Most big institutional investors only want to make investments where they can reasonably expect a chance of at least a $100M exit. For larger funds, this can be an even bigger number. For Saas companies, you could expect this kind of exit by generating $12-17M in revenue. For hardware companies, you could only expect this kind of exit by generating $100M in revenue. BTW, this doesn't mean that you shouldn't start a hardware company necessarily--you had just better realize that it brings a unique set of challenges. For a variety of reasons you may want to couple a software company with a hardware company (think Blackberry). This kind of thinking is also helpful when you think about strategic investment decisions in a company. I was recently talking with an entrepreneur acquaintance who does generates 20% of his business from a traditional enterprise software product and 80% from a Saas product. The enterprise software product has much longer sales cycles, costs a lot more to manage and deploy, and is a giant pain to maintain relative to the Saas product. I told him that I thought every dollar of Saas revenue was worth $2-3 dollars of enterprise software revenue and that I would seriously consider abandoning any future sales of enterprise software just to focus on the Saas business. Maybe I was wrong but multiples can clearly inform this kind of thinking.
Multiples generally point to a leveraged exit. One of the exciting things about multiples is that they remind us that modern finance has taught us that indefinate streams of cash flow can be equated to a lump sum payment now. Further, we know that the lump sum payment now is generally bigger than the cash stream. This fact sits at the foundation of modern entrepeneurship on both the early-stage and late-stage sides of the camp. Nearly all venture or private-equity backed investors and entrepreneurs are not interested in creating busineses that simply generate a healthy cash flow indefinately. This might be nice for those entrepeneurs looking to create a lifestyle business but it doesn't work for investors because they have to give money back to their investors in some reasonable timeframe--typically within 5-7 years. So for VCs and private equity investors, they need to believe that they will be able to convert a cash flow stream into a lump sum return within about 5-7 years. Multiples remind us what we can reasonably expect here. The great news is that while you may not be able to live high on the hog while you are building your business, you should be able to look forward to a time when you get a really nice payment.
So what are the limitations of multiples?
I may have to talk about this more later because I promised my wife I would go downstairs. However, here are my initial thoughts. Obviously multiples are not a full blown analysis. In fact, they are not even close. At VR, we use a multiples-based method due to the scarcity of data on the companies we are valuing. While they aren't perfect at all we do believe that they can give enlightening information about valuation ranges, industry /company valuation trends, etc. At the end of the day some form of comprables analysis will always be the critical foundation to any valuation of a private company.
Simple to use. One of the coolest things about multiples is that they are simply to use. It is often very hard to find the right multiples, but once you find them, they make valuing a company easy. VR makes finding them easy for you (http://www.venturereturns.com/company_komp_builder.php?newFlag=N&pType=5). Now, for example, let's assume you are interested in the value of a particular Saas (software as a service, like Salesforce.com) company. Saas multiples are really high right now--generally between 6-8x revenue and 30-40x EBITDA. This means that if you have a Saas company doing $5M in revenue, it could be worth up to $30-40M.
Multiples yield business insight. Multiples can actually teach you a lot about different businesses. For example, they can basically tell you what the value of $1 of revenue in one kind of business is worth versus the same amount of revenue in another business. Again, let's take Saas as an example. Let's compare Saas to hardware companies. Hardware companies are lucky if they can get 0.8-1.5x revenue multiples. The revenue multiples teach us that $1 of revenue in a Saas business is worth about $6-8 of hardware business. This can be instructive as entrepreneurs are considering business opportunities, as VC and PE investors are looking at deals, and as businesses are making investment decisions. I can promise you that any investor worth his or her salt will think carefully about multiples. Most big institutional investors only want to make investments where they can reasonably expect a chance of at least a $100M exit. For larger funds, this can be an even bigger number. For Saas companies, you could expect this kind of exit by generating $12-17M in revenue. For hardware companies, you could only expect this kind of exit by generating $100M in revenue. BTW, this doesn't mean that you shouldn't start a hardware company necessarily--you had just better realize that it brings a unique set of challenges. For a variety of reasons you may want to couple a software company with a hardware company (think Blackberry). This kind of thinking is also helpful when you think about strategic investment decisions in a company. I was recently talking with an entrepreneur acquaintance who does generates 20% of his business from a traditional enterprise software product and 80% from a Saas product. The enterprise software product has much longer sales cycles, costs a lot more to manage and deploy, and is a giant pain to maintain relative to the Saas product. I told him that I thought every dollar of Saas revenue was worth $2-3 dollars of enterprise software revenue and that I would seriously consider abandoning any future sales of enterprise software just to focus on the Saas business. Maybe I was wrong but multiples can clearly inform this kind of thinking.
Multiples generally point to a leveraged exit. One of the exciting things about multiples is that they remind us that modern finance has taught us that indefinate streams of cash flow can be equated to a lump sum payment now. Further, we know that the lump sum payment now is generally bigger than the cash stream. This fact sits at the foundation of modern entrepeneurship on both the early-stage and late-stage sides of the camp. Nearly all venture or private-equity backed investors and entrepreneurs are not interested in creating busineses that simply generate a healthy cash flow indefinately. This might be nice for those entrepeneurs looking to create a lifestyle business but it doesn't work for investors because they have to give money back to their investors in some reasonable timeframe--typically within 5-7 years. So for VCs and private equity investors, they need to believe that they will be able to convert a cash flow stream into a lump sum return within about 5-7 years. Multiples remind us what we can reasonably expect here. The great news is that while you may not be able to live high on the hog while you are building your business, you should be able to look forward to a time when you get a really nice payment.
So what are the limitations of multiples?
I may have to talk about this more later because I promised my wife I would go downstairs. However, here are my initial thoughts. Obviously multiples are not a full blown analysis. In fact, they are not even close. At VR, we use a multiples-based method due to the scarcity of data on the companies we are valuing. While they aren't perfect at all we do believe that they can give enlightening information about valuation ranges, industry /company valuation trends, etc. At the end of the day some form of comprables analysis will always be the critical foundation to any valuation of a private company.
posted by VentureReturns at
6:01 AM
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