Valuations are Prices: How to Price a Startup
Every week a lot of people are asking us the same question (And also internally we are discussing this question quite heavily): How can you tell the valuation of an early-stage startup? Especially business students coming straight from uni are very into this question as their VC course told them a lot of stuff on how to value a startup and now they want to see if this models are working in the real world. The answer is No in most cases.
The first thing that is important to consider that we think it is not about valuations — it is more about pricing. There are no real assets. There is no real discounted cashflow as everything is unstable and the business can change every 6 months. So a lot of classical valuation methods do not work in an environment where making a loss is the norm rather than an exception. Therefore we like to call it pricing. The above picture tells you something important — your startup is like a burger and has a price tag attached to it. But how do you know which price tag you have and what you can go fundraising with?
In the very early days of Pre-Seed and Seed investments this depends a lot on supply and demand or as we call it „FOMO“ among investors as well as on negotiation skills of the founders. But the more mature the company gets the more numbers driven the whole business gets. Therefore I want to talk about one framework I came up with based on a lot of theories, research and different blogposts.
The equation
The foundation
The underlying base of the equation is the forwarded revenue (ARR in case of a SaaS business or eg. GMV in case of E-Commerce — this does make a difference as the multiples you are working with later on do already reflect this). You use the forwarded revenue as you are interested in the future growth potential of the company and not really the past performance. Normally you are taking the next 12 months or the runway for the desired round, which in a lot of cases is not more than 12 months anyway.
Multiple
The next step is to multiply the foundation with the underlying revenue multiple for your industry. Therefore we take the median of comparable public listed companies — Or private multiples (if they are available) that are already adjusted for risk and illiquidity compared to public listed companies.
Many of you will ask now: Why you do not take the pricing of similar startups? This would make sense yes but in most cases you do not have enough and accurate data you can work with. But does using public multiples sense for private startups?
Hmm, Yes and No. In a way it is not really considering the special situation of high growth private companies but at the same time it is the only credible source you have out there. There are not 40 private deals in your sector where your are aware of revenue and Ebitda multiples and their past post-money valuations. And if the underlying dataset is bulls**t then so probably is the rest. Garbage in — garbage out.
So take the public multiple as your anchor.
As an example you can us the Bessemer Cloud Index as a data provider for SaaS multiples (SaaS is a anyway a very good example as most research around startup valuations is about SaaS). And also trust investment banks as they are getting loads of money and having big teams doing fancy reports.
The factor
The factor now does make the difference if you are under- or outperforming the public median multiple — and is the result of a lot of different subfactors.
For example:
1. Customer total and Growth rate MoM
2. Revenue total and Growth rate MoM
3. Burn / Capital Efficiency
4. Region
5. Management Team
6. Gross margins
7. Unit economics
8. Competition
X sector specific KPIs like churn rate or average basket size etc.
Those subfactors are industry agnostic. In addition to that it makes sense to add sector specific KPIs like churn rate or average basket size. These subfactors in total will drive your factor that has an influence on your price tag (1 -/+ X). So how do these influence now your factor and therefore your price tag? And which factors are the biggest value drivers?
Basically that is the big question mark. If you know the answer please tell me. Growth is always a good guess. Good margins are not bad either. There is one rule of thumb: if you are better than the average then it influences the factor in a positive way — if you are worse then the effect is a negative one. Fair and square. But you don’t know the market data and therefore it is getting tricky again.
This is therefore also the point where you can start arguing with potential investors (as they also in most cases don’t know the market data) because you cannot argue about revenue or multiples. So why is your price tag higher than average? Maybe because you are in a SaaS subsector that currently is superhot and multiples are better than average ones. Or maybe because your growth rates are high and your margins even higher. Come up with good, credible answers and sell them consequently.
Example
Company Awesome Ltd., a very cool SaaS startup based in Berlin raised EUR 3M @ 10M pre-money and therefore has a post-money valuation of EUR 13M. At the time of the last investment Awesome Ltd. had a forecasted ARR of EUR 1.5M for 2017. According eg. to the Bessemer Cloud Index the current Revenue median for SaaS is 5.8.
So the market price should be somewhere around 10M. Now we can assume why Awesome Ltd. raised at a post-money of 13M and is overperfoming the market. This can be the sub-sector, the team, the growth rate, etc. Now the KPIs who are determining your factor are kicking in. And this is where it gets tricky and we don’t have a clear answer.
We did this whole exercise with our portfolio of around 60 companies. And to our surprise it was pretty, pretty accurate! And also in a lot of cases we knew why some companies are overperforming market data. Especially the more later stage the company gets the more exact these numbers are.
This is how a snapshot of our later stage Portfolio looks like (of course without giving you exact numbers ;)).
What are the problems of this equation?
- Time horizon of the forecasts and accuracy
- Lack of data
- Different sub-sectors with different multiples
- Short „hypes“
- Not enough public listed companies in a specific sector
Conclusion
If you go fundraising (or investing) keep in mind that those frameworks, KPIs and multiples are existing and that numbers are important. In our industry a lot is based on fairy dust — but good investors are numbers driven (also when they don’t tell you)! Therefore do your homework.
If you are investing ask yourself: Do I get a relevant return on my cash investment? This depends a lot on a specific sector and future multiples in specific sectors. This means be ahead of the trend as you want to exit your investment within the next 5–10 years.
And because you cannot change the market — even your best founder team cannot (But they might can create a totally new market — but that’s a different story). For example the glory days of E-Commerce are over as multiples are moving towards the corridor of 1X -1.5X GMV -and in some cases lower than 1.
The next step for us is to go deeper in that equation and examine what factors are driving the value more than others and what a startup has to fulfil to do a proper fundraising round with professional later stage investors. We will also keep tracking our own portfolio to get a better insight into the real value drivers. So research basically just started.
To come to an end — I would be very happy to receive feedback and get your assumptions, conclusions, input etc. Anything from this is absolutely bullshit to I know the answer and say the factor is 1.25 (always)!
Messages to: andreas@speedinvest.com
Very interesting readings related to this:
http://aswathdamodaran.blogspot.co.at/2016/10/venture-capital-it-is-pricing-not-value.html
https://techcrunch.com/2016/10/07/determining-the-worth-of-your-saas-company/
https://25iq.com/2017/02/17/a-dozen-lessons-about-productmarket-fit/
https://de.slideshare.net/03133938319/numbers-that-actually-matter-finding-your-north-star
