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What are revenue multiples?
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How are revenue multiples calculated?
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What factors affect revenue multiples?
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What are the pros of using revenue multiples?
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What are the cons of using revenue multiples?
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What are some alternatives to using revenue multiples?
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Here’s what else to consider
If you're running or investing in a start-up, you might have heard of revenue multiples as a way to value a business. But what exactly are they, and what are their advantages and disadvantages? In this article, we'll explain what revenue multiples are, how they are calculated, and what factors affect them. We'll also discuss the pros and cons of using revenue multiples to value a start-up, and some alternatives you can consider.
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- Kishore Dasaka I help business owners make informed financial decisions for long-term success | Entrepreneur | Fractional CFO 🚀 |…
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- Dan G. Head of Insights at Equidam, the Startup Valuation platform | Crunchbase contributor
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1 What are revenue multiples?
Revenue multiples are a type of valuation metric that compare the market value of a company to its annual revenue. They are often used to value start-ups that are not yet profitable or have high growth potential. Revenue multiples are calculated by dividing the market value of a company by its annual revenue. For example, if a company has a market value of $100 million and annual revenue of $10 million, its revenue multiple is 10x.
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- Dan G. Head of Insights at Equidam, the Startup Valuation platform | Crunchbase contributor
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Revenue multiples are a short-hand way to compare the valuation of similar companies (same industry, same business model) by revenue performance. In recent years, revenue multiples have been applied as a method of valuing companies - for which they are deeply inappropriate. They are, in the best case, a practical way to calibrate a valuation to the market conditions at that time. Revenue multiples fail as a valuation method on two counts: They fail to look at the subject company with any meaningful resolution, due to the focus on comparison.They rely on finding suitably similar companies which is challenging in a market where companies are unconventional by nature.
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**Pros of Revenue Multiple Approach:**1. Simplicity & Transparency2. Ideal for Early-Stage or High-Growth Companies: Particularly advantageous for startups or firms poised for rapid revenue expansion3. Facilitates Industry Comparisons: Allows for straightforward benchmarking against similar companies within the industry4. Emphasis on Top-Line GrowthCons1. Neglects Profitability & Costs: Overlooks crucial aspects like expenses, profitability, and operational efficiency2. Excludes Non-Revenue Metrics: Fails to account for vital indicators such as customer retention, market share, and competitive positioning3. Doesn't Address Inconsistent Growth Patterns4. Subject to Industry Variances
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- Kishore Dasaka I help business owners make informed financial decisions for long-term success | Entrepreneur | Fractional CFO 🚀 | Chartered Accountant 💰
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Revenue multiples are a benchmarking technique, where you value your startup based on the multiples of similar startups in your industry. The key here is to find startups that operate in the same industry, geography, serving the same customer, and possibly at the same stage of growth.Using revenue multiples are one of the best ways of valuing early stage startups, which are not yet profitable, and where other methods like DCF do not work (since cash flows aren't predictable)
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Here are some of my pros and cons of using revenue multiples to value a startup:Pros:Simple and easy to use: Revenue multiples are easy to calculate and understand. Useful for comparing similar companies: Revenue multiples can be helpful when comparing similar companies in the same industry.Considers future growth potentialCons:Doesn't consider profitability.Doesn't consider the company's unique characteristics: Revenue multiples do not take into account the unique characteristics of the company, such as its brand value or intellectual property.Can be unreliable for startups: Revenue multiples can be unreliable for startups, as they may not have a consistent revenue stream.
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- Joe Reevy Retired business guy and chartered accountant. Nonconformist, rational, creative. I help good people. Built businesses on a shoestring and sold. Not a softie. Exceedingly intelligent. Ethics before gain...always.
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Revenue multiples ignore the potential scale of the market. I'd value a business more highly which has low current income with a large potential market than one with more revenue now whose potential future market is smaller.
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2 How are revenue multiples calculated?
Revenue multiples can be calculated using different sources of market value and revenue data, such as market capitalization, enterprise value, and revenue. Market capitalization is the total value of a company's outstanding shares on the stock market, and is the easiest way to calculate revenue multiples for publicly traded companies. However, it can be volatile and influenced by market sentiment. Enterprise value is the total value of a company's equity and debt, minus its cash and cash equivalents, making it a more comprehensive way to calculate revenue multiples for both public and private companies. Revenue is the total amount of money a company generates from its sales or services, which can be based on historical, current, or projected figures depending on the stage and growth rate of the company.
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Often revenue multiples for start-ups are determined using 'comparable' businesses - businesses that address a similar market, or have a similar value proposition or solution.But keep in mind that early stage valuations are more of an art than a science, and as the paragraph above mentions, fluctuate wildly based on current market conditions.
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- Kishore Dasaka I help business owners make informed financial decisions for long-term success | Entrepreneur | Fractional CFO 🚀 | Chartered Accountant 💰
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✅ Stick to the Basics: Revenue multiple is a valuation metric. It is calculated by taking the company's current valuation and dividing it by its current or estimated revenue. It's essentially an answer to the question: "How many times the revenue is someone willing to pay for a company?"✅ Look at Comparable Companies: To find an appropriate revenue multiple, look at the multiples of similar, publicly traded companies in their sector. This gives a ballpark figure, but the catch is that, established companies may have different trajectories and risk profiles than startups.✅ Adjust for Risks: High-growth startups might command higher multiples due to their growth potential. On the contrary, more risk could reduce the multiple.
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Calculating revenue multiples is both subjective and precise in nature. As the multiple is an indicator of future earnings or revenue, one has to make assumptions about how much the business is going to grow. The more traction + scalability in a business model suggests a higher revenue multiple, whereas slow growing businesses tend to get lower multiples. Benchmarking using comparables is another way of obtaining a revenue multiple, what other companies have achieved multiple using a similar business model within the same space with similar metrics.
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3 What factors affect revenue multiples?
Revenue multiples can vary significantly depending on the industry, market, and growth stage of a company. Factors such as profitability, growth potential, and competitive landscape of an industry can affect revenue multiples. For example, software companies generally have higher revenue multiples than manufacturing companies due to their higher margins, lower capital requirements, and scalability. Additionally, the size, demand, and attractiveness of a company's market can also influence its revenue multiple; a company that serves a large, growing, and underserved market will likely have a higher revenue multiple than one that serves a small, saturated, and competitive market. Furthermore, the stage of development and growth of a company can also affect its revenue multiple; a start-up in the early stages of product development and customer acquisition can have a higher revenue multiple than a mature company that has reached its peak growth and profitability.
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For me, four factors influence the revenue multiple paid:- revenue growth (double or triple YOY growth percentage)- Gross profit margin today- expected EBITDA profit margin when it materializes- market competition today or expected market entrants in the future
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4 main factors: Market sentiment: is the industry on a high growth trajectory?Quality of revenue: ideally, scalable recurring revenueAssets: possessing difficult to replicate assets (such regulatory approvals) Revenue growth: 20% + YoY
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4 What are the pros of using revenue multiples?
Using revenue multiples to value a start-up has some distinct advantages, such as simplicity, relevance, and flexibility. These multiples are easy to calculate and understand, as they only require two data points: market value and revenue. They are also widely available and comparable across different companies and industries. Moreover, they are relevant for start-ups that are not yet profitable or have negative cash flows, as they focus on the top-line growth potential of the business. Revenue multiples can also be adjusted to account for different scenarios and assumptions, such as using different sources of market value and revenue data, or applying different discounts or premiums based on the risk and opportunity of the business.
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- Kishore Dasaka I help business owners make informed financial decisions for long-term success | Entrepreneur | Fractional CFO 🚀 | Chartered Accountant 💰
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✅ Simplicity: Unlike some valuation methods, using revenue multiples is fairly simple. No need to dive deep into financial projections (which are subjective). Just look at your current revenue, slap on a multiple, and you've got a valuation! Especially useful when you're in early-stage talks with investors or partners.✅ Benchmarking: Many sectors have established revenue multiples. Startups can easily compare themselves to peers, understanding where they stand in the game of valuation. This helps when negotiating with investors or assessing market position.✅ Focus on Growth: For startups, it's often about top-line growth. Revenue multiples encourage this perspective, rewarding those who can scale fast and efficiently.
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5 What are the cons of using revenue multiples?
Using revenue multiples to value a start-up also has some disadvantages, such as not reflecting profitability, efficiency, or sustainability, as well as the variability and relativity of multiples. Revenue multiples do not take into account the costs, expenses, or cash flows of a company, nor the quality, diversity, or retention of the revenue streams. Additionally, they are highly dependent on market conditions, industry trends, and growth expectations. Furthermore, external factors like investor sentiment, market hype, or regulatory changes can also have an effect. Lastly, revenue multiples are relative measures of value that depend on comparison with other similar companies or industry averages and can be inaccurate if the comparable companies or industry benchmarks are not relevant, reliable, or consistent.
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- Ben Littauer (he/him)
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I'm a Boston-based seed stage investor. At the stage I invest there are often no revenues, so multiples end up being zero. Not a great metric. And basing off projections is highly dependent on the aggressiveness of the entrepreneur. Anyone can show $1B in revenues in 10 years, but believably? I prefer the term "price" to "valuation" in any case. It will be based on the investor's perceived risk and perceived reward, and will be compared to other companies with similar profiles. It is thus a market-dependent number, as can be seen in the higher "valuations" seen in Silicon Valley than in the Northeast. The best way for an entrepreneur to price their deal is by talking to a lot of investors and getting their feedback.
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As a saas, seed-stage startup CEO turned Chief Growth Officer:-market-driven vs. venture-driven-susceptible to economic trends-susceptible to geopolitical conflicts-forces you to "think like" a venture capitalist/investor-yet you are not a startup fund, usually-FOMO drives revenue multiples up - regardless of whether they "should" or "shouldn't." (everyone ends up being human)-90% of startups fail, and most of the original "projections" you built, will become useless.-Growth > Rev. VCs will "fund growth" (even if you're not profitable)-tacking on someone else's business model on top of yours -fulfilling the vc model on top of your own tend to create conflicts, and expand opportunities for misalignment/poor communication
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- Ben Littauer (he/him)
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In addition, be aware that pricing your round too high comes with the peril of a down down following, which does nobody any good.
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- Kishore Dasaka I help business owners make informed financial decisions for long-term success | Entrepreneur | Fractional CFO 🚀 | Chartered Accountant 💰
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✅ Profit Insights: Revenue is not equal to profitability. High revenue with massive losses? Well, that's a red flag according to me. Focusing solely on revenue can overlook underlying financial issues.✅ One-Size Doesn’t Fit All: Different industries have revenue multiples. Using a generic multiple might not reflect a startup’s actual value within its specific sector.✅ Pre-Revenue Startups: Valuing pre-revenue startups can become extremely challenging (or rather impossible) when using a revenue multiple. So, for most early rounds (seed, pre-seed), this method becomes useless.
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Revenue multiples can be a preliminary way to get a ballpark valuation for start-ups. They are usually significant in industries when the cost of production (COGS) is either altogether standard or marginal.However, they fail to take into consideration any risk factors: if we look at Fintech in particular, then assessing risk is paramount. Revenue multiples are seldom the basis for an M&A transaction: when merging with a strategic buyer, you may look a past transaction multiples to give you a rough indication of the possible valuation range. In Fintech, other multiples can be more effective, particularly when valueing B2B start-ups.
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6 What are some alternatives to using revenue multiples?
Revenue multiples are not the only way to value a start-up; there are other methods that can supplement or complement it. Discounted cash flow (DCF) estimates the present value of future cash flows, based on its projected growth rate, discount rate, and terminal value. This method is more comprehensive and accurate than revenue multiples, but it requires more assumptions and inputs. Alternatively, earnings multiples compare the market value of a company to its profits or earnings, such as EBITDA or net income. This method is more relevant for start-ups that are profitable or have positive cash flows; however, it can be distorted by accounting policies, non-recurring items, or capital structure. Additionally, depending on the industry, market, and business model of a start-up, there may be other metrics that can be used to value it, such as user base, customer lifetime value, gross margin, or unit economics. These metrics can provide more insight into the performance and scalability of a start-up; however, they may not be comparable or standardized across different companies or industries.
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- Kishore Dasaka I help business owners make informed financial decisions for long-term success | Entrepreneur | Fractional CFO 🚀 | Chartered Accountant 💰
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It depends on the stage in the startup lifecycle. In early and pre-revenue stages, its best to go for a convertible, and postpone the game of valuation. According to me the best time to use a revenue multiple is when a decent level of product-market fit, and predictability has been achieved.The best alternative is the DCF approach. This method estimates the value of an investment based on its expected future cash flows. For startups, it can be a more comprehensive look than just revenue, but predictions can be challenging due to their volatile nature. This method is especially relevant today in the era of "find the path to profitability" vs the earlier mantra of "grow at any cost"
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7 Here’s what else to consider
This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?
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- Randy Ridley Executive Product and Services Sales
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My start up experience suggests that tracking initial marque customers is the gateway to understanding the value of early stage start ups.
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- Marc Kitten
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(part 1)I would propose an alternative perspective, linking the metric to the maturity of the business, as I do in my valuation classes.Early on, there is just no basis for forecasting profits, when the business is just starting to have revenue. At that stage, there is no reasonable alternative, and even the revenue multiple must carefully leverage the choice of comparables which should be at a similar stage.At the other end of very mature and stable businesses, nothing can be as precise as the P/E ratio, but it still benefits from adjustments for risk, growth and payout ratio.
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- Reza Jafari
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In my experience, the revenue multiple should include the ecosystem that the startup has created and currently serves as an active member of that ecosystem. The contribution of the startup and the allocated benefits can translate into the potential growth and future opportunities towards profitability.
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- Marc Kitten
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(part 2)In the middle... one tries to find a compromise between the precision of the profit metric and its volatility / difficulty to predict it. In this middle stage, there is a good incentive to decouple the financing and the long term investments from the operational performance, hence the preference for the EBITDA multiple in most segments of Private Equity.In most cases, you should still try to analyse the results of as many relative valuations as possible as one of them may return an interesting signal
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