Is it possible for a startup to process healthy revenues — perhaps 10s of millions — but not receive a valuation that is premium? If so, why?

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JASON LEMKIN

Valuations are way, way, all over the place.

Let’s step back. A “traditional” acquisition, in a traditional non-tech industry, with low growth and high profits … is generally valued as a small multiple of profits. Say 2–3 years of profits. That’s it.

If you think about it, that makes sense.

I buy your slow growing woodworking business. It makes $100k a year in profits. I pay $300k for it, all my life savings. After Year 3, I’m in the black as the acquirer, and finally get to make $1 from this business. That’s the world of traditional cash-flow based, slow growth acquisitions.

It makes sense.

The rest of M&A is confusing.

The faster you are growing, the higher a multiple of today’s profits an acquirer can pay. But maybe only up to 5–10x profits.

OK so let’s be clear. Your start-up is basically worthless as a multiple of present or realistically, future profits. You have no profits and no real hope of any profits in many cases. And even if you are cash-flow positive, it usually isn’t all that much cash. Usually you’d be lucky to be worth 1x revenues in the abstract.

So what are you worth?

Well, the good news is, in tech, most of the acquirers themselves have healthy multiples:

If they want to buy something, they are generally OK paying an “accretive” price (at a lower multiple) for almost anything they really want to buy.

And they are generally OK paying a higher multiple for higher growth, if they are buying an established startup for revenues.

E.g., if the acquirer trades at 5x revenues and is growing 20% YoY, and the startup is at $5m ARR growing 150% YoY, a 10x or eveb much higher multiple is relative easy for an acquirer to pay.

And if the acquisition is about fixing a big hole, a big problem in the acquirer, the acquirer will often pay a % of its total market cap equal to that hole. E.g., Facebook paid 10% of its entire value to buy WhatsApp.

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Published on May 18, 2016
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