Founders and investors often use multiples to establish the value of a company and compare it with its peers in the same industries.
However, not a lot data about private companies and fundraising is made public, especially valuations and multiples — which makes it hard to make comparison between different businesses. This is especially true for innovative high-growth companies, as they often operate in sectors that are still developing and expanding .
Public markets can provide useful metrics that allow us assess, value and understand private companies.
Among these, multiples can come in extremely handy to Founders and investors who need an approximate benchmark based on financial data such as revenue, profit or EBITDA.
Deriving a private company valuation by comparing it to public counterparts is not always a precise method. Because public businesses are typically more liquid, larger and less risky, start-ups valuations tend to incorporate a discount compared to public ones.
Valuation Multiples by Sector
What are valuation multiples?
Valuation multiples are financial measurement tools that evaluate one financial metric as a ratio of another, in order to make different companies more comparable.
Multiples analysis can prove a useful and quick tool to understand mismatches between a company’s performance and its competitors’. It is also useful to better appraise its strategic position in a sector, and gain insights into the main factors driving value in an industry.
To properly compare a company to their peers, Founders should look at those who compete in the same market, are subject to the same set of macroeconomic forces, and have similar growth and returns on capital.
Some of the most popular and widely used multiples are Enterprise Value (EV) over the trailing-twelve-months (TTM) Revenues and EV over TTM EBITDA.
Enterprise Value (EV) is a measure of a company’s total value. EV is the sum of a company’s market capitalisation, plus its total debt, minus any cash or cash equivalents.
Trailing Twelve Month Revenue
EV / TTM Revenue (sometimes referred to as EV / TTM Sales) is the ratio between the enterprise value of a company to its annual revenues (sales).
A lower EV/Revenue multiple indicates that a company is relatively undervalued.
Trailing Twelve Month EBITDA
EV / TTM EBITDA is the ratio between enterprise value and the earnings before interest, taxes, depreciation, and amortisation. The lower the multiple, the lower the valuation of the company.
Enterprise Value multiples are preferable because earnings ratios can get distorted by leverage.
Alex Bohtra and Zane Williams, two McKinskey senior experts, argue that corporate performance and multiples are inextricably linked. Companies that consistently deliver superior ROIC and revenue growth outperform their competition’s multiples.
Also, multiples vary significantly within different sectors, reflecting the diverse growth rates and profitability of different parts of the economy.
This means that there are no shortcuts to achieving higher valuation. For a business to hit the industry-average multiple, it must match the industry-average expected performance.
Executives can focus on driving growth, higher margins and greater capital productivity to improve the overall performance, which will lead to higher multiples.
Tech M&A in 2021
There is no overstating the case for how 2020 has expanded the role of technology, with most of our daily life moving online.
In a year dominated by a global pandemic, the tech industry made it through largely unscathed. In fact, Tech M&A spending in 2020 reached its highest since the dot.com collapse.
After a though first two quarters, the total value of tech M&A transactions reached $600bn by the end of 2020.
4 out of the 10 largest Tech M&A deals of 2020 involved CyberSecurity and TeleHealth companies, highlighting trends brought into focus by the pandemic.
While tech IPOs dipped at the start of the pandemic, they rallied in the second half of 2020, with 360 tech companies going public, up 33% from 2019.
Tech & SaaS Multiples in 2021
The SEG SaaS Index is comprised of 99 publicly traded software companies that primarily offer solutions via the cloud and / or through a subscription or transaction-based model.
After a difficult second quarter that saw deal volume dip to its lowest level since 2018, SaaS M&A volume reached record levels during the second half of 2020
Heighted demand for SaaS companies drove a breakout in revenue multiples.
After dipping in March, the median EV/Revenue multiple for public SaaS companies had a V-shaped recovery by May and climbed to new record heights. December’s 12.9x EV/Revenue multiple represents an 84% increase over the March trough.
On an annual basis, the SEG SaaS Index posted a record EV/Revenue multiple of 11.5x in 2020, notably two times greater than the 5.5x EV/Revenue multiple from 2016.
According to SEG, the top 25% of the SaaS Index reached a median EV/Revenue multiple of 35.8x, almost three times the Index median of 12.5x.
The companies in the bottom 25% are characterised by a low growth rate. They posted a median revenue multiple of 3.6x, less than a third of the Index median.
This shows just how much variance can be found in multiples based on growth and profitability standards of each sector. Because of that, multiples should be used with caution and always contextualised.
The median EV/EBITDA multiple also reached record heights, going from 51.9x in 1Q20 to ending the year at 77.4x.
As most of the public SaaS companies in the index had negative EBITDA, with a median margin of -0.2%, the EV/EBITDA multiples were calculated only based on profitable companies. Therefore, this metric is biased and should only be used as a benchmark for profitable companies.
The fact that such high multiples are achieved by loss-making companies, proves that the SaaS market continues to be incredibly in-demand and valued by investors.
Investors continue to prioritise growth over profitability in. Over the last three years, buyers placed a premium on SaaS companies exhibiting economies of scale.