Understanding Valuation Multiples

Valuation can feel like black magic. But there's actually a method to the madness. Here's what really drives company valuations.

The Basics

Valuation multiples express company value relative to a financial metric:

• Revenue multiple: Value / Annual Revenue
• EBITDA multiple: Value / EBITDA
• ARR multiple: Value / Annual Recurring Revenue

SaaS Valuation Framework

Base Multiple: 5x ARR

Add for:

• Growth >40% YoY: +2-3x
• Net revenue retention >120%: +1-2x
• Gross margin >80%: +1x
• CAC payback <12 months: +1x
• Enterprise customers: +1-2x

Subtract for:

• Growth <20% YoY: -2-3x
• High churn (>5% monthly): -2x
• Gross margin <60%: -1x
• Customer concentration: -1-2x
• Founder dependency: -1x

Example: $2M ARR company

• 50% YoY growth: +2x
• 110% NRR: +1x
• 75% gross margin: +0.5x
• Total multiple: 8.5x
• Valuation: $17M

E-commerce Valuation

Base Multiple: 3x EBITDA

Add for:

• Strong brand: +1x
• Recurring revenue: +1x
• Owned inventory: +0.5x
• Multiple channels: +0.5x
• International presence: +0.5x

Subtract for:

• Platform dependency: -1x
• Commodity products: -0.5x
• High returns rate: -0.5x
• Seasonal business: -0.5x

Service Business Valuation

Base Multiple: 3-4x EBITDA

Add for:

• Recurring contracts: +1x
• Low client concentration: +0.5x
• Proprietary methodology: +0.5x
• Strong brand: +0.5x

Subtract for:

• Key person dependency: -1x
• Project-based work: -0.5x
• High client concentration: -1x

What Really Drives Value

1. Growth Rate Nothing matters more than growth. A company growing 100% YoY can command 2-3x the multiple of one growing 20%.

2. Predictability Recurring revenue is worth more than one-time sales. Buyers pay for predictability.

3. Margins High gross margins indicate pricing power and scalability. Aim for >70% for SaaS, >40% for e-commerce.

4. Market Size Bigger markets support higher valuations. $100M market caps your upside.

5. Competitive Position Clear differentiation and defensibility command premium multiples.

6. Team Quality Strong management team reduces buyer risk and increases value.

Strategic vs. Financial Buyers

Financial Buyers (PE Firms)

• Focus on cash flow
• Lower multiples (3-6x EBITDA)
• Want proven business model
• Optimize for returns

Strategic Buyers (Companies)

• Focus on strategic fit
• Higher multiples (5-10x+ revenue)
• Value synergies
• Pay for growth potential

Improving Your Multiple

Short-term (3-6 months):

• Clean up financials
• Improve key metrics
• Document processes
• Build data room

Medium-term (6-12 months):

• Increase growth rate
• Improve margins
• Reduce churn
• Diversify customer base

Long-term (12-24 months):

• Build strong brand
• Develop competitive moats
• Expand market opportunity
• Build management team

Common Valuation Mistakes

Overvaluing

• Using peak multiples from 2021
• Ignoring market conditions
• Not accounting for risks
• Comparing to different business models

Undervaluing

• Using only EBITDA for high-growth business
• Ignoring strategic value
• Not considering market timing
• Underestimating IP value

The Reality Check

Valuation is part science, part art, and part negotiation. The "right" valuation is what a buyer will pay and you'll accept.

Focus on building a great business with strong fundamentals. The valuation will follow.