Tell me what your startup is worth. I dare you.
There is no murkier exercise in business than figuring out the valuation of a company. This is especially true when the company is a startup.
5 Ways to Increase Your Startup's Valuation
- Chase revenue. The more revenue you generate, the higher the base valuation before applying the multiple.
- Focus on growth. The higher your year-over-year growth, the higher the multiple.
- Decrease reliance on finite resources. Valuations based on people and hours will use lower multiples.
- Get profitable. Profitability and EBITDA growth result in higher multiples at lower revenue.
- Find the right buyer. Be proactive about an acquisition, Don’t wait for it to come to you.
You can do a search for how you might value your own company, you can even ask ChatGPT, and I’d be willing to bet that you’d be overwhelmed with valuation methods and formulas that base company value on everything from revenue to EBITDA to social media followers.
I did not make that last one up, but please don’t use it.
I’ve sold companies that had little to no revenue at sky-high multiples. I’ve also run into brick walls trying to get an acquirer to value my company more than prior year’s revenue. It can drive you to distraction. And it can also lead a founder to make big financial mistakes.
As you might imagine, the only person who can tell you what your company is actually worth is the person writing the check to buy your company.
But let’s figure out a better answer.
Looking for a Big Exit
I got a great question from a founder whom I would already call successful. They’ve built a lot of automation, so they have a small team. They have valuable proprietary IP. They operate on a subscription model, so they know their CAC and LTV and can forecast growth relatively accurately.
They will generate $1.5 to $3 million this year on greater than 50 percent margins. They believe they can grow at least 50 percent year over year over the next three years. At that point, the founder, who has been doing this for a while, wants to sell.
One problem. Even though the company seems to be printing money, they don’t want to get lowballed on the multiple.
“I see so many variations from 4x being high to 8x being super, but then I see companies publicly trading at 40 to 80x, so it’s a little confusing. Everyone I ask has a very different answer. It seems like it’s just a crapshoot as to how strong the economy is, whether acquirers are in buying mode or not, and if the acquirer is buying for income or growth. At this point, all I know is if I have a solid business that runs without me and makes crazy money. I will for sure get 4x revenue, but how do I get 8x or 20x?”
My answer is: Yes. You’re right about all of that. So let’s take a breath.
Why and When Do You Want to Sell?
Just to be clear, this is not financial advice and it’s based only on my own experience. You’ll want to engage with an attorney who specializes in M&A at some point, and a good one will have more data than just my data.
My first thought is the obvious one: Why do you want to sell?
I don’t mean to get into your personal life, and I’m sure you have a valid reason, but from what you describe you sound like you’re running a business that’s a perpetual motion machine and doesn’t take a lot of your time. So I ask because if you’re not being forced or pressured to sell, you’ll want to put together a timeline.
When founders come to me and say things like, “I need to sell my company right now,” I’m like, “You’re kinda screwed.”
This is because the primary factor in getting to your valuation — beyond all the formulas and multiples — will be your leverage position when you sell. If you don’t have to sell, you have more leverage, and ideally, you’ll want to be on the radar of several potential acquirers so you can use that leverage to get a better price.
When I sold ExitEvent, a startup networking and information source, back in 2013, it was very much a public-facing entity. I was waving away acquisition interest almost from the beginning. So when I did decide to sell, a decision I made to be able to spend all my time working on a much bigger startup play, I already had a group of four potential buyers I could go to. Two of them turned out to be serious, one of those turned out to be perfect.
It still took about four months of negotiation and another two months of lawyering.
So the timeline should start now.
What Deserves Higher or Lower Multiples?
In my experience, most acquirers will use last year’s revenue as a baseline. But what they are mainly looking for in terms of a multiple is year-over-year (YoY) growth, and the number they’ll fixate on is 100 percent.
In other words, you want to be doubling revenue every year. Now, this is usually a standard for pre-profit or pre-EBITDA companies. Once the company becomes profitable, it makes sense to forecast revenue growth at less than 100 percent — still high, mind you, but less than 100 percent. Instead, you’ll want to be pushing to grow EBITDA at 100 percent or more.
And yeah, the valuation multiple is going to be all over the place. There are a few standard guidelines.
Obviously, the earlier the company, the higher the multiple on revenue, but that’s just due to math, It doesn’t mean more overall money into the transaction. If my revenue is $1,000 per year and I sell the company for $20,000, that’s a 20x multiple.
Service-based companies rarely sell for more than 2x to 3x revenue, and if the company is not plain killing it, it’ll be more like 1x. This is because the valuation is based on the output of people and their time, which are finite resources, as opposed to IP, which is less finite, though not infinite. The lower multiples are also usually a case of the acquirer not being sure that 100 percent of the customer base will remain or re-up when ownership changes hands.
IP Is Critical
It’s almost always the IP that’s baked into software or otherwise technical companies that get them into that 10x to 20x stratosphere, but there are often other industries where a 20x multiple is not shocking, including professional/financial information services, like the founder’s company. Basically, almost any company with a hefty amount of IP and a proprietary software component can get into that range.
The “whims of the acquirer” you’re feeling is probably just the residual effect of applying a market multiple. In other words, acquirers (and investors) do indeed look at recent transactions for companies that look as much like your company as possible and try to apply the same valuation. It’s not a lot different than real estate transactions and comps, and can be affected by the health of the macro economy, the industry or market economy and the acquirer’s own plans and tolerance for risk.
But all of those are guidelines, because you’re going to get what someone is willing to pay.
Settle on a Number, Build Your Leverage
You say you want to scale to $6 million to $12 million, which is roughly three to four times the revenue you’re forecasting for this year. If you can scale like that over three to four years and maintain those high margins — which is not automatic, in fact far from it — then it feels like you’ve got some time to explore what your exit might look like.
Start your timeline now and build up your leverage.
ExitEvent was my own self-founded, self-funded startup, a lot like yours. And because I was also working on a bigger startup play at the time, I built ExitEvent to be mostly software self-sufficient, just like your company. ExitEvent was still very early when I decided to sell, but like I said, that was because I needed to focus solely on the other startup.
But that proactive selling decision was easy to make because I already had a couple potential acquirers poking around. I did nothing to attract them, but you can give yourself a multi-year timeline to find them and get them interested.
What About That Multiple?
ExitEvent sold for around 10x prior 12-months revenue, although on a smaller annual revenue number than what you’re looking to get to.
I mean, to me, 10x for your type of business (or my own) seems to be a good benchmark. When you get to $6 million in revenue, you should ask yourself: Does this potential acquirer have $60 million they could spend to buy my company? Could I push them to $120 million? Do they have the resources and the will to realize an outsized return on that investment?
A lot could happen over the next three to four years. If you achieve that $12 million in revenue, you might get offered $18 million or you might get surprised by $200 million, maybe as a cash and stock mix.
So in your case, I’d probably use 10x as a loose benchmark and not spend a lot of time honing in on an exact number until you start that process of researching and reaching out to potential acquirers — now — and eventually start hearing floater offers.