Morning Report: Private tech companies command far higher revenue multiples than public tech companies. It’s an odd situation given that the latter are liquid while the former are decidedly not. What’s going on?
According to Bessemer’s State of the Cloud 2018 report (here), startups are not only able to command revenue multiples (a valuation derivative) far higher than their public counterparts, but the trend is actually re-accelerating.
Indeed, as the following chart from the report shows, 2017 brought a sizable rebound in the amount of money that private investors are willing to pay for present-day startup revenue. Here’s Bessemer’s chart:
Now annual recurring revenue (ARR) is a good thing for a company to have. Recurring revenue is more predictable than non-recurring revenue, so investors are sometimes willing to pay more for it than other types of top line. But if investors in public companies are willing to pay around six times ARR, why in the flying heck would private investors be willing to pay nearly three times that much for private company ARR? (Recall: private companies are illiquid investments.)
The simple answer is that they don’t, or at least not really. Instead, private investors are buying future ARR, looking at a combination of base (current) ARR and growth. So private companies that have higher growth rates against their current ARR can likely command a higher revenue multiple than their slower-growing compatriots.
There’s nuance here (CAC payback periods, gross margin expansion or compression, LTV, and other various acronyms that are really mere revenue quality metrics), but in short, growth is what makes that 15.9 number is perhaps less bonkers than it looks at first read.
As you might imagine, Bessemer, having a vested interest in other people eventually buying the companies it funds, finds this argument compelling.
15.9x Is Only Partially Crazy
What happens when you take the private ARR multiple and divide it by the growth rate of the companies in question? You get what Bessemer calls ARRG (they make various pirate jokes, which we can avoid), or annual recurring revenue, divided by growth.
By this rather adjusted figure, valuations look a bit saner. The following Bessemer chart shows the revenue multiples we examined before, with an additional set of results added. In the image, the green line is private company ARR multiples, divided by growth:
Parity is reached when we compare the green line and the public results (blue).
The gambit at play here is that Bessemer doesn’t show the public company ARRG line in the example. Only comparing private ARRG to public ARR is a bit non-GAAP for my tastes.
What might be fun would be to show the gap between private ARRG and public ARRG multiples.
But the argument makes directional sense. It is reasonable to keep in mind the far-higher growth pace that private companies can post compared to their public counterparts when valuing their present-day revenues. So long as that growth remains possible (which is easier than normal in our current expanding economy), the bet that investors are making today may pay off tomorrow.
But what if everyone is overpaying?
Enter The Bad News
In what is rapidly becoming a favorite post of mine, USV’s Fred Wilson wrote about revenue multiples for SaaS companies back in 2011. He argued for somewhat conservative revenue multiples for both private and public SaaS companies, but with a discount on private companies instead of a premium.
As I am sure we have quoted before, here’s the key paragraph:
If you have a SAAS business, then your company’s valuation should roughly be 5x this year’s revenues and 4x next year’s revenues. These are for public companies. Investors will typically take a 20-25% discount for private company valuations because private company investments are not liquid. So maybe 4x this year’s revenues and 3x next year’s revenues is an appropriate multiple for a privately held SAAS business.
Now 2011 was a far cry from 2014 and 2015, when things got quite hot out in the SaaS world. The market calmed down later, as we saw above. But both private and public SaaS multiples are still far above what Wilson considered reasonable previously.
We’ll know more about what is reasonable when the correction finally forms. But for now, private investors are buying heaps of future growth at inflated present-day prices.
Something to keep in mind.
Illustration: Li-Anne Dias
From The Crunchbase Daily:
- Some unicorn valuations just keep going up. The latest is China’s Ant Financial, which is reportedly planning to raise up to $5 billion in fresh funding at a valuation of over $100 billion. The financing would put the online payments giant one step closer to a hotly anticipated IPO.
- B Capital Group, the VC firm launched by Facebook co-founder Eduardo Saverin, has closed on $360 million for its first fund, which invests in spaces including healthcare, fintech, and consumer-facing technologies.
- Apparently $121 billion isn’t enough. Qualcomm’s board of directors has issued a statement saying that they are turning down Broadcom’s bid, the largest tech acquisition offer in history, because they believe it undervalues the company.