Having said that, for technology or tech-enabled businesses (whether service or product companies), there are a number of key drivers of valuation that will impact a company’s value within those market comparable ranges. Below is a list of some of the key drivers for more mature tech or tech-enabled businesses (this excludes start-ups that are raising venture capital):
- Percentage of revenues that are recurring or re-occurring. Recurring revenue especially in the form of SaaS revenues are the gold standard in terms of attractiveness for investors. The higher the percentage of revenues that are recurring, the more a company’s valuation becomes a multiple of revenues rather than a multiple of EBITDA.
- Profitability or specifically EBITDA as a percentage of revenues. Companies that for example deliver 15% to 20% EBITDA margins are far more attractive than those that generate single-digit EBITDA margins. It’s also important to hit a certain critical mass to attract private equity investors. Most PE firms won’t buy a company unless it has at least $3M in EBITDA.
- A low customer concentration risk is important as investors don’t want a high percentage of a company’s revenues dependent on a handful of customers. A general metric is that no single customer should be greater than 20% of revenues and the top 4 or 5 customers shouldn’t account for more than 50%.
- Are the company’s revenues growing year over year or are they flat or declining? Similarly, investors put a premium on companies that are in a clearly growing industry rather than a declining industry based on the “a rising tide will raise all ships” premise.
- The caliber of management beyond the founder of a business is a key factor. A company needs to have a strong secondary management team beyond the founder(s) so that it isn’t dependent on one or two people. This of course also makes it easier for a founder to exit a business without a lengthy earn-out or other golden handcuffs.
- Future revenue growth potential is a big selling point. Acquirers are willing to pay a premium if they believe that there are untapped revenue streams that may come in the form of new products, technologies, markets, or distribution.
- Product/solution differentiation within a certain market segment can have a big impact on valuation. Nobody wants to buy a company that has a “me too” or commodity service or product. The more specific and defined a product is and the more differentiated it is from your competitors, the more compelling the growth story is for a company.
There are numerous other factors that also impact valuations but if your company scores high on the above metrics, it will definitely be at the top end of the spectrum in terms of valuations relative to your competitors.