The revenue multiple, or in other words the ratio of a company’s valuation to its revenue, is a commonly used metric to value startups. The reason is that most startups have negative EBITDA and net income, so it isn’t possible to value them based on these metrics.
However, it isn’t possible to simply take one company’s revenue multiple and directly apply it to value another company.
Specifically, different companies demand valuations which reflect different revenue multiples. The reason for this is that a company’s revenue multiple is driven by numerous factors. The most important of these are:
- The company’s growth rate: Companies that are growing faster command higher revenue multiples. Since it’s easier to grow fast off of a small base, earlier stage companies tend to command higher revenue multiples than later stage ones.
- The size of the company’s addressable market: Companies targeting larger addressable markets have more room to grow their revenue by capturing more of their addessable market. As a result, they command higher revenue multiples than companies targeting smaller addressable markets.
- The company’s margin structure: Companies with superior margin structures (higher gross margins, contribution margins, EBITDA margins, net income margins, …) will have more money left over from each dollar of revenue that they make. They will therefore command higher revenue multiples. Although most startups have negative EBITDA and net income margins, many have positive gross and contribution margins. It’s therefore possible to value them based on gross margin and contribution margin multiples, which are better reflections of the fundamentals of the business than the revenue multiple.
- The company’s long-term defensibility: Companies with business models that are difficult for competitors to challenge will be able to retain their revenues and profits for longer periods of time in the future, and will therefore command higher revenue multiples.
Also published on Medium.