Tag Archives: Defensibility

The drivers of revenue multiples

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:

  1. 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.
  2. 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.
  3. 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.
  4. 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.

Global IT companies, avoiding trends, and defensibility

In this recent interview, Peter Thiel of Founders Fund makes several important points that I agree with:

  1. Successful IT companies, which depend on talented people, capital, and the right governance structures, will increasingly emerge from global locations rather than primarily from Silicon Valley.
  2. Investing in specific companies, led by the entrepreneurs behind them, produces better returns than investing in trends.
  3. Companies that have the potential to be one of a kind, or in other words companies which are defensible, are better investments.

I couldn’t embed the video in this post, but you can watch it here.


Entrepreneurs are doers by nature. They have ideas for what customers want, build teams to execute on these ideas, and execute.

Assuming that the entrepreneur has correctly identified a real customer want, this approach will likely produce a business that makes money in the short term. However, this isn’t enough for the business to survive in the long term.

The reason is that, if the customer want is really there, competition will either already be there or it will soon emerge. The bigger the customer want the entrepreneur identified, the greater the competition.

And for a business to survive in the face of competition, it needs to be defensible. In other words, it needs to have a characteristic, or a combination of characteristics, that stops its customers from moving to the competition.

Defensibility comes in many forms. It could be a very strong brand that has perhaps even given its name to a product category, like Coca Cola. It could be the lowest price provider due to a combination of economies of scale and the leveraging of an intrinsically low cost customer service channel, like Amazon. Or it could be a business with strong network effects that prevents users from having the same experience on an alternative network, like Facebook. Or it could be a combination of these characteristics.

Without a source of defensibility, a business’ initial growth will soon taper off and may even reverse into decline, thereby threatening the company’s survival.

As a result, you need to think about the defensibility of your business before jumping into execution. Your company’s survival, and thereby your return on the years of work that you’re going to put in, depends on it.