I have gotten some form of this valuation question a lot recently from entrepreneurs. Valuation is always tricky because it is both art and science. Two different independent people will likely not agree on the valuation of a business. Now layer in some of the recent economic and market conditions and that can further make determining a company’s valuation difficult. Here are a few thoughts on how to think through this.

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General valuation principles

In a perfectly theoretical world, the value of a company is the net present value of all future cash flows. For a large and stable company with lots of revenue, customers, historical consistency and data you can make some assumptions to get close (and even that is not guaranteed) … but for a startup that is not likely. There are other company valuations based on market multiples (revenue or EBITDA based on industry) as well as comparable transactions (recent companies invested in or sold). Those three methods can help triangulate a range of likely valuations, but for a startup may not tell the full story.

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Adjustment factors

You often need to make adjustments to the above principles based on certain factors. If you are very early in your business raising on just an idea or minimal revenue, the multiples will need to adjust. Different industries (i.e. SaaS vs. services) have different multiples, so be careful applying the wrong one to your business. Strategic acquirers/investors may also have potential synergies to the business that could allow them to pay more. But the biggest adjustment now is for market conditions. In peak 2021, the median forward revenue/ARR multiple for a SaaS business was >15x. Today that is down to 5.5x (over a ⅔ drop!). In the long run, the market is correct, but remember in the short-term market conditions may over/under value companies.

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Be careful what you say

I have heard several common themes recently. Some investors have told entrepreneurs we are in for a certain valuation … then as they drag on the process or go through Due Diligence, they cite deteriorating market conditions as a reason to try and adjust to a lower valuation. I also see founders who say they want to raise $X at $Y valuation, then realize the market will not bear that and readjust to a lower dollar raise and/or lower valuation. Remember in a rising market, every day you wait the theoretical valuation goes up (forces investors to do deals quickly because price is going up = good for entrepreneurs), but in declining markets like we are currently in, every day you wait the theoretical valuation goes down (makes investors wait because price is going down = not good for entrepreneurs).

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There is no right answer to valuation, but be aware of some of the common methods of valuation, apply appropriate adjustment factors, and remember this is ultimately a negotiation between two parties to mutually agree on something fair. The right partner is far more important than the specific valuation.

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