What are revenue multipliers for technology startups

Current start-up dates

There are many reasons why it is particularly difficult for founders to determine the exact company value of their start-up compared to established companies. It is all the more important for them to have at least a realistic idea of ‚Äč‚Äčtheir own company value. Because every percent that founders give too much in the early stages of their development can be worth hundreds of thousands or even millions of euros. We show how you can get a realistic overview of the value of your start-up.

Established companies usually use so-called earnings value or discounted cash flow methods to determine the company value. These are based on the intuitive logic according to which every investor expects a corresponding return on the provision of capital. The expected return is based on the risk that he is taking with his investment. When investing in a start-up, investors expect a significantly higher return than with an already established, less risky company.

To determine the company value, future cash flows, i.e. payments to the investor, are discounted to the current point in time. These cash flows can be generated, for example, through ongoing profit distributions, the sale of company shares or an IPO. The current value of these future cash flows is determined by discounting. This allows the value of future payouts to be converted to the current day and thus made comparable. Thus, the forecast cash flows and the expected return determine how much the company is worth today.

No two startups are alike

Depending on the type of start-up, very different aspects play a role in the valuation. This starts with the question of what the start-up's value drivers are. In the case of a classic retail product, such as a new smoothie, these are certainly also classic value drivers such as sales growth, margins, etc.

The value of a new gaming app, on the other hand, will depend more on the number of downloads and users. In the case of a biotech start-up, the main value driver can again be the existing patents or technologies. These are all very different value drivers, but ultimately they all lead to the same question: How much money can be made with the smoothie, with the gaming app, with the new technology or with the patents?

Of course, an innovative, in the best case protected technology gives a start-up a competitive edge. And of course, scalability, disruption, network effects, internationalizability and, last but not least, the founding team are decisive for the company valuation of a start-up. Nevertheless, these are all conditions and characteristics that are intended to ensure that a company generates the highest possible profits in the long term.

How to do it!

Where is the added value for the customer? Why and how much is the customer willing to pay for the new product? How can the start-up grow as quickly as possible? What is the start-up's USP? Who are the competitors? How big is the lead over the competition and how can this be expanded? Founders must be able to answer all of these questions. These answers must also be found in the business plan, which forms the basis of a well-founded company evaluation.

Discounted cash flow method

The methodological basis of the start-up evaluation lies in the proven discounted cash flow process. It is crucial to go systematically through the evaluation process and to take the special features of the start-up into account in every step. The two main pillars of a systematic company valuation are the forecasted future cash flows and the company-specific discount rate with which the cash flows are discounted to the present day.

When forecasting future cash flows, it is important not only to estimate sales and profit, but also to determine the key figures in between, such as operating costs, investment costs, taxes, etc. This is the only way founders can ensure that the investor can understand the derivation of profits. It is particularly important for start-ups to have a sufficiently long planning horizon. Even if it is much more difficult to estimate sales in five years than for the next year, a certain uncertainty is always preferable to a planning horizon that is too short.

Orientation aids for the individual key figures can often be found in industry-specific market studies and at other companies. There are basically two approaches that are used to forecast business figures.

Top-down approach and bottom-up approach

With the top-down approach, sales figures are derived from market size, market growth and the desired market share. This approach is particularly suitable for start-ups such as software companies that are not subject to significant capital or production restrictions. With the bottom-up approach, founders start with an estimate of how much can be produced or sold and derive sales, operating costs, investment costs, etc. from this.

This approach is suitable for start-ups that are restricted, for example, by production or capital restrictions. In general, the top-down approach results in higher forecast sales and cash flows than the bottom-up approach.

Discount rate

Since the discount rate for discounting the cash flows reflects the return expectations of investors, it is determined using the risk costs of the capital provider. If a start-up has already taken out outside capital in the form of loans, this must be taken into account by including the outside capital costs. Many start-ups are naturally financed purely by equity.

The risk costs for this are determined using the so-called beta factor, which in the case of start-ups reflects both the market and company-specific risk. In practice, this beta factor is determined by analyzing the historical volatilities of comparable companies. In principle, when determining the discount rate, an adjustment should be made over time. This takes into account the fact that the investment risk of a start-up decreases over its life cycle.

Terminal Value

In addition to the forecast cash flows and the discount rate, there are a few other factors to consider when making the valuation. On the one hand, it must be determined what will happen to the company at the end of the forecast period. This is represented by the so-called Terminal Value, which represents the company value at the end of the forecast period. Normally, a going concern premise is assumed, which means that the terminal value reflects the continuation of the cash flows into infinity. Furthermore, the company value should be adjusted with regard to a possible failure of the start-up. For this purpose, founders can fall back on numerous studies that provide industry-specific probabilities for survival rates based on historical market data.

Key person discount

In addition, a key person discount may be necessary, which takes into account the likelihood that a key person in the start-up will leave it. In practice, this is often shown using so-called sensitivity analyzes. If there are different co-determination or distribution rights or if an investor has protection against dilution, this can have significant effects on the company valuation. Depending on the type and scope of these rights, practice offers different procedures and methods for determining the precise value effects. Ultimately, a liquidity discount should be applied when evaluating a start-up. This takes into account the difficulty in reselling start-ups compared to listed companies. In practice, the discount for the illiquidity of a company is often determined on the basis of so-called restricted stock studies.