So you are considering to sell your startup or have an offer on your table. How do you know what is a good exit value for your startup?
First of all, forget about asking financial analysts to assess the market value. It's pointless (especially if your startup has early traction).
The market value for your startup that you plan to sell is what the market is willing to pay. But there is good news - you can significantly influence the exit price of your startup to your advantage. You just need to be aware of how the buyer thinks and makes decisions on acquiring startups.
Prior to building and eventually selling my startup, I had a 9 year career in mergers & acquisitions. I would help buy and sell companies, manage the sale process or determine the fair market value. My conclusion - deals are rarely driven by the rational mind. This is supported by research, in particular a study from Stanford University (U.M. Malmendier, G.A.Tate, 2005) has found that it's excessive confidence—a.k.a. the egos of CEOs—that explains the higher rate of acquisition than when compared to their counterparts.
A sound market value for the exit price of the startup always lies within a spectrum. CEOs of the acquiring companies to a great extent make decisions with their emotional mind like anyone else, and to cement their decision they need rational arguments to support the emotional decision. It’s the startup founder's job in the acquisition process to provide the buyer with plenty of fitting rational arguments in order to make the acquisition not only go through, but to do so at the right price.
Let's look at how the buyer would value your startup.
What Are the Components That Make up the Value of Acquiring Your Startup?
- Consideration + Value = Total Value. When a strategic startup buyer makes an acquisition offer (Consideration), they expect to extract additional value as a result of the acquisition. Otherwise, there is no rational point to buy.
- Stand-alone enterprise value = what is the value of future cash flows that the business is likely to generate regardless of who owns the business.
- Synergies = besides the stand alone value, the buyer sees additional benefits for their company - in the M&A world they are called synergies. Such as the startup's product helping the acquirer reduce their costs or increase their revenue, or improved reputation.
- Consideration = the buyer will not want to pay the total value that they can extract from the deal (Consideration+Value) - they would be just as well off not proceeding with the deal. You on the other hand can try negotiating a deal price beyond the stand alone value - having the buyer share part of their synergies. It depends on how strong your position is. For example, do you have other buyers? See my previous post how to try create FOMO and competition among buyers. So typically parties come to the deal consideration (price) somewhere in the middle.
What Value Does Your Startup Bring To the Acquirer?
ou should try shifting the narrative from the stand-alone value of your startup to - what value is your startup providing the buyer? Firms will often claim that their startup acquisitions are strategic, which is just a way to justify a valuation that is beyond a financially justifiable reality.
In the context of the above - the startup founder should focus on convincing the buyers that the synergies are enormous. For example, your product can improve the buyer's margin by 1.0%, which is estimated at [enter your estimate] millions, or your startup product can increase sales by, say, 5%.
Beyond the economic value there are multiple motivations for startup acquisitions (source):
- Talent hire ($1 million/dev as a rule of thumb in the valley; need to readjust for your location)
- Product gap
- Revenue driver
- Strategic threat (avoid or delay disruption)
- Defensive move (can’t afford a competitor to own it)
Once you know which of the above suggestions motivates your prospective buyer, you will know which buttons to push and be able to influence the negotiations.
How to Estimate the Exit Value for Your Startup
In the corporate finance world there are two typical ways of how market value is estimated - discounted future cash flows and multiples on earnings.
- DCF - discounted future cash flows - you forecast what cash flows the will business generate in the future and discount it back to present value. I would not recommend attempting this exercise in the context of valuing startups - it is so sensitive to many assumptions that it becomes pointless, especially in the tech world or if you are still growing more than 20% per year.
- Multiple on revenue or EBITDA (Earnings before interest, tax, depreciation & amortization) - which is an approximation of free cash flows that the business is expected to generate.
Price = EBITDA x Multiple
Let's take a deeper look at multiples.
- For a stable, growing company in a traditional sector you would expect an earnings (EBITDA) multiple of 6-10x. For reference I recommend checking out the dataset regularly updated by Prof. Aswath Damodaran - used frequently by anyone working in corporate finance. If the buyer will want to negotiate for a lower price, you can expect them to use this as an argument.
- Price = Sales x Multiple is another common way to estimate the value of the company. You can look up the sales multiple dataset by industry here - the median value is 1.5x.
- The sales or earnings multiple reflects (1) how stable one expects the future cash flows to be, and (2) how fast the company is expected to grow.
- If your startup exit deal value will be based on multiples, then I suggest you negotiate applying on revenue instead of EBITDA. The chances are you have not yet reached profitability, or the scale to unleash your full profitability potential. The distribution channels and the back office resources of the buyer can enable the buyer get the startup to profitability faster. So applying a multiple on sales instead of EBITDA would result in you capturing some of the synergies of the deal.
What is a reasonable revenue multiple to value your startup?
Deal terms are often kept confidential, which makes it a challenge to assess what is the market price for startups. Tech.eu and Avolta Partners recently researched tech exit transaction multiples in Europe. It suggests a wide range. For example, SaaS companies were sold at 1.4x-8.4x revenues, while fintech startups at 7.0x-17.6x revenues.
Should You Apply the Startup Revenue Multiple to 12 Months Trailing, Last Financial Year, or Forecast?
Assuming you are growing fast, you would want the multiple to be applied on the predicted results for next year, or better yet on the next 2-3 year forecast results. However, the buyer might argue that only the finalized last financial year results are reliable, therefore should be used.
A compromise is to apply to the last trailing twelve months, that way you have a mechanism for the price to automatically adjust as months in discussions with your buyer pass. It's also another way to create urgency for the buyer - make the offer and move fast in the deal. That is, assuming you are growing. Agreeing on the results used for the multiple depends on your bargaining power in the negotiations. Such as being ok to walk away from the deal or having multiple buyers (see more on the latter in my previous post).
How to Estimate Startup Value if You Don't Have Revenue
What if you are pre-revenue? Or what if your MRR is so small that you would need to apply a ridiculous multiple to get to any reasonable startup exit value? What most founders don't realize is that your startup even at that stage is likely to be worth something for the right buyer. Selling is likely to be a better outcome for founders, the team and investors, than closing.
Without strong growth and revenue you have less leverage in negotiations. However, you can still make a competitive bidding process for your company. Here are a few examples of how you can help the buyer estimate a deal price:
- The buyer wants your functioning product. The alternative for the buyer is to assemble a team and build this in house. You can estimate how much it would cost the buyer to build in house, and use the figure for exit price anchoring.
- You have established what the product will cost for the buyer to build in house, but it will probably take 12-18 months for them. How valuable would it be for your buyer to have the product the next day? If you have multiple competitors interested in buying your startup, and each buyer is aware of the competitors, this can prompt your buyer to pay extra so that their competition does not get it.
- The other alternatives are soft landing and acquihire exits. In those scenarios the investors either get nothing back or just their investment back. The main purpose is to create a soft landing for the team and maybe the founders.
- You can also anchor the price to what you have raised - you might say that you have raised $X and your investors are looking for a 2x return. I would recommend using this only when you have orchestrated a competitive bidding process.
You might have received a term sheet and are entertaining the idea of selling your startup, or your growth has stalled. So you’re working out your exit strategy. The first step is understanding what the reasonable exit price for your startup is. Much of it relies on you understanding what the motive is for the potential buyer and how to use that to your advantage. Now you have much more leverage and ammunition to walk into negotiations with confidence and get the term sheet signed for your startup exit.
What do you think? Let's take the conversation over to Twitter - my handle is @rkulbergs.