None of you asked, but we did it anyway. We spoke with 18 specialist VCs and did a look-back on the deals Alpha VP has seen in the last three years to give you, our loyal ComedySeller fans, a unique insight into valuations in the private market.
We looked at six common industry verticals that VCs invest in: Enterprise SaaS, E-Commerce, FinTech, Healthcare IT, Real Estate Tech and Logistics.
First, we analyzed public company comparables in each of those industries. Then we compared that data with the 18 VCs’ opinions and Alpha VP’s aggregated deal flow.
Let’s dive into the public companies first. Industry standard, as a way to compare public companies with unprofitable private companies, is to use Enterprise Value (“EV”) / Revenue to discuss valuation. For private companies, that ratio is presented as Pre-Money Valuation / Revenue. To get a sense of growth and profitability, we also looked at 3-year Compound Annual Growth Rates (“CAGRs”) and Gross Margins (“GM”).
Now, here is where it gets interesting. The graph below brings over the public data from above and shows it in relation to the private market. The private market data points are an average of those 18 expert VCs’ thoughts and Alpha’s aggregated deals in each vertical. We had, on average, three VC opinions on each vertical. Then, we added Alpha’s deals as another data point and averaged it into the VC opinions.
If you are still with me, it is only going to get better from here. We are about to take a closer look at each industry. And I am going to keep the same order throughout the rest of this post, so if you just want to get the inside scoop on FinTech, skip over the next few paragraphs.
Enterprise SaaS companies, as mentioned above, see similar valuations in the private and public markets. 12x EV / Revenue is the top end of the reasonable range VCs will pay. In terms of line items VCs focus on when evaluating an Enterprise SaaS deal, they put more weight on Gross Margin than they put on Gross Revenue. This is because VCs believe healthy margins are more of a differentiator and give them a better sense of how the companies will scale.
Many VCs use “the rule of 40”, when evaluating deals in this space. The rule says that growth rate plus margins must be at least 40%. If you are growing at 20%, you should be generating a profit of 20%. If you’re growing at 50%, you could have -10% margins. Notice top line revenue isn’t part of that equation.
For key performance indicators (“KPIs”), LTV / CAC was by far the most important KPI expert VCs look at. For an in-depth look at LTV / CAC, check out the ComedySeller’s post here! To go even deeper into Enterprise SaaS companies and what they trade at, if that is even possible after reading this thorough analysis, there are a lot of resources available. Check out BVPs Emerging Cloud Index, which currently trades at 11x. Also, Tomasz Tunguz and Christoph Janz have insightful posts on this topic. Christoph’s 2018 SaaS Funding Napkin is below.
E-Commerce companies are typically valued as a multiple of Gross Merchandise Volume (“GMV”). GMV is the $5 you spend for new toothpaste on Amazon. Amazon’s “take rate” is what they actually make from your $5 after they do their revenue share with the merchant. VCs look for take rates of ~20%.
For KPIs, VCs search for companies with Contribution Margins equal to 3x their cost of customer acquisition (“CAC”) within 12-18 months. Next they focus on churn, as merchants always follow the customers.
FinTech valuation discussions got quite heated, and the valuation range ended up fairly wide, from 6-15x Pre-Money Valuation / Revenue. Early Stage, Seed and Series A deals trade towards the top end of the range, at 10-12x. Payment networks and acquirers trade at 4-6x revenues. Digital / Network companies trade at 9x+. For online brokers, look to pay ~5x and for exchanges, closer to 9-10x. Some of the larger, public companies, like Visa / Mastercard trade well above the range, from 16-18x.
When looking through FinTech companies’ Income Statements, sales and transaction volume come first. Scale is more important than margins when VCs take a first look. Further, there is a strong focus on quality of revenues. That means a truly recurring SaaS FinTech revenue business would be valued at a higher multiple than a business that has a services component, since services-heavy businesses typically have lower gross margins and are less scalable.
In terms of KPIs, churn is first, followed closely by LTV / CAC.
Wow. Thank you for still reading. Here is your mid-post reward!
If you still need to take a break, go stand up, call your high school English teacher, and tell her you are sorry for complaining that Atlas Shrugged was too long and Ayn Rand isn’t the most boring author you’ve read.
Healthcare IT valuation discussions were also quite detailed. At a high level, the industry trades at 4-5x. Medical Devices come in towards the top of that range, at 4.5x. Information Services trade at 2.8x, Home Care companies, 1.4x, and Diagnostics at 1.1x.
For companies in this industry, Operating Margin is most important line item VCs look at. For KPIs, it is utilization. What is the company’s Daily Active User (“DAUs”) count? What is the retention and churn on those users? VCs look for different hurdles depending on the stage of the company and its business model. We are seeing a significant shift in Healthcare IT business models that reflects companies striving for lower churn. According to Rock Health, 61% of companies that started out with a B2C model switched to a B2B or B2B2C model.
Exits came up the most in conversation with Healthcare VCs. Most companies that are built around some aspect of workflow automation see exits of $100-150 million. In order to get a higher exit, north of $500 million, companies need to show some patient engagement component.
Real Estate Technology companies, similar to Enterprise SaaS, cover quite a few different industries. Ranges for valuation are between 3-7x for the sector. Property management software companies trade in the middle, at 5x. Mortgage data technology companies come in at 4.4x, and companies attacking the real estate sharing economy trade at 3.9x. The focus for VCs is on profitability, and real estate technology was the only industry where EBITDA came up in conversation.
In order to develop a competitive moat, VCs focus on where companies play in the regulatory environment. For exits, keep in mind that balance sheets are thin for construction companies. Further, technology is outside the wheelhouse for REITs. In order to sell for $500 million+, companies in this space need a true, proven ROI for its customers.
Logistics companies, as mentioned above, trade at the lowest revenue multiples, at a range of 1-3x.
The logistics world is a pricing war, and it is difficult for pure logistics companies to maintain more than ~10% net margins. Companies in this industry focus more on increasing margins than top-line growth. Logistics is an old school, fragmented industry that is slow to adopt new technology.
Alright, all done with the industry deep dives! To close out the conversations with the VCs, we asked them if they thought valuations will be higher or lower in 2021. Now, here is a very helpful set of quotes we got back in response to that question. We saw a nearly perfect split of VCs sharing that valuations are on the rise, valuations will decrease and valuations will stay the same.
“Prices will be higher ~15% higher, assuming there isn’t a major correction in private asset values or economic downturn.”
“Valuations have been consistently getting more expensive, and we are at the peak. Valuations will start to come down, especially for those that do not have a profitable core business model. I would say about 20% lower.”
“Valuations, on a multiple basis, will stay the same. Meaning they will continue to trade in line with public comps.”
In summary (finally), look for expert VCs leading rounds. They understand the intricacies of how to value companies in their respective industries, and hopefully can add significant value post-investment. Give valuation some additional thought when a corporate venture capital firm is a part of the round. In every year from 2012 to 2017, the average deal value of deals with corporate venture capital involvement was ~3x the average deal value of those deals without it.
Different industries have different valuation triggers. It may not always make sense to value revenue above all else, as margins and profitability could play a larger role in certain industries.
When evaluating a potential new deal, always pull together a competitive company analysis. That can include public and private comps, if you have them logged in your deal flow sheet or can find reputable sources online. And think about the exit landscape, which is vitally important when considering how much you should pay for a deal. What does the recent M&A landscape look like? What did its public peers trade at when they initially IPO’d?
If you want a copy of the presentation I walked through at the conference, send me a note!
I am a 25 year-old venture capitalist and amateur stand-up comedian living in NYC.