Understanding Your Company's Key Value DriversKristin Luck
Market research is rapidly changing and broadening from an old paradigm of traditional research to a new one that converges with both business intelligence and data analytics providers. With advertising spending continuing to increase (projected to reach $1T by the close of 2024), data-driven insights across multiple paradigms (customer, business, and third-party data) are of increasing importance…and of increasing interest to investors.
The number one question posed to us at ScaleHouse by the founders and executive teams we work with is, "What is my company worth?" Although we can estimate valuation ranges through methods like discounted cash flow, comparable company, and precedent transaction analysis, what a company may be worth (and to whom!) is highly nuanced. Markets and buyers are in constant flux. Rather than worrying about the valuation of your business today, we encourage firms to focus on growth via the following four strategies that historically drive higher valuations, regardless of market fluctuations.
1. Demonstrate Recurring (or Reoccurring) Demand
One of the value drivers of a company is stickiness of its service or product. Do you have repeat buyers or licensing agreements that guarantee revenue over a specified period? The more you can show that demand for your product or service isn't just a one-off purchase and that buyers are willing to commit to buying again and again, the higher the value of your revenue stream.
Note this means recurring revenue (as in licenses or multi-year contracts) OR reoccurring revenue (meaning clients are consistently buying from you and, ideally, increasing their spending, year after year). Both recurring and/or reoccurring revenue drive higher valuations in data, insights, and analytics firms.
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2. Customer Growth and Retention
Many companies have a near singular focus on new customer acquisition without proper focus on existing customer experience and building up loyal users and brand evangelists. We forget that customer love is better than like. As Reid Hoffman says in this "Masters of Scale" podcast episode, "all the money and all the marketing savvy in the world cannot sustain growth in the long run. You need more than your customers' attention; you need their unflagging devotion." It's one of the key value drivers of a company. This commitment to customer growth also means an equal commitment to reducing customer churn. If you're delivering an amazing customer experience and have deep client relationships, chances are you're not worrying about churn. But for those firms that haven't doubled down on existing customer growth, controlling churn is paramount. You should target for 20% or less churn in service-based businesses, 10% or less in SaaS.
Focus on increasing company value via four strategies that consistently drive higher valuations, regardless of market fluctuations.
3. Low Customer Concentration
Low customer concentration means your revenue is spread out across a broad customer base. Why is this important? If you have a $60M business made up of six $10M customers, what happens if two of those unexpectedly churn? Overnight, you have a $40M business with a high expense base. What is less risky is a $60M business spread over 20 customers. This is not to say that you should NOT focus on growing a $10M client, but rather, it's important to understand the inherent risk of having too much revenue centralized within a small client base. Diversification is key to mitigating risk, both for your firm and for a potential acquirer, and is thus a key value driver.
4. Profitability (or a clear path to it!)
Although we certainly see firms sold that aren't profitable, an argument can be made that a company's value is nothing more than its anticipated future revenue discounted at the cost of capital to their present value. Unless you're in hyper-growth mode, profitability is a major factor in implied value. To quote Peter Cohan in Inc. "Growth used to matter more than profitability, but investors aren't buying it after WeWork's implosion." You can also see this in the right sizing of valuations for companies in this sector, like Qualtrics.
For instance, through the end of Q3 2023, the median run-rate ARR valuation multiple of the 68 public B2B SaaS companies was 6.7x. SaaS valuations peaked in August 2021 at 16.9x (roughly 7 months after Qualtrics IPO), then declined over the next 12 months to 7.5x in August 2022, and have stayed in a range of 6.2x to 7.5x from September 2022 to September 2023.
Naturally, these are going to be larger companies as the median monthly recurring revenue for these firms is $51.6M, but the private markets tend to follow the public, so this is good data to reflect on when considering private B2B SaaS multiples. Likewise, most buyers in this sector are looking for services companies with a minimum of 15% EBITDA margins.
Interested in an outside perspective on value drivers or value of your company? Looking for an objective analysis of historical financial performance? Thinking about putting your company up for sale in the next 24-36 months?
From pro-forma creation and analysis to valuations, consider ScaleHouse an extension of your internal finance team. With over 50 combined years of experience in private equity, investment banking, and corporate finance, we have a unique understanding of the different levers that can be activated to ensure you're maximizing the value of your company. Not sure you are? Reach out to us.