a boutique investment banker, I am often queried about revenue
multiples—by entrepreneurs, investors, CEOs and venture capitalists.
"What is the latest multiple of revenues in this sector?" is the usual
query. Sometimes they are asking in the context of an M&A
transaction and sometimes regarding valuation for an investment
The multiple of revenue is not a good way to think
about value. In fact, it is totally bogus for any transaction that is
strategic. The multiple promotes wrong thinking and decision making
because it is based on a faulty premise. The faulty premise is that
value and revenue are highly correlated. The correlation is loose at
First, let me differentiate between financial transactions
and strategic transactions. In a financial transaction value is based
on a company's financial performance. In this case, value is determined
by financial metrics, typically the multiple of net earnings and the
multiple of operating profit. These multiples are highly correlated
with value and are quite sound. In addition, these multiples can be
legitimately compared to other transactions and to publicly-traded
A strategic transaction, on the other hand, is one
in which the value is based on a company's key assets, such as
technology. Certainly revenues are good; they give you credibility.
However, the value is in the technology, not the revenues. Think about
it—revenues could be triple or revenues could be half and the
technology is still the same. The very fact that someone is talking
about the multiple of revenue indicates that it is not a financial
transaction because if the company had earnings, they would use a
multiple of earnings.
By definition the value of a strategic
transaction depends on the strategic importance of the company to the
buyer. For example, the same company might sell for $3 million, or $7
million, or $11 million depending on how buyers view the strategic
importance to them. Value is not a function of revenues, but a function
of how important and how useful the technology (or other assets) is to
There are two primary reasons why revenue multiples are not valid:
Revenue multiples do not account for growth or profitability. Last I
checked, growth and profitability are significant attributes of any
business and are important components in determining the value of a
company. How could a valuation metric that does not consider either
profitability or growth be of any use?
Revenue multiples are not comparable from one transaction to another.
People are very familiar with comparing value metrics and they assume
that ratios are comparable. They compare house prices and they compare
car prices—two examples from our daily lives. People assume that if
there is a valuation metric that it is comparable. Multiples of revenue
simply are not comparable.
Why are multiples of revenue not
comparable? Because there is not a real, or deep, market for technology
companies. There are many buyers for houses and many buyers for cars so
deep markets do exist and comparable market data is valid. However, for
a strategic transaction there may be only five or eight companies in
the whole world that truly are viable acquirers for a specific
technology firm at a point in time.
A third minor point is
that even if revenue multiples were comparable, the range is so wide as
to be of no help. Multiples of revenue range from about .4 times to
about five times. What use is this? This is analogous to saying that
your house is worth somewhere between $400,000 and $5 million. This is
not the least bit helpful in determining how to set a price for your
How Buyers Really
may talk in terms of revenue multiples, but buyers do not think in such
terms. Buyers think in terms of how much value they can create with an
acquisition, the additional operating profits they can generate, and
how the acquisition might speed entry into an adjacent market.
Acme Widget needs a particular technology, they can develop it in house
or acquire a technology company (Omega Corp.) that has already
developed the technology. The acquisition team can estimate how much it
would cost to develop it internally and add a time premium if they can
utilize the technology immediately. Let's say that Omega's competitor,
Beta Company, was acquired last year. The price of that transaction is
irrelevant to Acme's decision-making. One or two data points do not
make a market. Just because Beta Company sold for 3.5 times revenue,
why should Acme Widget pay 3.5 times revenue for Omega?
take a quick sidebar. Notice the language. The phrase "Beta Company
sold for 3.5 times revenue" is meaningless. Actually Beta sold for $10
million; it did not sell for 3.5 times revenue. Sure, one can divide
the $10 million price by the $3 million of revenues and come up with a
3.5 times multiple but it is meaningless. One could do a similar
calculation dividing the sales price by the average employee weight to
get a multiple, obviously not meaningful. Language can play subtle
tricks and this is an example of one that people buy into.
digress. So, why should Acme Widget pay a similar multiple as Beta? It
shouldn't, of course, because there is no connection. A buyer paid $10
million dollars for Beta because that was what they thought the company
was worth to them. All that matters to Acme Widget is the value that
they perceive from the acquisition of Omega.
multiples are interjected as a negotiating ploy. A buyer may cite the
revenue multiple to make his offer sound credible or appear attractive.
Don’t be fooled by a buyer who quotes revenue multiples. Many
entrepreneurs assume that buyers think in terms of multiple revenues;
Intel acquired CognoVision for $17 million a few
years ago. CognoVision develops video analytics software and had
revenues of about $1 million. Was 17 times revenues the appropriate
revenue multiple? Were similar transactions completed at 17 times
revenue? Did Intel ask its investment bankers what the appropriate
multiple was? Of course not; Intel determined the price by figuring out
how much value CognoVision would contribute to its operations.
Multiples of revenues had nothing to do with it.
of the reasons the revenue multiple myth persists is because human
beings do not like uncertainty and they crave numbers for value. People
also like to sound smart and tossing around multiples of revenue makes
them sound like they know what they are doing.
value of a technology company with minimal earnings is quite difficult
and inexact. The only way to know what the value is to you is to
analyze and think it through to determine what the value is to your
One can make wrong decisions when thinking incorrectly
about value. When considering the best time to sell, entrepreneurs
often have a dollar goal in mind. "If we double our revenues and we can
get our target number." This is not necessarily so.
mistake that CEOs make relates to competitors who have sold. "We won't
sell unless we get a higher multiple than our competitor who sold for
2.5 times revenues last year because our technology is better than
theirs." This can be troublesome to say the least.
So, the next
time you start to utter the term revenue multiple, remember that this
is a ratio calculated after the fact, not a valid rationale for value.