With companies wrapping up the year and starting to plan for 2018, one of the most common requests we get is for present and future valuation analysis in advance of year-end board meetings. Unfortunately, potential valuation or “what the market is saying” is never as easy as a few graphs slapped together with your internal financials, but this article aims to provide a broad market update for high-recurring revenue software and technology companies.
As a starting point, we look to evaluate the market through the lens of the public markets – specifically what we refer to as the “Leonis SaaS Index”, an equally-weighted index of companies that offer the subscription-based pricing model. To correct for the inevitable tumult of IPO, we’ve excluded first day performance for the companies that have gone public since September 2017.
As the graph indicates, the Leonis SaaS Index companies are continuing to outperform the Nasdaq on both a year-over-year and month-over-month basis. The dip in early 2016, however, highlights the fact that the valuations of these companies continue to be based primarily in the metrics of growth and multiples of top-line revenue. Powerful growth in revenue means a better valuation overall, but when that growth slows, valuation can come down precipitously. The same basic principle applies to the private market to middle market companies, where Leonis works day-to-day.
The chart above details the average trading multiple (as defined by enterprise value over total revenue) and how that tracks with year-over-year growth rate for companies in the Leonis SaaS Index. Take this with a grain of salt, however, as the multiples game is a hard one to play at the market-wide level. In our analysis, Q317 multiples alone range from 5.3x all the way up to 7.8x, when looking to the industry-specific trends as opposed to the broader market trends shown here. For companies that do not fit into a neat box (as almost none of them do), the storyline and positioning of the company can swing a valuation several turns of revenue.
How does this information affect your company’s strategic plans? The short answer is that it should not, unless you’re looking to enter the market for capital or an exit in 2018. The strongest correlation to valuation in technology companies continues to be total growth, by whatever metric that’s defined. The tone of investors is no longer “growth at all costs”, as unicorns and cash-hungry business models struggle for more and more injections of capital. The companies that are going to get the best valuations in 2018 are those that are growing and profitable, or have an extremely clear path to profitability. As an entrepreneur or a manager, the core tenet remains “how to we make more money for our shareholders?” The answer remains (or perhaps has returned to) “grow stably, quickly and along the path to profitability.”
As always, if there’s a way that we can be more nuanced than the “make more money” guidance above, let us know.