High growth software companies are valued based on forward revenue multiples. In other words, to calculate the enterprise value of a business, you multiply the revenue by the forward multiple. But, how does the market set the multiple? What predicts the forward multiple, or correlates with it?
I pulled together the data for the basket of the roughly 60 publicly traded SaaS companies and ran a linear regression to understand the predictive power of the many key metrics reported by public companies.
The answer: revenue growth and sales efficiency dominate the model. Cash flow margins, net income margins (profitability), gross margins, and many other metrics are largely irrelevant.
Revenue growth correlates with forward multiple at 0.81.
Sales efficiency isn’t far behind at 0.75.
If you’d like to predict the forward multiple for the next software company to file their S-1, use this formula.
Forward Multiple = 6.3 + 38 x Revenue_Growth + 2 x Sales Efficiency.
It should get you within 20% of the forward multiple observed in the market today.
By popular demand, here are definitions:
- Revenue growth – year over year growth in revenue
- Gross margin – gross profit divided by revenue
- Cash flow margins – cash flow from operating activities divided by revenue
- Net income margin – net income divided by revenue
- Sales efficiency – (gross_profit_this_year – gross_profit_last_year)/selling_and_marketing_expense_last_year
This blog was originally authored by Tomasz Tunguz of Venture Capitalist at Redpoint. Republished with permission.