How do you determine the appropriate exit multiple for a startup?

The valuation of a company depends on what value it creates for the buyer. It can be acquiring a market, technology takeover, acquihire or gaining financial or tax benefits, or eliminating competition. Understanding the motivations of potential buyers allows you to optimize the company's growth to maximize valuation for a given scenario. In each, you count the company's valuation differently, but most importantly, what's the goal for the buyer? First of all, what the buyer acquires is priced. In acquisitions of a financial nature, determining the value of a company is not very challenging. In acquisitions due to technology or IP, it favors the seller. You must always consider the opportunity cost of taking or refusing the offer.

In my experience, businesses aged two years or more hold more appeal for investors, as they present a more reliable track record. The older the company, the easier it is for investors to make future performance predictions based on trends, thereby lowering investor risk. As a company ages beyond the two-year mark, they often command a premium multiple. However, while age is a significant factor, it's not the sole consideration during valuation. Other elements, such as market position, industry, and the firm's assets, also shape the valuation process significantly.

One thing I've found useful is to use Revenue-based valuation, more commonly known as ARR multiples in SaaS companies. The ARR multiple gauges the ratio between a company's valuation and its Annual Recurring Revenue (ARR). It's calculated in a simple way: divide the firm's current valuation by its ARR. For example, if a SaaS company’s ARR is $5 million and it’s valued at $50 million, the ARR multiple is 10. This means investors are willing to pay ten times the company's ARR to own a share in the company. This method is useful because it is straightforward and provides a quick snapshot of your business's potential worth.

In my experience, typical exit multiples for SaaS companies can range between 5.0x to 10.0x. For businesses valued under $2 million, the multiple typically ranges from 5.0x to 7.0x. Meanwhile, for businesses valued over $2 million, the multiple can range from 7.0x to 10.0x. However, these are general guidelines and the actual multiple may vary based on various factors, including the company's revenue growth, profit margins, churn rate, and the age of the company.

While it's common for private SaaS owners to compare their company valuation to public SaaS businesses, this is often misled as public SaaS companies tend to have higher valuations due to several reasons. These include access to more capital, a large customer base, significant market share, and top talent. This could lead to an inflated perception of a business's worth as the gap between public and private SaaS valuations can be fractionally above 50%. Always remember that the valuation techniques and models for private SaaS companies are distinct from those used for public ones. A small-scale comparison without considering business dynamics can potentially lead to disappointments or inaccurate predictions.