In a recent engagement with one of our startup clients, the CEO faced a challenge in determining the optimal valuation ahead of their upcoming funding round. Her initial approach was to use a simple average revenue multiple to estimate their perceived valuation based on the following 12 months’ revenues. But, this approach was too basic for the complexities of their business model.
Based on EV/Revenue multiple of 6x, with a deduction of debt and cash, the CEO estimated a perceived valuation of $79.2M using the past year's annual revenues of $13.2M. See Table I.
To address this issue, we recommended a more thorough analysis that segmented the company's revenues into its three main streams: SaaS, Hardware, and Services. After considering factors such as profitability, gross margins, growth potential, market size, competition, and benchmarking, we applied separate multiples to each revenue stream.
Table II showed that the SaaS revenue stream had the highest multiple of 12x, thanks to its steady income, high gross margin of 86%, and ability to grow quickly. On the other hand, the Hardware revenue stream had a lower multiple of 4x due to the high manufacturing cost and lower gross margin of 48%. The Service revenue stream had the lowest multiple of 2x because it was more labor-intensive and had a lower gross margin of 29%. During our valuation exercise, we discovered that the combined valuation of the three revenue streams was lower than the CEO's initial estimate, at $62.8M.
We uncovered synergies between our SaaS and service revenue streams upon closer analysis. By integrating selected services into our subscriptions, we could reduce manual processes, boost gross margins, and increase scalability, ultimately leading to cross-selling opportunities. Table III shows that we successfully reallocated $2.5M of service revenues to SaaS revenues without changing our overall revenue (see yellow cells). This strategic move significantly boosted the company’s valuation, now at $87.8M.
Chart I illustrates the valuation “journey” from the beginning of the "Fundability" process to the conclusion. The process began with a perceived valuation of $79.2M, then decreased to $62.8M through a "plain vanilla" LOB split with EV/Revenue multiples. However, the valuation was eventually raised to $87.8M after reassessing the service to SaaS and refining the value proposition to customers.
