Why Sector and Size Matter in Tech Company Valuations
Valuation of tech companies is not as simple as multiplying the revenue by the multiple for the sector, e.g. 5x for software. Valuation depends on a company's sector dynamics and growth stage.
Sector Dynamics
Artificial intelligence is a white hot sector. Anthropic is raising $2 billion in a new funding with a valuation at 66 times forward revenue (1/8/25 The Information - Anthropic Makes OpenAI Look Cheap, Again). If a company is expected to be very valuable on a probability-weighted outcomes basis, the investor can afford to pay a higher entry valuation which may look ridiculous at the time. https://a16z.com/when-entry-multiples-dont-matter/ If you invested in Google or Zoom at a ridiculous valuation in their seed rounds, you would be joining Musk in Mar-o-Lago.
For traditional technology companies, sector still matters, although not in such a dramatic fashion. ERP companies are valued at 3x revenue while semiconductor companies are valued at 12x revenue. For a comprehensive valuation, comparable companies, public companies trading in the market, and precedent transactions, recent acquisitions, need to be analyzed specifically in a company's sector.
Size Matters
Less than $10 Million in Revenue
For a tech company with less than $10 million in revenue, the acquirer will not value the company at the revenue times a multiple on a stand-alone basis. The acquirer will do its own internal build or buy analysis to determine how unique the product is, the urgency of bringing the product to market and the return on investment. The acquirer will conduct technical due diligence with the engineering teams on both sides meeting and test the product. In a transaction with Ascento Capital's client StreamWeaver, the acquirer, BMC backed by KKR, tested the product twice to make sure of the product quality and integration with existing systems. If the engineers give a green light, then the corporate development team will create an internal financial model to estimate sales of the product with their global distribution channels and project three years of sales, cut that number in half for risk and then cut that number in half for the valuation of the seller. The corporate development team will value a company at a much higher valuation if there are competing bids, which is the key role of an investment banker.
Tech companies often make the mistake of waiting until they achieve a revenue number, e.g. $10 million, before they start an M&A process, since by that time their product is no longer unique and their most likely potential acquirers have already built a competing product or acquired their competitors. Evidence of product market fit is important, but substantial revenue is not at this stage.
More than $10 Million in Revenue
For tech company with more than $10 million in revenue, the acquirer will develop its own "synergistic" valuation model based on the buyer's distribution of the seller's products on a global basis. The seller's "stand alone" valuation will always be lower that the "synergistic" valuation developed by the buyer, since the buyer can leverage its global resources. In discussions with the buyer, it is useful to point out synergies, since the more synergies in the buyer's model, the higher the buyer's valuation. It is important to understand the buyer's perspective in a transaction. In a recent transaction, Ascento Capital's client Proant in Sweden provided their view on revenue synergies in detail to the acquirer, Abracon backed by Riverside Partners, which helped increase the valuation.
A detailed valuation will include comparable companies, precedent transaction but also include key drivers such as growth rate, geography and total addressable market size and for SaaS companies churn rate, customer acquisition costs (CAC), customer life time value (CLV) and CAC/LTV. Once this analysis is complete, the seller can negotiate a higher valuation using forward revenue numbers and a conservative earnout.
More than $100 Million in Revenue
For a tech company with more that $100 million in revenue, similar valuation factors play a role, i.e. revenue multiples, and revenue and cost synergies, but the acquirer will also examine EBITDA multiples assuming other comparable companies trade on a revenue and EBITDA basis and also the discounted cash flow method, since this method becomes more relevant for tech companies with predictable cash flows. Acquirers will also analyze cross selling opportunities, and market expansion, since these factors are more relevant for larger companies. In a transaction for an Indian client, Firstsource, the acquisition of a large company in the U.S., market expansion was the primary driver.
Over $500 Million in Revenue - Take Private
In a take private of a public company, the valuation is already determined by the public markets and the tender offer will include a premium to this public market valuation based on the last 90 days of trading to incentivize shareholders to sell their shares. The typical premium in a take-private transaction can vary, but the typical premium for take-private transactions in 2024 ranged from approximately 30% to 50%. Premiums can vary significantly across different sectors. The increase in private equity activity and available dry powder contributed to more take private activity and higher premiums in 2024.
For the target public company, a take private can be beneficial since private equity firms will provide the capital for initiatives like international expansion. In a recent take private of Comarch in Poland where Ascento Capita played a pivotal role, the visionary son of the founder hired Ascento Capital to create interest from top tier private equity firms which resulted in a successful take private with the intention of accelerating international expansion.
Conclusion
Valuation is very sector specific and should be taken into account. Size matters for valuation and knowing the different value drivers at different growth stages will result in a higher valuation for the seller.
