I'd pay more for a business doing $500k in revenue with $250k profit (50% margins) than a business doing $1M in revenue with $100k in profit (10% margins).
Usually it's dependent on the person selling (or their advisor). If a company is very profitable (e.g 50% margins) then an earnings multiple makes sense and the advisor will essentially present the company in such a way that it's pretty clear to the potential buyer that they're expected to think of valuation in terms of profit multiple. Incidentally, lots more buyers out there are comfortable doing that then revenue multiple. However, a revenue multiple has become the norm for companies with very highly recurring revenue (e.g. SaaS) and where the company has been run for growth instead of profit. There are many fewer buyers who will do that though, and getting leverage for deals like that is harder (a big driver of returns for some funds)
No sensible buyer (i.e. not strategic) is going to pay high revenue multiples for a private illiquid company. Exceptions to this might be when they have some advantage (existing customers etc) to sell to. But nearly all PE shops overpay on large deals.
By strategic, I don’t mean “sensible” or “smart”, I mean it’s a buyer where the asset is considered strategic, hence it would always fit under your “when they have some advantage” umbrella.
It assumes a lot of costs are fixed, and do not scale with income. Software is weird like that.
Double the 500k R / 250k P company without more expenses, and you now have 1 M R / 750k P. Double the 1M R / 100k P and you now have 2 M R / 1.1 M P.
Especially if a firm can come in and do a round of layoffs (Replace support with outsourced, fire marketing, replace devs with outsourced).. it would be pretty easy to get the margin really really high for a few years, which is all they may be looking for.
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It's almost always revenue, but I'm not sure why.
I'd pay more for a business doing $500k in revenue with $250k profit (50% margins) than a business doing $1M in revenue with $100k in profit (10% margins).
Usually it's dependent on the person selling (or their advisor). If a company is very profitable (e.g 50% margins) then an earnings multiple makes sense and the advisor will essentially present the company in such a way that it's pretty clear to the potential buyer that they're expected to think of valuation in terms of profit multiple. Incidentally, lots more buyers out there are comfortable doing that then revenue multiple. However, a revenue multiple has become the norm for companies with very highly recurring revenue (e.g. SaaS) and where the company has been run for growth instead of profit. There are many fewer buyers who will do that though, and getting leverage for deals like that is harder (a big driver of returns for some funds)
No sensible buyer (i.e. not strategic) is going to pay high revenue multiples for a private illiquid company. Exceptions to this might be when they have some advantage (existing customers etc) to sell to. But nearly all PE shops overpay on large deals.
By strategic, I don’t mean “sensible” or “smart”, I mean it’s a buyer where the asset is considered strategic, hence it would always fit under your “when they have some advantage” umbrella.
It assumes a lot of costs are fixed, and do not scale with income. Software is weird like that.
Double the 500k R / 250k P company without more expenses, and you now have 1 M R / 750k P. Double the 1M R / 100k P and you now have 2 M R / 1.1 M P.
Especially if a firm can come in and do a round of layoffs (Replace support with outsourced, fire marketing, replace devs with outsourced).. it would be pretty easy to get the margin really really high for a few years, which is all they may be looking for.
Also maybe, some forms of financing are based on revenue, and just care that there is enough profit to cover the interest e.g. https://en.m.wikipedia.org/wiki/Revenue-based_financing