Category Archives: finance

Building teams with team-based budgeting

Recently, an executive coach was advising a CEO I work with on building teamwork in his company, and encouraged him to do “ra-ra” type activities (group outings, that kind of thing).

That’s meaningless.  While it’s always nice to get people together for a bit of fun, the real way to build teams is to get people working together on actual business problems.

Team-based budgeting is the method I have used for many years to perform the budget process and build teamwork, and it makes a lot more sense than what is often done.

In most companies, budgets are done by each manager turning in a budget to the CFO, the CFO puts it together for the CEO, the CEO cuts out expenses and adds additional revenue, and poof! – the budget is presented to the board.

Not really a workable process.

This brings me to the subject of team-based budgeting.

I’ll start with a story: Many years ago, I started as the president of a software company and found several things wrong with the accounting and finance functions:

– No one had responsibility for a budget.
– The VP of Sales was in a heated deadlock on commissions.
– Forecasting was done on a hope and a prayer.

At the time, the company was small — about $15 million in revenue — and so, at that size, it had largely been run on a sort of “financial dictatorship” by the major investor. Well, considering that this shareholder was dealing with a management team that didn’t really understand finance, his point of view was understandable.

However, it’s important to develop a team-oriented approach to forecasting and budgeting. By implementing this approach, I rapidly had the whole senior management team working together smoothly on the finance functions. Better yet, we were able to grow very fast, to nearly $50 million in revenue, without any outside capital. Because we responsibly controlled costs, as a team, we were able to do great things, without a lot of money.

But it really wasn’t that hard. All I did was:
– Rework the financials to make them clear and understandable.
– Make the managers responsible and accountable for their budgets.
– Implement team budgeting

Reworking the financials
Of the three financial statements required to run a business (P&L/income statement, cash flow and the balance sheet), the one that managers must have a good grasp of is the P&L. The other two can be worried over by the CEO and the CFO.

And there we run into a problem: GAAP accounting, which can muddy the scene. Revenue recognition, accruals, depreciation and amortization can make it like a company is bleeding money hand over fist, but when you really look into it, it’s actually doing just fine. Or, a company can look wildly profitable, but is a toxic mess (anyone ever heard of the old Computer Associates?). Reading a modern financial statement, especially for a software company, is a bit of an art in itself.

So first I pivoted the focus onto billings as the topline focus. Billings is what sales guys go for, what they see “on the board”. They closed a deal, and it was for $100k. That’s what they see, and that’s what motivates them, and that’s what you want them to get.

There are fine nuances to get into here, that aren’t worth cluttering up this article with. It’s different in a SaaS environment (where you typically compensate on MRR/ARR and make that your target), and yes, there are cases where you may not compensate on billings. But the bigger point is, get a number that’s real to the sales people, that they can go fight for.

So the first thing I got everyone around was the concept of one topline number. And it was the billings number. This was in direct contradiction to what the CFO had been doing earlier (bizarrely, paying commissions on recognized revenue).

Now to the expenses: there are expenses that managers have control over, and ones they don’t. They go out and buy something for $10,000, it’s $10,000. It’s not some amount amortized over a period of time.

I wanted the managers to know that if they bought something, it didn’t matter how we would book it from an accounting perspective: they bought it. Business live on cash flow, and the impact of cash decisions is vitally important for managers to understand.

So I went a step further, creating a “modified EBITDA”. Basically, I turned the P&L into a cash-based accounting system (we still maintained a separate set of standard GAAP financials for the board, investors and other external parties).

To create my modified EBITDA, I simply added back in certain capital expenditures to my EBITDA figure to get an income statement that reflected actual cash spend, making it easier for everyone to understand.

And then I got them all in room and we budgeted as a team.

Now, depending on your business, you can probably ignore the other pieces of advice here, but this last one is important.

The way you do team based budgeting is to you set the goals in advance of the meeting — a realistic target. Like: “20% operating income, 25% increase in sales.”, and so on.

You then give all the managers enough time to pull their numbers together. Each has a departmental spreadsheet for their own area.

For the sales forecasting side, I would work between the product teams and the sales teams to get our product launch dates figured out, new versions, etc. I would take the teams off-site and we would work through the product planning. (Product planning is a huge driver for revenue, and something to spend quite a bit of time on).

And then I got all of the management team in the same room. We sat with a large-screen projector, and our spreadsheet was built with links where I would have all of their files loaded at the same time. Then, we would go through every manager’s area, and they would have to account for their expenses. As we made changes to each department’s budget, the main P&L forecast was automatically updated, giving a very quick view of the impact of each little change.

Now, peer pressure is a powerful motivator. We’re all on the same team, so when the sales person says “I can’t get sales without more leads”, the marketing person is right there to answer him, and the CEO is right there to work with the team.

When I first loaded that spreadsheet, it was comical, as a first-pass budget always is. Everything was in the red, because sales people sandbag and managers ask for more money than they need. But after a marathon two or three-hour session, we started to get to reality.

The CEO is driving the process. But the CEO is letting the team work on the heavy lifting of figuring out where to get the money.

I’ve literally been in a situation where I said “not enough money for a Christmas party”. R&D and sales then began to horse-trade expenses back and forth to get the money for the Christmas party. We got our Christmas party. (I really doubt I would have killed the party, but it was the idea that counted — that we had to work out a way to cut more costs so that we could earn the luxuries.)

After one marathon session, managers are given homework, to go back and figure out ways to get the costs worked down more (or get the sales up). Department heads have individual break-out sessions with other department heads to work on the budget. And then we have another team meeting a week later.

After that, the budget is pretty much a wrap.

Getting to the target number becomes a game. And when you have a game where everyone works together, you have a team.

Key is that the managers own their budget. They are given leeway to execute on their plan, although I still had in place basic cost controls to ensure that costs were still being managed.

Pushing responsibility down into the organization is the way that company’s succeed. And team-based budgeting is the first step to correctly delegating and managing authority.

White lies to yourself about revenue may make you feel good, but the end always sucks

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Revenue: It’s what CEOs are judged by. But all too often CEOs give white lies about revenue to themselves, their staff and investors.

I’m not talking about criminal stuff. It’s just, well, not being totally honest about the state of the numbers.

Let’s look at a few that I’ve seen.

Reporting new license revenue and recurring revenue as one number.

This is so common, it’s almost a joke. I routinely talk to CEOs who say “our numbers are up”, and then I ask the question: “Is the new license revenue up?” and get the real answer.

New license revenue is what’s new. A new customer, and it is the single most important revenue number.

Recurring revenue is from customers renewing a subscription or a software maintenance plan.

Recurring revenue is driven by three things, in order of importance:

  1. product quality, price and relevance,
  2. quality of technical/customer support and
  3. renewal sales activities.

If you focus on these three key drivers, recurring revenue chugs along happily. For enterprise software companies, typically 75–90% of your customers will renew their subscription (or buy a maintenance plan). 85% is a good goal. I’ve experienced as high as 100%. But that’s an outlier, and if you have 100% renewal rates, you’re not as smart as you’re lucky. Customers do drop off in a normal world.

In consumer software companies, the number is typically lower, perhaps in the 65%–70% range.

(Of course, if you’re a pure SaaS/subscription business, you’ll focus on churn.)

The biggest mistake a sales manager can make is to confuse these two revenue sources. Recurring revenue reps should not be compensated as highly as new license reps (and they often are, because the numbers are so large). They should be compensated on a good base plan, with commission tiers or bonuses tied to the percentage of existing customers who renew their license subscription, with the total dollars booked being less important.

That’s not to minimize the revenue role of a renewal rep, as they should be compensated for aggressively selling add-on licenses, additional plans, and other revenue opportunities. The point here is to put the picture into perspective.

Focus on your new license billings as your number one priority.  Have that number as a KPI that everyone knows.

Then have a separate KPI for total recurring revenue dollars and the percentage of customers renewing.

Don’t hide poor new license billings by merging the number with recurring. That’s just lying to yourself and your investors.

How to calculate renewal revenue

Companies are all over the place in terms of how they calculate renewal revenue. And, you can play with the numbers to make yourself look better.

But again, we’re looking at an honest number to run your business. In the above link, Carbonite is a company that has a good approach.

To make it simple, keep two statistics:

Renewal Count

How many customers are up for renewal in a given period?  (a)

How many of those renewed? (b)

And you get:

b/a=renewal rate

It doesn’t matter if they renew in that month, or in a different month. One simply keeps track of the rolling average of renewal rates.

Renewal Dollars

What is the dollar value of the renewals in a given period?  (a)

What were the renewal dollars (including upsells, crossells, additional licenses, etc.) in that period (b)

And you get:

b/a=renewal dollar rate

 

The point is to separate thinking in the organization from existing customers and new customers.

Incorrectly calculated subscription revenue

Subscription-based revenue is another method that’s often incorrectly calculated, often completely innocently.

As you probably know, there are two key calculations in subscription revenue: MRR (Monthly Recurring Revenue) and ARR (Annual Recurring Revenue).

The formula for MRR is dead simple = Total # of Paying Customers  x  Average Revenue Per User.

Now, MRR/ARR metrics are commonly used in reporting, but they are not included in GAAP or other reporting schemes. But they are very important to investors, and to the management of a SaaS company.

So here are some common errors in SaaS reporting. Some of these are surpassingly common.

  • Including quarterly or annual contracts at full value in a single month. Even if someone pays you a lump-sum quarterly or annually, you still need to divide the numbers up to match the MRR figure. (I know, it seems obvious, but I’ve seen this mistake done all too often). Bookings are different than MRR.
  • Underreporting by including fees in the MRR number. Don’t under-report the number by discounting, from the MRR number, credit card charges, delinquency, etc. It will throw off the true number. Instead, break those out separately.
  • Including one-time payments. Don’t bundle in one-time payments into your MRR. These are just that: one time payments, whether NREs, or license fees, or whatever. Report them separately.
  • Including free trials. Don’t include free trails in your MRR numbers. It’s fairly idiotic, but it does happen surprisingly more than one would expect.
  • Not netting out discounts. Net out your MRR net of discounts. In other words, if a customer gets 20% off per month for prepaying, then report the number net of discounts.

(Hat tip to Profitwell — and a shout-out, as they have a great free tool for SaaS reporting.)

Under-reporting can be almost as bad as over-reporting.
Under-reporting revenue (to be “conservative”) can also really kick you in the teeth, as I’ve learned first-hand.

Just get the right number, don’t play games and be completely honest with yourself and with your team and investors. You may not be popular in the short-term, but in the long-run, you’ll be running a better business.

And that, in the end, is what counts.

Dissecting the dissector: Mary Meeker’s presentation

Each year, Mary Meeker of KPCB does a data-overwhelming presentation on the state of the internets.  Her slides and slide volume are famous: this woman knows data (there are even attempts to make her slides better).

There are not many surprises in this year’s presentation, but there are important highlights that are valuable.

There’s a lot of money being made. Tell us something we didn’t know.
The presentation starts with a nice throwaway slide. It’s largely useless but a nice way for Kleiner Perkins to pat itself on the back and for Warren Buffet to feel silly.

(So the market cap of internet companies is massively bigger, because, well, the internet is massively bigger. Plus there’s this asset inflation thing going on.)

ASSET INFLATION

Okay, on to the meaty stuff…

If you haven’t figured it out, it is all about mobile.
Mobile, peeps! Just yesterday, I went to the website of a well-known technology company, only to find that the website was unusable on mobile (clearly, they ignored me).

But this is all not about creating mobile websites. It’s about mobile as the fundamental paradigm. The desktop is a “who cares” proposition. If this isn’t clear to everyone within hailing distance, I don’t know what else to say.

So, we start off with the obligatory OMG THERE ARE SO MANY MOBILE USERS!!112!!

Whatever.

Mobiel12931888123818231A

But this is interesting:

Thisisinteresting 1231231238

In other words, the daily usage of digital media on mobile is now the majority of the time spent during the day. Kind of obvious, but it’s still yet another wake-up call.

But don’t worry, there’s still plenty of greenfield:

Greenfield19238123818

 

ARPU (not a typo)
Then, she talks about advertising, but in the context of Average Revenue Per User (ARPU), it’s up but the growth rate is slowing.

It’s still incredible, but…

Here’s the impossible-to-understand chart by Mary Meeker:

Arpu12398123

But someone (namely, me) puts the data into a spreadsheet and then it’s clearer what’s happening.

Averagerevenueperusers123123

Okay, that looks sweet.

But now let’s graph the growth of Facebook:

Facebook average growth 19238

And Twitter:

Twitteraverage user growth 12988

Yeah.  The growth is slowing. Ugh.

Desktop advertising. A big fat “meh”.
Oh, and just in case you didn’t get the memo, desktop advertising isn’t where the party is.

Desktop yoy

 

TV is so… not
Now, again on that whole mobile thing, take a look at mobile screen viewing.

It’s beating TV.

Tv viewing 123008123

 

(And she also basically says not to even bother with horizontal videos for ads, stick to vertical.)

Enterprise software is dead. Long live enterprise software.
There are quite a few slides spent on something that I really consider important.

Enterprise software as we have known it is dying.

Instead, we have innovative and (often) amazing tools by companies like Slack (reducing email traffic materially), payment gateways (Square and Stripe), business intelligence (Domo, my personal man crush on an enterprise software company), secure documents (Docusign), customer messaging (Intercom), customer service (Directly), HR (Zenefits), spreadsheets (Anaplan), recruiting (Greenhouse), and much more.

The future 12980801823123

 

This is important and what I’m spending a lot of my time right now working on — the complete revolution in enterprise software, from stuff that was disintegrated and required proactive action on the part of the user, to products that are integrated and are themselves proactive (domo is a perfect example). Some of these solutions are truly awesome, and I mean that.

Big data was the first big breakthrough, but there’s a lot more behind the story. It brings the vision of software as a unifying activity, not what it has been in the past — by any stretch of the imagination.

Do I sound breathless? Yup, guilty.

So onward, soldiers, let’s look at some more slides and have a bit of fun.

Messaging is huge.
Okay, messaging is big. I mean — really big. Messaging apps are top in global usage and sessions. No surprise, since human beings spend a vast amount of their time communicating (even if it is cat videos and other crap).

Messagign123912381823123

 

Will mobile be the central communication hub? Of course. It’s already happening. And that’s really important to understand if you are into that space. Or any similar space, for that matter.

Power to the peeps.
Now, along the way, some people may have forgotten about the most critical aspect to this whole community thing: the actual user.

And the user is now the curator and creator of content. It’s really massive.

Look at this data: Power to the people, indeed.

Apowertothepeople 129381823

And listen to the kids. They are leading the pack:

Cherishthechildren12391238

 

Cybersecurity wake-up call.
Then we move into my wheelhouse, security, where there are no surprises. But certainly some clarity. Again, mobile, BYOD, these are real issues.

A security 1293818123

 

A security 18833

 

The global stuff.
So then we get to a touchy subject, the global economy. If you’re pro-China, now is the time to pay attention. And if you’re pro-America, now is the time to really pay attention.

Usa loving 12888123

 

Now the good news: Americans will have more time to spend on cat videos on their smart phones.
And with US population growth outpacing job growth, more and more people are on the dole. There is probably a bit of bread and circus going on, but one cannot discount what has happened to the US.

The dole18881233

 

Immigration is slightly up. And that’s good, not bad.
Immigration is up. I think this is very positive, as immigrants, despite some who scream otherwise, infuse our economy and culture with freshness and vitality.

(Wait, you think that with downward job growth, this is a problem? Actually, no. Immigrants boost economies.)

Immigrants 128388123

 

Life still sucks for wedding planners.
And another reason we need immigration: We are going to need fresh citizens, because a) Americans don’t marry much anymore and b) the average household size has plummeted.

Marriage and household

 

Pay attention to the millennials. They are the biggest portion of our workforce now.
And now, with millennials being the biggest percentage in the workforce, expect the workplace to change.

Because they have different needs and wants than other types of employees:

Millenials 12888123

Keep a spare lance around.
And freelancers (yay fiverr) are 34% of the workforce. Yup.

And that’s good news, because the economy is not going to help them.

 

Freelancers 1888123

 

Elance, Airbnb, Etsy, Thumbtack, Uber, Fiverr, etc. are all a big help to freelancers.

China is doing the Estonia thing.
Okay, in China you can use WeChat to interact with the government.

Hey — I want that here.

China wechart 999123

There’s more on China and India starting on page 150 and the rest is other useful information, particularly on UI design.

So that’s my color commentary for now. You can see the whole report, here.

 

The words I never want to hear: “There’s no budget for that”

Im_having_an_out_of_money_experience_hat-re5694050474b4cafa619600b9039fe02_v9wfy_8byvr_324Over my long and sometimes entertaining career, I’ve had the pleasure of working on many product launches.  Some have been wildly successful. Some, not so much.

There’s one thing I found in common with all launches: Marketing funds didn’t necessarily play a part in the success of the product. I’ve seen products released without a big budget do incredibly well. I’ve seen products launched with a big budget do poorly.

Hence, there’s one statement I’ve heard over the years that personally drives me a bit batty: We don’t have the money to launch the product. 

It is utter nonsense.

Obviously, the ideal is to have a great launch budget! However, don’t get yourself tangled up on the need to have money. You actually don’t need much to market successfully these days. In fact, you didn’t need much 20 years ago, either.

What you really need for a successful launch is some smarts and, most importantly, the intention to have a successful launch.

The “smarts” part of it comes from experience, which can be learned.

As an example, many years ago, I launched a product at a startup which had nearly zero revenue. With very little in launch funds, we built an amazingly successful brand (we didn’t even have to pay our costs up-front, as we negotiated payment terms with most of our suppliers”).

I spent a big portion of my budget on a ton of surveys of potential customers.  This allowed me to get my positioning and messaging right. I spent a lot of time on this part. This allowed me to have the confidence to push hard on the rest of my marketing, because I knew what the customer wanted, and how to get the customer to buy the product. (You don’t even need to spend a lot of money doing surveys. You can do them yourselves at the local mall, or use Google surveys. Or, go to online groups where your typical customers congregate and ask them to do a survey using Surveymonkey.)

The second thing I did was heavily leverage the press to write about the product. These days, press is “dead”, but that doesn’t mean you can’t still use similar communication channels. There are still many writers out there that people read, such as blogs and sites like CNET or ZDNET.

(In order to determine the correct communication channels, one does what I call a “customer work-back”. You define the customer, and then work back where they get their information and where they purchase.  This allows you to a) determine the communication channels and b) the distribution channels. For example, if your customers are system administrators in mid-sized companies, you simply find out where they get their information from and where they typically purchase. And there’s your basic communication and channel strategy.)

The rest of the launch was pretty much block-and-tackling. This product was going into both online and retail, and there is a bit of detail around these two parts that aren’t worth getting into in this blog.

But the broader idea was that we did a lot of homework up-front, got our messaging nailed down, used free communication channels to promote it, launched the product with a lot of confidence, and the rest was history.

So here’s some quick ideas as to how you can marketing very inexpensively these days:

–  Websites are ridiculously cheap, so you don’t need to spend money on expensive designers. You can create a stunning website yourself in a day or two using great WordPress themes like Avada.  Use free graphic services like logomakrTheNounProjectpicmonkey and pixlr. Or, use inexpensive services like 99designs, guru or elance. And don’t bother using ugly stock photos. There are so many incredible free images out there, it will make your head spin. I won’t get into all the tips and tricks. This stuff is pretty straightforward given a will to get something done.

–  Mail, mail, mail. Use a good mailing service like GetResponse or Aweber to really build your fat funnel and do things like using auto-responders. Learn about this stuff. It really works. All of the big email marketing companies have tons of videos. You can also look at classic direct mail, which, believe it or not, still has a place.

There’s a funny thing about mailing; you don’t always see the results directly from the mailing, but you see it elsewhere.  The key thing is to focus constantly on quality communication out.

–  Use leverage wherever possible. The incredible thing about the internet economy is the idea of leverage — one keystroke can get your message to many, many people. QuickSprout has a useful infographic which describes the leverage strategy for low-cost marketing. It focuses on using communities; incentivizing users to share; using affiliate programs; doing blogger and youtuber outreach (as well as guest blogging); using your existing network; getting your friends to share; and getting out there in person.

–  Learn to hustle. Don’t be embarrassed by getting out there and hustling for business. Most people respect a bit of hustle. People who don’t are not the people you should care about.

I remember many years ago going to a tradeshow with a few boxes of product along with me. We were a tiny startup with zero funds. So I entered as a tradeshow attendee, found an empty table and started selling product, right there on the tradeshow floor. No, I didn’t pay for a booth. But darn it, we needed the money, so we sat there and paid for our trip, selling right there on the floor.  Then, after selling all of our product, we spent the rest of the day hustling on the tradeshow. I would also go to user groups and sell directly to user group members — an easy way to generate lots of cash. I even snuck into major industry conferences through the back-door without paying (okay, that’s a bit bad, but we really had no money), and then would hustle business at the conference. Tradeshows are a great place to hustle, especially if you’re selling to other companies (such as an OEM product). Go directly to the booth and ask for the person “in charge of …”, and if they’re not there, get their contact information.

I admit, I have a bit more hustle than most people, and I often wonder why people are too scared to get out there. But I suppose I don’t have a big problem with rejection. If you do, get over it. All businesses have a lot of rejection, but if you don’t get out there and hustle, something terrible will happen: nothing.

–  Barter. Do the $5 marketing plan.

–  Use LinkedIn and send free gifts. The most powerful business networking tool is LinkedIn. Or, use other data services to find potential target customers. Then, send the target a free gift, and ask for a meeting. At one company I work with, this “gift” strategy yielded some of their best leads. Another company I’ve worked with would send an email to a target customer, offering “to buy them lunch” (really, a $20 gift card). The exchange was to do a survey, which ultimately lead to the customer being educated on the product. $20 for a highly qualified lead? That’s not bad.

There are many other ideas. The point is not to get tied up in “we have no budget”. That’s very dangerous (and false) thinking. Some of the most successful tech companies companies today have had no marketing budget (Facebook, DropBox, AirBnB and many others). What they had was a great product or service, a lot of desire and a lot of persistence. And in the end, these three ingredients have no equal when it comes to success.

Tech company valuation for noobs, and how to sound cool when talking about it

I recently had a conversation which seems to repeat itself time and again — an entrepreneur wants to start a business, calls me for some basic advice, and then we get into some of the details.  Invariably, we get around to the subject of valuation.

Since this is a blog where you can feel comfortable asking “stupid” questions, I’ll make it safe for you. So, here’s the reality: Your high-tech business is worth as much as you can get for it.

There’s no formula.  There’s no cash flow model which can justify a startup’s valuation.  There’s just what you can get.

Jim Clark, after successfully starting Silicon Graphics, went on to start his next venture, Netscape.  He arbitrarily set a valuation in the mid-teens (I recall it being around $15 million, but my memory is a bit vague).  Of course, this is a ridiculously large valuation, but he could get it.  He did the same thing again with WebMD.  He got the most he could get from the market.

Others may not be so lucky.

How it all happens is the art of raising capital, and for better or worse, a major job of the entrepreneur.

Pre- and post-money
As you probably know, key terms are pre-money and post-money (often referred to as the “pre” and “post”). Pre-money is the valuation before you raise money. Post-money is the valuation after you raise money.

It’s dead simple: Your dilution (how much of the company you give away) is simply determined by dividing the amount raised by the post-money valuation. Let’s say you value your business at $4 million (the “pre-money”).  You raise $1 million (the “raise”).  You now have a $5 million post-money. Divide $1 million by the post-money ($5 million) and you see that you gave away 20%.

Often, for pre-revenue startups, founders raise angel money first, which then converts at the valuation of the Series A. The Series A is the first real round of funding, and startups hope that it is an institutional round. In my opinion, it is more favorable for the entrepreneur to raise angel money to convert at the Series A valuation. However, angels sometimes would rather go straight into a valuation discussion.

Valuing a tech business that has revenue
After your business is running a while, you will likely want to look for an exit.  If you’re like most entrepreneurs, you’ll tell your investors that you want to go public, but really, most tech companies get bought rather than go through the cumbersome IPO process.

What valuation you get is, again, a subject of some considerable subjectivity.

The acquirer (and the bankers), will typically go with a combination of models that justify the valuation.

There are three primary models used in valuing companies:
–  Discounted-cash flow
–  Comparable public company valuations
–  Precedent transactions

Discounted-cash flow (DCF) — if you don’t know what this is, let the banker worry about it.  In tech company valuations, it’s not a vital model, but it’s heavily used in non-tech industries, where the business is predictable and well-established (or, similarly, in tech companies where there is an established and predictable business). The DCF simply presumes a set of cash flows occurring annually over a future period of time, assigns a terminal (end) value of the business, and then discounts the cash flows to the present (because cash in the future is worth less than cash today).  How it discounts is based on old mathematical models dating back literally 150 years, but is now automated in any spreadsheet program.  Again, it’s not worth worrying about too much.

Comparable public company valuations — A more important metric, this method uses the valuation of public companies in your space to determine how the broad market is valuing the business. In technology, there are a number of multiples that are used, but often, a multiple of revenue is employed.  You can get an idea yourself of comparable public company valuations by assembling a list of public companies in your space, and looking up the multiples on any major finance website (Yahoo has a nice section that shows the key multiples for any company, under “key statistics” on any public company quote page).

What companies you choose for your valuation has an impact, but be careful not to BS too much by only selecting the hot companies in your space, as any reasonably intelligent acquirer knows very well what companies are comparable to yours.

So, for example, if you’re in the security space selling an advanced firewall product, you might choose Symantec, Palo Alto Networks, Fortinet and FireEye (not the best examples, but I’m just giving examples here).   Take the core valuation metrics (multiples of cash flow or EBITDA, multiples of revenue, etc.) and then calculate the average and the median, and apply it to your own numbers.

Key multiples typically used are multiples of revenue and multiples of EBITDA.

EBITDA is a very important metric for some buyers, in particular private equity and growth equity investors. [As a side note, I will add that Cash Flow is not the same thing as EBITDA, and this is important to remember for working through your financials and your strategy. I got caught in a trap years ago between Cash Flow and EBITDA. I was heavily Cash Flow focused (specifically, Cash Flow From Operations — CFFO). For technical reasons not worth getting into here, my EBITDA was poor, but my CFFO was wonderful.  I thought I could explain it away to investors. I couldn’t: they simply cared about the EBITDA.  It was shortsighted on their part, but in the end, it was my fault for not realizing just how important EBITDA was to these institutional buyers. I’ll never make that mistake again.]

Plenty of bankers publish information on financial metrics for prospective clients; Pacific Crest Securities has one of the better models, published every few weeks. I’m sure if you contacted them, they’d be delighted to put you on their mailing list.

Precedent transactions — this is the most important valuation metric, as it is what other companies in your space are being acquired for today.  Any banker has access to services which provide this vital data, but you’ll likely have your own list of companies that have been acquired, what they got acquired for, and what the multiples were.  Again, you’ll apply this to your own numbers. Keep track of deals in your space.

Muddling through
After looking at precedent transactions and comp public multiples, you’ll have an idea of what your company should get valued at. A good banker is very, very useful in this process.

Now, different buyers have different metrics.  Financial buyers typically pay on a multiple of cash flow (perhaps 3–6x cash flow for a highly leverage acquisition, perhaps 7x-10x cash flow for a non-leveraged situation, sometimes more for something that’s important to them).  Strategic buyers (in other words, non-financial buyers) are all over the map.  If they believe it’s strategic, the sky, literally, is the limit.  I’ve seen numbers that are stratospheric.  I’ve also seen numbers that are surprisingly low.

In the end, get what you can get. This is where the art of negotiation really, really matters.

Of course, never lie and fudge your numbers.  You can get in awful trouble post-acquisition, and besides, do you really want to make all that money in a sleazy way?

So good luck and feel free to contact me if you want any advice in this process.