Valuation - Reasoning

There are so many variables, it depends entirely on the specific investor and the way they operate. Companies that look overpriced to some investors look very underpriced to others. I think a classic example is comparing the venture capital mindset versus the private equity mindset.

Let's use a SaaS (software as a service) company rapidly burning cash but paying less and less to acquire new users thanks to a solid product and word-of-mouth supplementing existing marketing channels. Let's assume LTV (lifetime value) is amazing as well. To keep things simple, maybe we assume MRR (monthly recurring revenue) is $100k.

For a venture capital firm, they would value the company at $5M - $10M+ most likely regardless of TTM (trailing twelve month) EBITDA being negative because they know there's good value in the product if the company keeps acquiring users at a healthy rate and LTV holds.

Conversely, a traditional private equity investor would look at that and puke because they know they can't get as much leverage (increases returns!) on a company with negative EBITDA, if any and are used to valuing companies primarily off EBITDA multiples. (BTW, this has changed a lot over the last 3 - 5 years with specialized PE funds & lenders focused on SaaS companies but I'm too lazy to think of a better example).

I can give you a real life example too if you want? We recently picked up a severely distressed company with a ton of debt.

a) The model isn't scalable enough to ever be a unicorn like VCs/angels want. They wouldn't value it highly at all.

b) The company is too small for traditional private equity and way too small for any trad distressed investor.

So basically the two main categories of investors would give the co. a very low valuation, if anything.

Our approach is unique in that we use our own capital meaning we can go after smaller deals because our own personal IRR is high enough to justify it and we're a bit of a weird mix between VC/PE. Our team and I specialize in the industry they operate in, so we were able to see clearly what mistakes they're making and saw a clear path back to profitability & growth...meaning we were happy to do the deal and give them a decent (all things considered lol) valuation.

Since investing we stabilized the co in a few months & brought it back to profitability. In 2019 we'll focus on growing EBITDA rapidly and then leverage the co. and pay ourselves a chunky dividend. Mmmm...dividends.

Hopefully that helps but basically the TD;DR is that valuation always depends on who is looking at the company and what their underlying strategy is/thesis behind what will propel the value of the equity they're buying.

As far as books on valuation go... the classics are McKinsey's book on valuation and Damodaran's books on valuation. There are more VC/tech oriented books that cover valuation too, but valuing early stage companies, especially if pre-rev, is way way way more art & feel than science.

Edit: sorry about the marketing acronyms, went back and added details, keep forgetting this is a finance forum lol