Why not value a cash flow positive software business off ARR instead of EBITDA?
I get why you can't value a business that isn't generating cash (let's say it's cash flow neutral) off of EBITDA, and as such would value off of ARR.
But why not value a more mature software business off of ARR? (I understand that an EBITDA multiple values it off the cash flows, which is what you are buying it for, but why not ARR?)
Secondly, and this is the money question, what would valuations look like if you valued a mature software business off ARR? Would ARR multiples be similar to what they are for high growth, non-cash generating businesses that are typically valued off of ARR?
You could - if you’re buying a business with both EBITDA and revenue then there’s an implied multiple on each, and you could quote either one. Revenue multiples are often still used for companies that are viewed in “growth” stage - even if they’re EBITDA-positive
Ultimately though, profit is what the investor gets to take home, not revenue, so if you can only know one multiple it makes more sense to know how much you’re paying for every dollar of profit rather than every dollar of revenue. Typically, non-earnings multiples are more relevant when you need a proxy for earnings / earnings capabilities - but if you already know EBITDA you don’t need a proxy
You certainly could value off of ARR, but that masks the fact that companies have different margin structures. Valuations and divergence between companies on valuation are typically a function of growth, sustainability of that growth and terminal unit economics. On a growth-adjusted basis, you'd probably see a greater dispersion in ARR multiples for mature software businesses because unit economics are better known (i.e., investors are solving for EBITDA multiples to adjust for that difference in margin structure). Most pre-profit software businesses put out a generic "80/20" terminal unit economics target and barring any other data points I suspect most investors take that at face value.
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