Here's my question to all the tech gurus out there.
Subscription-based software business has some revenues (let's say 1m), decent but not phenomenal ARR growth and has spent to-date 5-6m in R&D. They tell us that valuing them off revenue is not gonna fly, as revenue doesn't quite reflect yet all the investment in R&D (that will, in theory, generate more revenue at a higher growth rate in the future).
If you can't simply apply a multiple to revenue based on ARR and ARR growth, how would you go about valuing this business then - is there a premium you would add to reflect the "future value" of the R&D spend?
Thanks in advance!
I don't think their is one hard and fast rule when it comes to valuation, as you know it is more of an art than a science. That said I am on the buyside focused on SaaS investments, albeit relatively new, and not once have I ever heard of a company ask for multiples on their R&D spend. Thinking about this fundamentally, it doesn't make sense to apply a multiple to what is recognized as an expense (ie you would never have a S&M multiple for Enterprise Value). You can directly control how much you dump into R&D, but you can't directly increase your revenue. I think one space where valuation methods could be a bit more unorthodox would be in the pharmaceutical and bio tech space, where I am unfamiliar with. Then again this SaaS company and unlikely to play in either of those spaces. I hope this was more helpful, than it was confusing.
What does S&M stand for?
Sales & Marketing
You might be surprised to know that a LOT of biotech firms use multiples such as P/E. It is ridiculous. EV/EBITDA is also applied, but both don't make much sense since biotech firms many times don't have net incomes, and are not leveraged or have big depreciation expense. Most of their cost is labor (options, bonus, salary). administrative, third-party (contract research organizations), and royalty payments/license-in payments. What makes sense is EV/Revenue. No, I don't think it makes a lot of sense to look at EV/R&D for biotech firms.
Somehow my VP insists we look at P/E multiples and P/B multiples when we pitch biotech firms
That is insane...
I think my gambling career should be judged by my total outlay, not my winnings.
Can they prove the value of that incremental R&D? Have they been able to upsell existing contracts or sign new contracts because of this development work that are not yet showing up in revenue? If yes, there’s a reasonable argument to apply a multiple to those annual contract values. Otherwise I mean you can do the revenue multiple on actual revenue, plus $6M to pay them for what the R&D is worth at this time.
also I can’t imagine that R&D has gone that great - if they are they wouldn’t sell now (who dumps $6M into a business to turn around and sell it off of $1M revenue? Unless this is just a small minority check in which case they clearly need your cash anyways)
You could theoretically calculate R&D divided by Revenue and use that as an x axis on a graph with revenue multiple as the Y axis. If you then displayed the logos of comparable companies, you might see a pattern and be able to justify a valuation based on companies spending the same anount of R&D relative to revenue. Not saying that’s an amazing idea but it could be a cool of trying to tie R&D spending into valuation or why your company should go at a higher multiple if other companies are
TAM —> SAM —> penetration curve —> revenue potential for the company. Do a DCF and run it back or do an exit exercise and solve back to current valuation based on target IRR.
More fundamentally, what’s the value of their IP? If you are a strategic, why buy vs build if targets customer base isn’t meaningful? For a sponsor, why isn’t the company gaining traction? What’s the cost of r&d to achieve the future revenue?
All sorts of questions but I’ve never heard of an r&d metric—simply not representative of your future potential earnings from the target.
I’ve done some benchmarking exercises in banking to calculate the incremental top-line return on R&D investment.
Wonder if you could run a regression on any comps or at least look at historical change in R&D and impact on change in revenue. Make sure to take into account the lag (change in revenue might be attributed to change in R&D two quarters prior).
Just use apply forward multiples to the year they reach standard operating procedure.
Other thoughts: you can’t use equity value to ebitda multiples because equity value includes the capital structure and ebitda is independent from the cap structure. This R&D spend seems more so than not tied to the capital structure. You could do an equity value to spend multiple but you don’t know that r&d spend is correlated to valuation. You need to know what drives valuation multiples.
Molestias dolore accusamus tenetur suscipit at ut at. Sunt facilis porro suscipit a neque in quam dignissimos. Veniam reprehenderit exercitationem velit quae. Voluptatum unde neque nostrum.
Et doloremque dolorem vero necessitatibus. Et quod earum dolor temporibus tenetur rerum quo. Delectus ad animi ab dolores quisquam quasi. Fugit esse et voluptatibus corporis laudantium.
Voluptatem deleniti sint quaerat amet. Natus qui labore debitis quidem.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...