Valuations of private companies

Trying to value a private company is an art as much as a science. The main starting point is looking for other companies that can be used as comparatives and see how they are valued.  To those metrics, then adjustments have to be made depending on factors such as varying growth rates, addressable market size, product and client diversification, balance sheet differences and quality of management.    This list isn’t close to being exhaustive, but just gives a flavour of all the inputs that are needed when coming to a valuation.

This valuation is then used as a point-in-time snapshot for the company to help position itself for an event – often that is raising money to invest into the business – so the valuation needs to be sufficiently attractive to attract that capital, but not so high that it acts as a millstone round the company’s neck for future raises, if they are needed. Generally, investors do not like “down rounds”, when the value of the company is lower than a previous fundraising round, but there are exceptions, so a well crafted narrative can go a long way to helping in this regard.

As a long time investor in both public and private markets, there are times when there are significant divergences between these markets and they can provide interesting opportunities for some kind of arbitrage.   In the early part of the 2010’s, private companies were considered less attractive as they were opaque, illiquid and with no certainty of an outcome.  Given the tremendous growth of new tech, aided by vast flows of money into the private equity and venture capital industry, this situation has now reversed.  Stunningly successful companies such as Uber, Square/Block, Roblox and Oxford Nanopore have grown spectacularly under private ownership and when they have finally gone public, there has been an initial stampede for the shares.   Witness the starting valuation for Rivian, the electric vehicle company, which IPO’d for $60bn and promptly went to $100bn, despite only having $1m of sales!  And let’s accept that markets can be irrational for a period, but tend to get it right over the longer term.

Recently I have seen some other material valuation anomalies – but this time the private companies are being feted more highly than public ones.  I was recently shown a SaaS business with very high margins and growing at 50%+ per annum.  This company had £4m of revenues in the last 12m and was raising new funds at a £70m valuation, 18x historic revenues, but closer to 12x expected revs for the coming year.   Contrast that with another SaaS business that I know in the public market that has a £35m market capitalisation, £16m of revs, growing at 15%, closer to 2x revenues.   

Which is the “better” investment?   It is right to pay a higher multiple for the higher growth rate for sure, but buying the private company also requires you to make a call as to what valuation metrics will be important on a 3-5 year (or sooner) time horizon when the company decides to have a liquidity event. Contrast that with the public company which benefits from daily liquidity, something that for an investor like me is a valuable currency.   This example shows that there are no right or wrong answers to this conundrum, just that there are many factors that need to be taken into consideration.

Another example is a software logistics business trading on a perceived “growth” multiple, ie.where high growth was expected.  This company then bought a number of old-economy businesses (also known as vans and lorries) and expected investors to value the combined business at the same growth multiple rather than a blended approach. 

Amazingly, investors were willing to see beyond this form of financial engineering and did afford the company a significantly higher valuation, which was a complete surprise but helpful for me as an investor. However, since I cannot sell the shares as the company is private, it is a moot point and I will have to wait for a liquidity event to see if future backers of the business are prepared to be so generous.

I think we are at a time in the economic and business cycle where many private companies are trading and raising capital at significant valuation premiums to the publicly quoted peers.  This can be explained away by the fact that many of them are growing faster and some will turn into the major companies of tomorrow, but many will also fall by the wayside, so be careful out there as you won’t be able to sell if things start to look less rosy.