Buying High growth low profit
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Hi all,
While evaluating high growth tech startups and companies, we often see low or no profitability as the typical answer is that ‘we are in growth mode’. Curious, how does one think about valuing such companies based on P&L, Balance Sheet and Cash flow statements. What additional documentation would you ask for? Any metrics around CLTV, engineering strength etc, would be helpful…Manju
I think it’s still based on discounted future cashflow, which explains the growth stocks’ performance in the last few months. Inflation and interest rates have been low for more than two decades. Some of these growth companies have been valued at unrealistically high amounts. With central banks around the world wanting to increase rates to curb inflation, we see mean reversion in growth stock prices/valuations.
I would proceed with cautious with a inquiring about a startup with no history of profitability. It is unproven and extremely risky. I guess the rewards would be big if the risk pays off however I would only proceed if I had the relevant experience and new precisely how to make the start up profitable in that sector.
A common way to value such high growth startups is to use a Enterprise Value / Revenue or Enterprise Value / Gross Merchandise Value approach, which can help to give an indication of the value at a certain point in time. However, this method would need to be supplemented with a intrinsic value approach (i.e. DCF), albeit it needs to be forecasted over a longer than usual duration until it reaches steady state / terminal growth.
I deal in this realm quite a bit, as we commonly target startups with product development milestones. Critical here is to determine first and foremost the alignment of the target to our global strategy for 5-10 years. If alignment exists, we would then engage in a business plan and employ DCF (which is challenging with no profit history).
Hello, thank you very much
I believe that when there are no clear financial metrics, VCs and Private Equity companies tend to try to focus on the potential of professionals and not necessarily on the business. It is very common for startups to change their focus and products during the first few years, so professionals are more important than the business.
I do not have direct experience in this area but the influx of SPAC deals that have taken place in the past 5 years has shown how risky these investments are. The value is now penny stocks for most of those deals. The lesson is you just need to follow the basics; Look for contracts and products in the pipeline.
Agree with Gordon, that in my experience acquisitions in this scenario are based on Enterprise Value / Revenue based on private & public comparable multiples. What I’ve seen work better than others is tying the acquisition price & payout to earn-outs over the next 1-3 years to align the targets management team with hitting revenue and profitability goals. Compared to paying out the management team in cash & stock and praying they get to profitability.
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