# Calculating a company's PE value

My friend has a startup comapny. The company licenses a software for public participation (example: a municipality wants to conduct a survey/discussion between it's citizens regarding changes they want to make, so they create a survey in the software and the public votes).

His company currently works with a big municipality and 2 other smaller organization totalling to about 70K\$ a year (45K\$ NET).

He says that he chose a PE of 15 (instead of the usual 30 according to him) and he says he will probably add more organizations this year to get to 140K\$.

So he wants me to invest in his company right now for an evaluation of 2.1M\$ (140 * 15). So I'll be putting in 10K\$ to get 0.02 percent.

I wasn't sure about it so I figured I'll ask. I know it's a broad question but I'd like to know if the evaluation could be OK or if it's an extremely good/bad evaluation.

More information: the company was opened 2 months ago but they worked on the software for 6 months, they paid 50K\$ for the software, my friend is around my age (27) but he has a partner in the company which is older and has connections in the goverment sector (including municupalities).

• 10k/2.1m is ~0.476% not 0.02% Commented Feb 2, 2021 at 1:56
• 5 is an optimistic multiple on a two person company with three clients and <\$100k revenue per year. I agree with Fatties answer.
– quid
Commented Mar 4, 2021 at 6:06
• The PE ratio is based on current (actually last full year) earnings, not future prospects. The prospective earnings might justify a higher PE ratio, but can’t be used to boost the earnings on which the PE ratio is calculated. Commented Mar 4, 2021 at 7:01

Assuming:

• nothing at the company changes
• the two current owners are 50/50 partners
• the \$45k net earnings is distributed to the owners each year

Buying 1% of the company for \$10,000 puts a million dollar (\$1,000,000) value on a company that does surveys, which are not new or special, and earns less than \$50,000 per year. Your 1% ownership would give you zero decision making say and entitle you to a dividend payment of \$450. Without a HUGE amount of growth it would take two decades to get your \$10,000 back. Does that seem like a good investment to you? It's not as though you can just sell these shares when you want out, you're stuck. And all of this ignores how exactly a digital survey company managed to have \$35,000 of expenses.

I would only begin to consider this at 10% for \$10,000. Really I'd probably only get involved if I was becoming a 1/3 partner in the business.

I suspect this person isn't actually a friend because the offer at a \$2mm valuation is an insult which indicates that your friend has absolutely no idea what they're doing or thinks you're a mark. 30 is not a "usual" Price to Earnings ratio, Apple is priced at a 33 P/E... He offered you a multiple of 15 based on next year's not-yet-earned income relying on not-yet-won clients.

It's an utterly wild guess.

Valuations are total bullshit.

Regarding the specific "offer" you "friend" is making,

I pay 10K\$ to get 0.02 [possibly 0.5%] percent

Laugh and walk away.

The company is so tiny, it's hard to say it is worth anything yet. What if either of the partners quits the company, e.g. if it stops growing and they lose interest?

That said, you could look at valuations on BizBuySell.com and on this Inc.com chart. This chart is very detailed; even if it is ten years old, you should learn something.

Early stage software businesses are typically valued at a multiple of sales, not earnings, which varies based on growth rate. 10x sales is a reasonable benchmark. That would imply a valuation of \$700,000 to \$1,400,000.

How badly do they need money? Seems like you can get a better deal than \$2,100,000 valuation.

\$70,000 across 3 customers is a compelling accomplishment for an early stage bootstrapped company, especially with their largest customer being a municipality. It shows that not only do they have a monetizable product, they also know how to sell it. If you believe that there is a large market and a clear path to acquire more customers and retain them (customer lifetime value is critical), then \$2M could be a fair early stage valuation. You should carefully assess their software, financials, team and competitors. Survey Monkey and Qualtrics are both valued over \$1B so there is a high valuation appetite in the space.

I would read up on Y Combinator's SAFE (simple agreement for future equity) financing docs.