P/E multiples for privately held companies?

Question

Is there any rule of thumb on the valuation of privately held (tech) companies? The long held "average" I have always seen for publicly traded companies is a P/E of 15 (with tech having historically higher multiples). I presume the answer is no because private companies are much harder to value, but I'm just trying to get a gut feel for where those numbers might be.

Any guidance on what that valuation looks like with regard to pre-revenue, revenue, and profitable companies? How might this change based on primary ownership being the founders vs. VC/angel money?

Answer 1

You're indeed right, this cannot be answered affirmatively. I will try, without going too deep in details, to brush a shallow portrait

In its simplest form, a going concern company could be valued by the present value of a growing perpetuity (Cash Flow/(Required return - growth)), assuming compounding perpetual growth. That's a massive assumption for a yet to turn a dime company. That's why comparable transactions are usually used as benchmark.

In this case, your PE can be thought as the inverse of a growing perpetuity, and it's size will be determined by the difference between return and growth.

So when you're pre-revenue, you're basically trying to value a moonshot with everything to prove, no matter how genius the idea. Considering the high levels of financial risks due to failure, VCs will require biblical levels of returns (50% to 90% is not unheard of). Hence why they usually leave with a good chunk of the company in seed rounds.

When you've had a few sales, you got to know your customer and you've tested the markets, your direction gets clearer and your prospects improve. Risks moves down a notch and the next round of financing will be at much lower rates. Your growth rate, still high but nowhere as crazy as before, can be estimated with relatively more precision.

Companies turning a recurrent level of profits are the easiest to value (all else being equal). The financial mathematics are more appropriate now, and their value will be derived by current market conditions as well as comparable transactions.

With unlimited resources and perfect markets, the value of the company will be the same wether the founder is at the helm or the VCs are in the place. But considering many founders need the VCs' resources to extract the value of their company and markets are imperfect, the value of the company can change significantly depending on the decisions.

Hope that helps!