Benchmark Valuation

What is a benchmark valuation?

Benchmark valuation (German: Bewertung über Vergleichswerte) refers to determining or classifying a company's value on the basis of valuations that were actually agreed most recently for comparable companies, above all in funding rounds. Comparison values are the valuations of individual comparable companies, the customary valuation levels of a financing stage and the company's own last round. The method answers the question at what valuations comparable companies in a comparable situation most recently raised capital.

The method is widespread above all in venture financing. There, methods that derive value from future profits or cash flows reach their limits because profits are absent and planning extends far into the future. Founders use comparison yardsticks to develop a realistic valuation expectation for a round such as the Series A. Investors use them to check whether an offer is within the market range, and funds often use the price of the last funding round as the starting point for the ongoing valuation of their holdings. The result feeds into the negotiation of the pre-money valuation, that is, the valuation before the new capital is paid in, and thus into the term sheet with the key terms of the round.

Benchmark valuation is not to be confused with benchmarking, the comparison of individual metrics such as growth, margin or customer churn with comparison values. Benchmarking does not determine a value but shows where a company stands in comparison. Benchmark valuation uses this result to justify the position within a valuation range.

Yardsticks and sources

Four types of reference values are in common use:

• Market reports on funding rounds: analyses by data providers, industry associations and law firms show medians and quartiles of round sizes and valuations, broken down by stage, industry and region.
• Comparison rounds of individual companies: rounds of companies with a similar business model, similar size and similar growth. Usually only round sizes are published, valuations less often and terms almost never.
• The company's own previous round: The price of the last round is an anchor for new investors. They measure the new valuation against the progress made since that round.
• Capital requirement and customary stake sold: A company needs a certain amount for the next growth phase, and the existing shareholders customarily give up a certain share to new investors in a round. A valuation follows arithmetically from both.

If the reference valuations are related to a metric, such as annual recurring revenue, implicit multiples arise that can be transferred to the company's own business. Benchmark valuation then uses the revenue multiple as a tool. Its actual yardstick remains, however, the valuation level of comparable rounds, not a single metric.

Stage, industry and region

Valuation levels differ by financing stage, because with each stage the risk of failure falls and revenue and evidence increase. They differ by industry, because software with a high gross margin is valued differently from hardware or retail. And they differ by region, because the supply of capital, the investor base and exit opportunities are different. Values from the US market are therefore suitable only as an expressly labelled comparison, not as a yardstick for a German company.

Within a comparison group, the quality of the metrics determines the position. Which position that is shows a comparison of metrics with the group (benchmarking). A company with above-average growth, high customer retention and robust unit economics (profitability per customer) can justify a valuation in the upper quartile, that is, in the best quarter of the group. The median, by contrast, is not an entitlement but the middle of a distribution in which half of the companies are below it.

Round valuation and terms

A published round valuation is a price per share of the new share class, extrapolated to all shares including the employee pool (fully diluted valuation). The new shares, however, carry preferential rights that the founders' common shares do not. A liquidation preference (priority in the distribution of proceeds), anti-dilution protection or participation in the remaining proceeds make the investors' shares more valuable than the founders'. Anti-dilution protection grants compensation if new shares are later issued at a lower price. The extrapolated figure is therefore above the value that would result for all shares with equal rights.

For the comparison, it follows that two rounds with the same valuation can be economically different. A round with a simple, non-participating preference is not equivalent to a round with a double, participating preference. In the first case, on a sale the investor receives either its invested capital upfront or its share of the proceeds, whichever is higher. In the second, it receives double its capital upfront and, in addition, its share of the remaining proceeds. Payments in tranches, convertible loans with a discount or the purchase of existing shares alongside the capital increase also distort the picture if they are not disclosed.

Benchmark valuation in the negotiation

Comparison yardsticks protect founders from two mistakes. A valuation expectation far above the market range often means that investors do not even start the conversation. A valuation that is too low raises the question of hidden weaknesses and dilutes the founders unnecessarily. Outside regular growth rounds, comparison yardsticks carry less weight: the valuation of an interim financing until the next round (bridge round) or of a financing under time pressure follows the negotiating position rather than the market level.

Worked example: benchmark valuation for a Series A

A software company with EUR 3.5 million in annual recurring revenue plans a Series A of EUR 6 million, intended to finance the next 24 months. Two yardsticks are compared. The values of the comparison rounds are hypothetical.

• Customary stake sold per round, as a rule of thumb 15 to 25%
• At 25%: post-money 6 ÷ 0.25 = EUR 24 million; pre-money 24 minus 6 = EUR 18 million
• At 20%: post-money 6 ÷ 0.20 = EUR 30 million; pre-money EUR 24 million
• At 15%: post-money 6 ÷ 0.15 = EUR 40 million; pre-money EUR 34 million
• Five comparison rounds: pre-money valuation between 5 and 8 times ARR, median 6.5 times
• Applied to EUR 3.5 million ARR: 3.5 × 5 = EUR 17.5 million to 3.5 × 8 = EUR 28.0 million; median 3.5 × 6.5 = EUR 22.75 million
• Overlap of both yardsticks: pre-money valuation of around EUR 18 to 28 million
• Stake sold at the median of the comparison rounds: 6 ÷ (22.75 + 6) = 20.9%

Both yardsticks lead to a similar corridor, which speaks for its robustness. Where the company ends up within it is decided by its metrics compared with the reference group and by competition among investors. Before the comparison, it must be checked whether the comparison rounds had similar terms; a round with a double preference belongs in the calculation with a discount.

Distinctions: benchmark valuation, benchmarking and multiples

• Precedent transactions: purchase prices for the acquisition of entire companies. Benchmark valuation, by contrast, mostly relies on minority stakes in funding rounds, whose price contains preferential rights and no control premium.
• Revenue and EBITDA multiples: ratios that derive a value from a metric. Benchmark valuation can use them but is oriented towards the valuation level of comparable rounds as a whole.
• Benchmarking: the comparison of individual metrics such as growth, gross margin or customer churn with comparison values. It delivers no company value but shows whether a valuation at the upper or lower end of the comparison group can be justified.
• Venture capital method: derives today's valuation from an expected sale value and the exit multiple. Benchmark valuation looks at prices of the present, the venture capital method at the hoped-for exit.

Common mistakes

• Outliers as anchors. Exceptionally high rounds of individual companies with a special starting position are not a yardstick for the breadth of the market.
• Outdated reports. Published market reports capture rounds with a time lag. In rapidly changing markets, they reflect the current state only with a delay.
• Terms overlooked. A high valuation with far-reaching preferential rights is not comparable with a lower valuation on simple terms.
• Wrong comparison group. Rounds of other stages, industries or regions distort the yardstick, especially US values for German companies.
• Median as an entitlement. Anyone who demands the median without evidencing above-average metrics is already too expensive for half of the investors.

Frequently asked questions

Where can reliable comparison values be found?

In a combination of sources. Market reports from data providers, associations and law firms show ranges, and conversations with investors show the current state. No source is complete on its own, because many rounds are published without a valuation and almost all without terms.

How is a benchmark valuation calculated?

Through a comparison group and a cross-check. The valuations of comparable rounds are related to a metric, usually ARR, and transferred to the company as a range with a median. The cross-check uses the capital requirement and the customary stake sold: investment amount divided by the stake sold gives the post-money valuation, less the investment amount the pre-money valuation. Where the company lies within the range is justified by the comparison of metrics with the group.

Is the valuation of the last round a yardstick for the next one?

Yes, and an important one. New investors compare the valuation demanded with the previous round and the progress since then. A round at the same valuation is read as a sign of lack of progress. A lower valuation (down round) can additionally trigger the anti-dilution protection of earlier investors.

Why is the published round valuation above the value of the founders' shares?

Because it is extrapolated from the price of the investors' shares. These shares carry preferential rights, above all a liquidation preference, that common shares do not have. The value of a common share is therefore generally below the round price per share.

Does the price of a funding round also apply for tax purposes?

Not automatically. Under the German Valuation Act (Bewertungsgesetz), the fair market value of shares in unlisted corporations is to be derived primarily from sales between third parties that took place less than a year ago. Whether a capital increase with preferential rights meets this standard and how differences between the share classes are to be taken into account, for example in gifts or in employee participation, is clarified by the tax adviser in each individual case.

The Roemer Capital view

We ideally start financing processes when the liquid funds still last 12 to 18 months (runway). At the outset, we assemble the comparison group: rounds of comparable companies, market reports and the company's own previous round. Because a Series A to C round generally takes 6 to 8 months, we update these comparisons during the process.

Behind every reference valuation that an investor cites belongs the question of terms. We therefore compare offers not on valuation alone but on their consequences for the founders: stake after the round, preferences and distribution of proceeds in several sale scenarios.