Revenue Multiple

What is a revenue multiple?

Revenue multiple (in German Umsatzmultiplikator, also EV/Sales or EV/Revenue) refers to the ratio of a company's enterprise value to its revenue. Enterprise value here means the value of the operating business for owners and lenders together. A multiple of 5 means that the business is valued at five times its annual revenue. For software companies with a subscription model, annual recurring revenue (ARR) often takes the place of total revenue.

Formula: Revenue multiple = enterprise value ÷ revenue or ARR; conversely enterprise value = revenue × multiple

Revenue multiples are used when a company's earnings are still negative or do not reflect its future earning power. This concerns above all technology companies in funding rounds of Series A to C, sales of high-growth software companies to strategic acquirers and valuations ahead of an IPO. Those involved are venture and growth investors, acquirers and their advisers. The multiple appears in investment memoranda and non-binding first offers. The term sheet, by contrast, states the valuation itself, from which the multiple can be derived.

Why revenue rather than profit

A revenue multiple is a shorthand statement about future profits. Anyone who values a company at five times its revenue assumes that this revenue will later yield margins that support such a price. The multiple therefore contains expectations about growth, achievable margin and duration of growth without stating them openly.

This explains why revenue multiples vary so widely. Two companies with the same revenue can be worth very different amounts if one grows fast with a high gross margin and the other stagnates with a low margin. The gross margin is the share of revenue that remains after direct costs. A widely used metric that combines growth and profitability is the Rule of 40: growth rate and profit margin should together amount to at least 40%.

Reference bases: revenue, ARR and net revenue

The choice of reference base determines the result. Recurring revenue from subscriptions and licence agreements is valued more highly than one-off revenue from implementation projects or consulting, because it is predictable and recurs without renewed sales effort. Anyone who applies the multiple for recurring revenue to total revenue overestimates the value.

In terms of time, a distinction is made between revenue of the last twelve months (trailing) and planned revenue of the next twelve months (forward). For ARR, the current monthly figure is often extrapolated: monthly recurring revenue (MRR) times twelve. For marketplaces and intermediary platforms, the decisive figure is not the transaction volume brokered (gross merchandise value) but net revenue, that is, the commissions and fees that remain with the company.

Quality of revenue

Investors and buyers do not value revenue but its quality. The most important features are:

• Growth: level and consistency of the growth rate, ideally over several years and customer cohorts, that is, across groups of customers acquired in the same period.
• Gross margin: software revenue usually reaches higher values here than hardware, trading or services, because the direct costs per additional customer are low.
• Customer retention: the churn rate (churn rate) and net revenue retention, which shows how the revenue of a customer group develops over twelve months, including expansion and cancellations. Values above 100% mean that existing customers buy more overall.
• Efficiency of growth: the ratio of cash consumption (burn rate) to newly acquired recurring revenue. Growth achieved with little capital justifies higher multiples.
• Customer concentration: if a large part of revenue depends on a few customers, the risk rises and the multiple falls.

Revenue multiples in a funding round and a sale

In a funding round, the multiple is often stated as valuation divided by ARR. It should be noted that the post-money valuation is an equity value and includes the newly paid-in funds. For the multiple on enterprise value, net financial assets are deducted from it, that is, cash less financial debt (a negative net debt). The round price also applies to shares with preferential rights, such as priority in the distribution of proceeds, and cannot readily be transferred to all shares.

Comparables come from stock market valuations of listed software companies, from acquisitions (precedent transactions) and from funding rounds. Stock market multiples mostly relate to considerably larger companies and fluctuate with the interest rate level and market sentiment, in part considerably within a few quarters. Published values from earlier years are therefore not a yardstick for the present. As a company matures, the valuation basis shifts: once a company is sustainably profitable, buyers additionally test the price against the EBITDA multiple.

Worked example: calculating a revenue multiple for a software company

A software company generates EUR 4.0 million in annual recurring revenue from subscriptions and EUR 0.6 million from one-off implementation projects. The multiples are hypothetical example values.

• Total revenue: 4.0 + 0.6 = EUR 4.6 million
• Differentiated valuation: 4.0 × 6.0 = EUR 24.0 million for the ARR plus 0.6 × 1.0 = EUR 0.6 million for the projects = EUR 24.6 million enterprise value
• Undifferentiated application to total revenue: 4.6 × 6.0 = EUR 27.6 million, that is, EUR 3.0 million more
• Based on the planned ARR in twelve months of EUR 6.0 million, the value of EUR 24.6 million corresponds to a forward multiple of 24.6 ÷ 6.0 = 4.1

A second company with EUR 3.0 million ARR closes a funding round. It has no financial debt and EUR 1.0 million in cash before the round.

• Pre-money valuation EUR 16 million plus investment EUR 5 million = post-money valuation EUR 21 million
• Cash after the round: 1.0 + 5.0 = EUR 6.0 million
• Enterprise value: post-money valuation 21 minus net financial assets 6 = EUR 15 million
• Multiple based on the post-money valuation: 21 ÷ 3.0 = 7.0; based on enterprise value: 15 ÷ 3.0 = 5.0

Both calculations show that a multiple becomes meaningful only with its reference base. Anyone comparing offers or benchmark rounds must bring them to the same basis: enterprise value rather than equity value, recurring rather than total revenue, the same period.

Distinction: revenue multiple, ARR, benchmark valuation and Rule of 40

• ARR: the metric itself, recurring revenue extrapolated to a year. The revenue multiple is the ratio by which this metric is translated into a value.
• Benchmark valuation: places a valuation in context using the valuations of comparable companies or rounds. Revenue multiples are one possible tool here, not the only one.
• Rule of 40: a metric for the interplay of growth and margin. It explains differences in the multiple but does not replace it.

Common mistakes

• Transaction volume instead of net revenue. For marketplaces, only the revenue that remains with the company belongs in the calculation, not the volume that runs through the platform.
• All revenue valued equally. One-off project and consulting revenue receives considerably lower multiples than recurring subscription revenue.
• Post-money valuation as enterprise value. The newly paid-in funds are part of the post-money valuation. Without deducting them, the multiple is stated too high.
• Outdated market values. Multiples from an earlier market phase reflect a different interest rate level and a different sentiment.
• Extrapolating a peak month. An ARR extrapolated from an unusually strong month or from one-off revenue does not withstand due diligence.

Frequently asked questions

What is the difference between revenue multiple and EBITDA multiple?

The reference base. The revenue multiple relates enterprise value to revenue and values potential before profits arise. The EBITDA multiple relates it to operating profit and presupposes profitability. Once a company is sustainably profitable and its growth slows, EBITDA comes to the fore. A revenue multiple can then be cross-checked: revenue multiple divided by the sustainable EBITDA margin gives the implied EBITDA multiple. A value of 5.0 at a 25% margin corresponds to 20 times EBITDA, which can be justified only with continued high growth.

How is the revenue multiple calculated?

As enterprise value divided by revenue, for subscription models usually by ARR. Anyone starting from a round valuation first deducts net financial assets, because the post-money valuation is an equity value. For a valuation, conversely, revenue is multiplied by the multiple of comparable companies.

What revenue multiple is usual by industry?

There is no fixed value, but the differences between industries follow above all the margin. A retailer with a 4% EBITDA margin that is sold at eight times its EBITDA arithmetically achieves only 0.32 times its revenue. As a rule of thumb, software companies with a high gross margin, recurring revenue and strong growth, by contrast, are valued at a multiple of their revenue. Consulting and project business lies below, because it depends on individual people and contracts. Published indices mostly relate to large listed companies and are usable for smaller private companies only with adjustments.

Are trailing or forward multiples used?

Both are common. For fast-growing companies, investors often rely on the current ARR or the ARR planned for year-end. Comparables must then be determined on the same time basis.

How does customer churn affect the multiple?

It lowers it. High churn shortens the lifetime of the revenue and forces the company to use part of its sales effort solely to replace lost customers. Investors therefore examine the development of individual customer cohorts before applying a multiple.

The Roemer Capital view

Before a funding round, Roemer Capital prepares revenue so that investors can apply the multiple to the right basis: recurring and one-off separated, by segment and by customer cohort. Metrics such as a ratio of customer value to acquisition cost of at least 3 to 1 (LTV/CAC) and a payback of acquisition costs in under twelve months support the quality of revenue with figures.

If several term sheets are on the table, Roemer Capital converts each to enterprise value, that is, post-money valuation less net financial assets, and takes preferential rights into account. Only on this basis does it become visible which offer actually provides the higher multiple.