Valuing Early Stage Startups

Through five acquisitions (buy-side and sell-side), coupled with nearly 20 years of working for/with early stage startups, I've seen a few patterns emerge.

For companies of less than 10 employees, buyers have gravitated towards simple, clear, emotionally compelling reasons to acquire. With clear rationale, a handful of formulas are then used to settle on price.

In all of my experiences, acquisitions have "felt right" for the CEOs, executives and boards pulling the trigger. There's been chemistry with the founders/team. The deals have been easily explainable. And the buyers have believed that the acquisition fills important holes in their business.

With buyers positively inclined, the negotiated price often is looked at in several ways.

1) Revenue Multiple: the starting point for acquisitions of startups is usually a multiple of annualized monthly revenue. So, if a company is at $50K per month in revenue, the acquirer would annualize to $600K. From there, I've seen 2x to 10x multiples, driven mostly by growth rates and compounded by other factors (company age, perceived attractiveness, clients/customers, location, etc.). 

2) Engineering Hours Multiple: although not a primary value driver, acquirers sometimes gauge IP value by a cost to reproduce formula. So, if a SaaS business has 10K hours of engineering time invested, the acquirer might put a $150/hour estimate on the 20K hours = $3M. From there, I've seen companies sometimes apply a discount, given learning time and various code changes along the way.

3) Team Value Multiple: in climates where competition for talent is fierce, and when a core team is viewed as healthy and committed, acquirers will look at the value per key team member. Engineers, product managers, sales leaders and one or two key operators all might be considered. From there, multiples can range from $250K/head to $1M/head (note that the high end has typically been applied more to senior engineering groups).

Of course, there are lots of other factors that acquirers consider (cash on hand, burn rate, market factors, etc.) when buying a small, early stage startup. And ultimately, price is simply a matter of what feels right to the individual buyer and seller. But when gut checks pass, approaches like the three above are useful in helping all parties feel like the deal is fair and rational.

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