What is the final valuation?

If the founders of a startup manage to build an extraordinary software company that becomes very large (billions of dollars in revenue), at some point the company will be valued in-line with other mature, successful technology companies. Based on observation my rule of thumb that is a price/earnings ratio of circa 20.

The P/E ratio should be adjusted for growth rate, level of profitability, long-term prospects etc. This is not a small thing, especially considering that one of the most noteworthy things of the last 10-15 years is just how fast FAANG companies grew when they already had tens of billion of dollars in revenue.

And for smaller companies that haven’t reached ‘steady-state’ growth and profit margins, the P/E can reasonably be significantly higher both from lower than steady state profit margin and much higher growth.

In the earliest stages of a company’s lifetime, I don’t look at P/E or price/revenue but rather the likelihood (both operationally and funding-wise) of the startup becoming a large company and what characteristics it is likely to have at that point.

Author: Henrik Torstensson

Partner at Alliance VC. Investing in Nordic early-stage tech startups.

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