Valuing late stage, private companies



At some point, you might consider taking a job at a late stage, private company and may need to have an opinion on the value of its stock.

Valuing a stock correctly in the absence of a market is…hard, and so most people simply take the last funding valuation as the stock’s worth. Here’s one approach to pressure test that valuation.

Is the story believable?

Before doing any math, ask yourself whether the big picture makes sense. This step is important, as some companies manage to achieve impressive growth numbers but nonetheless fail to succeed in the long-term (e.g., Blue Apron, LivingSocial, Homejoy).

  1. Has the company proven its core thesis? Meaning, does the company offer a product that users like, where users retain at high rates,1 and that can generate sustainable revenue for years to come?2

  2. Why is the company currently growing? Word-of-mouth, international expansion, SEO, ads, or sales? If last year there was a single large driver of the company’s growth, how likely is it that this driver will continue to be as effective as it has been historically? Ads get more expensive over time, and SEO hits happen. Word-of-mouth is robust.

  3. Is the company competing in a large market? How quickly is the market expanding or contracting?3 Will competition suck the oxygen out of the room? Is this likely to be a winner-take-all market or one with multiple winners?

Do the company’s metrics add up?

Assuming you’ve convinced yourself that the company’s strategy will work over a 5-10 year time horizon, it’s safe to start considering point-in-time financials.

The most important metric to consider is the company’s valuation as a multiplier of its revenue. On the public markets, one can find tech companies with multiples anywhere from 0.5 up to 30, with the company’s revenue growth rate and profitability serving as important inputs into this multiple. The higher the multiple, the better the future financial performance investors expect via revenue growth or profitability. At the time of writing (December ‘19), here are stats from a few tech companies:

Company Market Cap /
Revenue		 Market Cap Revenue Q4 revenue
growth YoY		 EBITDA
Zoom 37 17B 0.46B 95% 0.02B
Slack 21.7 12.38B 0.570B 60% -0.51B
Pinterest 10.5 10.68B 1.02B 47% -1.28B
Facebook 8.6 573.34B 66.53B 29% 28.45B
Lyft 4.1 13.46B 3.27B 63% -2.49B
Uber 3.6 47.5B 13.1B 30% -8.01B
ANGI 3.2 4.12B 1.28B 18% 0.196B
Yelp 2.4 2.34B 0.99B 9% 0.060B
Groupon 0.7 1.67B 2.41B -16% 0.118B

Other questions you might ask:

  1. Does the company have a close public comparable? How do their vital statistics (e.g., revenue, growth rate, market cap) compare?

  2. If the company is not profitable, could it be if needed? For instance, if the company has positive contribution margins but has high fixed costs, could it reduce fixed costs to survive (e.g., by firing people)?

  3. What happens in an economic downturn? Does the company have sufficient runway or profitability to weather the storm? Or is the company dependent on raising additional capital to survive?

  4. If there is an exit, is there any term sheet structure in place that might harm employees’ ability to get paid? For instance, investors are typically paid out first in the event of an exit. In some cases, investors receive multiple dollars out for every dollar that they invest before other stockholders are paid, which potentially devalues employee stock holdings significantly.

What’s your personal risk tolerance?

  1. How long do you have to exercise your options if you leave? Many companies keep a 90 day window to exercise your options, meaning that you’ll potentially have to cough up a large chunk of change to keep your stock when you leave, or you’ll have to forfeit it. Other companies extend the exercise window for years. Adam D’Angelo has an excellent writeup from 2015 on how this works. (When I was at Thumbtack, we had extended exercise windows, which helped us close candidates.)

  2. If you took a job at a public company, you’d save $X more in liquid cash by virtue of the company being public. If you zoom ahead by N years, would you feel comfortable taking $X of your total savings and investing in this particular stock at this particular valuation given the knowledge that you have?

  3. Who would acquire this company if things don’t go as planned? Or is the company already too expensive to be acquired?

At the end of the day, choosing to join a startup is always a bet. If that bet goes well, you can put a meaningful dent into the world, your career could grow much faster than it would at a more established company, and you can save years of work through a hugely positive financial outcome. However, it’s extremely important to go in with eyes wide open — and hopefully these questions can help you do that!

Footnotes

1: Mixpanel's 2017 Benchmark Report indicates that most industries have an eight-week retention rate below 20 percent. In media or finance, retention rates above 25% are considered strong. In SaaS and e-commerce, retention above 35% is considered strong.
2: A SaaS app with high margins and tens of thousands of long-term paying users has proven something. A teleportation company that has failed to produce a working demo has proven nothing. A physical logistics company that users love but that loses money on every transaction is somewhere between the two.
3: Cornering the web search market in the late 1990s (10,000% yearly growth) would have been much more meaningful than cornering the DVD market in 2015, which by 2018 had halved in size.