Mahesh Vellanki from Redpoint put up an interesting post yesterday about ecommerce valuations. His major point is that revenue multiples aren’t that high, largely because the market is highly competitive and margins are low – often because of Amazon.
As you can see from the chart above, in Mahesh’s sample most of the companies have revenue multiples in the 1-2x range. Etsy is arguably more of a marketplace than an ecommerce company and marketplaces have higher margins, more defensibility and hence attract higher multiples, so I would discount them. Similarly at the bottom end Groupon and Overstock are troubled companies that we can safely ignore on the assumption that any of our businesses that achieve big exits will be succeeding.
The major drivers of multiples are growth and margin. Fitbit enjoys a 3.3x revenue multiple because it’s strong on both these metrics. They reported 168% YoY revenue growth in the Q3 earnings report and their EBITDA margin is 19%. 1-800 Flowers, meanwhile is valued at 0.6x revenues because growth is much lower – forecast at 5-7% next year, and their EBITDA margin is 8%.
Apologies for getting a bit finance-geeky, and you may want to skip this paragraph, but a bit of corporate finance logic can explain the link between revenues, growth, and margins. At the end of the day a business is worth the net present value of future cash flows, EBITDA is a good proxy for cashflows, and future EBITDA is a function of revenues today, revenue growth and EBITDA margin. Hence the revenue multiple is directly linked to growth and margin.
For ecommerce startups assuming that if the business is successful the revenue exit multiple will be in the region of 1-2x is the way to go. Faster growth, and particularly higher margins will get you to the top of the range. Coupling this analysis with a view on market size and likely market share generates an exit value which in turn should determine the financing strategy. Most good VCs only want to invest in ‘fund returners’ which means that the exit value multiplied by their stake should be around the same size as their fund.