The Limitations and Insights of Valuation Multiples in Software Investing
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Counterpoint Global Insights - Valuation Multiples
As an investor in modern technology companies, Bloom is challenged daily on when and how to use valuation multiples in concert within an expansive toolbox of pricing techniques to measure our opportunities to invest with our partner companies. Our takeaways below provide insight and understanding to some of the most recognizable valuation multiples, their usage and potential shortcomings.
Multiples are the tip of the iceberg. In most cases, there is more than meets the eye.
Widely used valuation multiples like P/E (Price to Earnings), EV/EBITDA (Enterprise Value to Earnings Before Interest, Taxes, Depreciation, Amortization), P/FCF (Price to Free Cash Flow), EV / ARR (Enterprise Value to Annual Recurring Revenue) are complex financial realities compressed into single figures. Although they are important calculations that are foundational to any investment analysis, they can provide oversimplifications, excluding a number of important operational considerations. These operational considerations provide a more comprehensive view of a company’s intrinsic value.
What Multiples Miss
Changes in accounting practices and the rise of intangible investments erode the informative value of earnings, leading to discrepancies between reported and adjusted figures. Multiples often fail to account for the return on investments and the impact of the time, capital intensity, considerations on intangible assets, and variations in profitability, capital structure, or tax rates.
Adjusting for Non-GAAP Measures
Companies regularly provide non-GAAP earnings alongside GAAP results, offering insights that require additional scrutiny. As businesses have unique characteristics, it is important to delve deeply into these alternative views. Stock-based compensation, restructuring charges, capital investments, EBITDA, FCF and M&A related costs should serve as breadcrumbs to formulate a view on a company’s exclusive operational position. Conclusion
While valuation multiples are indispensable tools in investing, they have inherent limitations. Investors should employ multiples as part of a broader valuation strategy, incorporating deep analysis of fundamental drivers and adjustments for intangible investments and non-recurring items.
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About Bloom Equity Partners
We’re big fans of mission-critical enterprise software, technology and tech-enabled business service companies with a competitive moat and a loyal, diversified, and growing customer base. Whether the business is bootstrapped, VC-backed, or a division of a larger organization, Bloom is completely agnostic to the structure. We are actively seeking investment opportunities that fall within the criteria below. We welcome the opportunity to discuss potential investments with founders, operating executives and intermediaries.
Our Investment Criteria
Industry: Enterprise Software, Technology and Tech-Enabled Business Services
Geography: North America, Europe, Australia and New Zealand
Revenue: $5M - $50M (>70% recurring)
Growth: 5%+ annual revenue growth
Retention: >80% gross annual customer retention
Profitability: Positive EBITDA or near breakeven within twelve months
Investment Type: Operational control required
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