to Value Your Business
September 2024
Price to revenues is a common way to place a value on a business where positive earnings are nonexistent or low. It is often used to value companies that have high R&D expenses, such as many software companies. The reason for capitalizing revenues, as opposed to using a multiple of some measure of earnings, is that many companies, especially start-ups, generate net losses or low earnings relative to revenues. Net losses or low earnings are tolerated if they are followed by the prospect of strong growth and positive earnings down the line. It isn’t unusual for companies to constantly spend large amounts on R&D costs for future products that result in low or negative current earnings. This makes utilization of price to earnings measures very difficult without the ability to segregate earnings from current products from future earnings derived via R&D and accurately project earnings from future products.
The methodology in using a price to revenues multiple is simple. The multiple of revenues derived from similar businesses in the same industry is applied to the subject business’ revenues to produce the invested capital value. Debt is then subtracted to derive the equity value of the subject business.
Using price to revenues multiples to value a business may be relatively easy, but it does have its downsides. First, finding similar businesses to derive a reasonable multiple may be difficult. Sources may be limited to publicly-traded companies (which could be too large to be meaningful) or businesses in private transaction databases (which has limited data). Second, the relative simplicity of the price to revenues multiple renders it less accurate than other methodologies. Its accuracy depends largely on finding comparable businesses for which adequate data is available.
Price to revenues is a valid means to valuing businesses when other methods cannot be used. Care must be taken to make sure the multiple used is commensurate with the potential/projected growth of the subject company. Negative earnings doesn’t necessarily demand a higher or lower price to revenues multiple. The appropriate multiple should take into consideration the amount being spent on R&D and the potential/projected growth and profitability of the business in the future.
Relevant Court Cases
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Taxinet Corp. et. al. v. Santiago Leon,
United States Court of Appeals for the Eleventh Circuit,
No. 22-12335,
filed August 19, 2024
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In re Dell Technologies Inc. Class V Stock
Holders Litigation,
The Supreme Court of the State of Delaware,
C.A. No. 2018-0816,
decided August 14, 2024
Recent Business Valuation Articles
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“Derivation of a Synthetic Beta using
the Monte Carlo Method as an Alternative
to the Comparable Company Approach for
Determining the Cost of Capital,”
by Gonzalo Mandagarán Rivas,
posted September 17, 2024
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“The Future of Valuation: Combining
ESG impact with EVA Methodology for Corporate’s
Value,”
by Marianus Hendrilensio Sanga and Resvina Situmorang,
posted July, 2024
Recent Engagements
- Consulting regarding Class A voting stock of a
building materials supplier on a minority
interest basis for gift tax reporting
purposes.
- Valuation of undivided fractional
interests in real properties for
gift tax reporting purposes.
- Valuation of the voting and
non-voting member units
of a mostly stock investment
company on a minority interest
basis for gift tax reporting
and purchase/sale purposes.
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