How can you get a realistic view of your company valuation?
Over the last five years, I’ve reviewed a significant number of Information Memorandums (IMs) – documents created by brokers to attract buyers for businesses. IMs often contain a mix of key facts and some level of spin, depending on how well the business is performing. As a reader, the challenge is to discern what may have been omitted. For instance, if growth numbers aren’t displayed prominently, that might indicate weak growth. Similarly, if recent performance is unclear, it could suggest that the company has been trading poorly.
Interestingly, about two-thirds of the IMs I come across lead to no further discussions – either the business doesn’t sell, or it fails to sell through the initial process. A recurring issue is a mismatch in valuations.
The Role of Brokers and Realistic Expectations in Company Valuation
Much like real estate agents who promise high selling prices to win listings, brokers often secure clients by proposing optimistic company valuations. Sometimes, these company valuations are driven by previous rounds of funding, where investors expect a return on a previous high valuation. In smaller companies, founders might aim for a valuation that provides each of them with a certain sum of money. While these are understandable starting points, they’re not always realistic.
That said, brokers generally provide value. While they may encourage some creative interpretation of financials (which could cause problems later), they have the experience and knowledge to optimise sale prices. However, as a seller, it’s important to maintain realism and not rely solely on the broker’s optimism. A failed process looks bad and soaks up huge amounts of time and effort. You won’t want to come back to the market for another year or two following a failure. And some stats say that 90% of attempts to sell fall through…
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Understanding Company Valuation: The Importance of ARR
A couple of years ago, Annual Recurring Revenue (ARR) was often the basis for company valuation estimates. Not all ARR is valued equally – its worth depends on the likelihood of customer renewals. For example, an e-learning company selling off-the-shelf content might have a valuation in the range of 3x ARR, given that its contracts tend to be short-term and easy to replace with competitors’ offerings.
On the other hand, platform ARR tends to fetch higher multiples – typically in the 5x to 7x ARR range, or even more. Why? A platform is usually more deeply integrated into a customer’s operations, making it harder to replace. That said, there are always nuances. Learning Management System (LMS) vendors might showcase well-known global brands in their IMs, but these deals might not represent selling a platform to the entire company. Often, it’s a point solution for a particular region or department, which lowers the overall ARR multiple.
The Shift in Company Valuation Trends: AI and Retention
As technology evolves, so do buyer preferences. Currently, the most valuable assets are platforms that incorporate cutting-edge technology like AI, especially if they serve as a “source of record” for multiple global companies. These platforms are difficult to replace, and buyers perceive them as more future-proof.
However, ARR isn’t the only factor in play – retention rates are equally, if not more, important. Gross Revenue Retention (GRR) measures how much of your customer base renews, while Net Revenue Retention (NRR) factors in upsells and cross-sells. Historically, the golden standards for these metrics are around 90% GRR and 100% NRR, but these numbers have been under pressure lately. Competition in e-learning is fierce, and customers are becoming more discerning with their spending.
Balancing Recurring and Non-Recurring Revenue
Every e-learning business has some level of non-recurring revenue, usually tied to implementation fees or custom content creation. While non-recurring revenue is valuable, especially for building customer relationships, it’s generally less attractive from a valuation perspective. This type of revenue typically gets a 1x multiple, as it’s not guaranteed to repeat. Companies need to constantly win new work to maintain it, making it a tougher, less scalable revenue stream.
That said, profit matters. Custom content, for example, can be highly profitable if managed efficiently. Brokers will often adjust EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) to present a more attractive profit number. Depending on the business’s scale, valuations based on EBITDA can range from 10x to 20x, especially in today’s market where efficient, profitable growth is highly valued.
The “Rule of 40” and What It Means for Your Valuation
Many businesses strive to meet the “Rule of 40,” which means that their growth rate plus profit margin should exceed 40%. In the e-learning sector, I’ve seen companies achieve this more often through profitability than through rapid growth. Growth, however, tends to be valued more highly because it indicates strong market traction and an effective demand-generation strategy. A company’s ability to tap into consistent demand is crucial for a high valuation.
While there are multiple factors that determine your company’s worth – ARR, EBITDA, and overall market conditions – a critical component of any sale process is aligning your expectations with market realities. If you’re aiming for a certain figure, such as £1 million per founder, it’s essential to ensure that this expectation is supported by one or more of these basic methods of valuation.
In Conclusion: Prepare for Negotiation
Ultimately, while valuation multiples can provide a useful starting point, the final price often comes down to negotiation. It’s important to be realistic and ready to justify why any aspects of your business that are underperforming can be improved more easily by a buyer than you’ve been able to.
And about those complex valuation models like discounted cash flow (DCF) that you may have learned in business school? While they have their place, especially in more stable industries, they’re rarely used in fast-moving sectors like e-learning. Buyers tend to focus on simpler metrics like ARR or EBITDA, which offer a clearer snapshot of performance.
By balancing realistic expectations with a strong grasp of your company’s core metrics, you’ll be better prepared to negotiate a successful outcome for your learning tech company.
Want to understand the potential value of your e-learning business? Or perhaps just get an independent perspective on whether or not now is the right time to sell? Get in touch.