The typical first reaction to hearing an investor paid 100X trailing twelve months or annualized current revenue to a company is, “What could possibly justify that valuation?”
Well, I’m shocked everyone is so shocked.
What I know is that the 100X investor has performed an analysis using a set of assumptions that justified the thesis that this investment will be a profitable.
Early-stage technology investors are risk-oriented and prepared to lose their investment. However, their analysis has convinced them there’s a better chance they will make money.
So, what justifies 100X?
Answer: A data-informed belief that revenue growth rate (and ultimately profit potential) will be so rapid that, in several years, the valuation paid today will look prescient to the valuation awarded in the future.
In my 45 years as a technology investment banker, I’ve lived through multiple valuation manias. I’ve built the spreadsheets showing investors a valuation is justified. These are never based on a single approach; a single multiple. Rather, the justification is derived from a combination of factors that collectively indicate future performance potential.
If an investor is convinced the “rocket ship” they’re investing in at a valuation of 100X current revenue is equivalent to 1x three-year forward revenue (the revenue it will achieve in the third year after the investment), it absolutely represents the kind of return venture capitalists seek.
Certainly, we know from any number of past examples that increasing annual revenue 100X in three years is rare. And it explains why down rounds occur for companies that overpromised and underdelivered.
But investors have no intention of pissing away their money.
The fact is the 100X Club, rocket ships and unicorns do exist. So, if someone invests what others deem a crazy amount, you can bet they’ve done the math. They have a reason to believe the 100X investment is worth the risk.
Now they may be wrong, or they may exceed their revenue projection, but they have a strong rationale for moving forward.
To understand why a 100X investment decision is not crazy, you’d need to do the math too.
But isn’t that the business and financial media’s job? Not to do the math per se, but to help readers understand the real thinking behind these choices. That would be far more helpful than suggesting venture capitalists are flying on a wing and a prayer.
