How does a company (squarespace) get 40million in minority investment when its revenue is say 5 million?
If a company (squarespace) is doing around 5-8million, how could they possible get a minority investment of almost 40 million?
Minority to me means less than 50%, so that would put the companies valuation at over 100 million.
How can a company be worth over 100 million when its gross revenue is 5-8million?
(it was actually doing only 2.2 million in 2009: http://www.inc.com/inc5000/2009/company-profile.html?id=200903390 )
I don't know much about valuation or venture investments, so I would love for someone to explain this to me.
Software Application Investors
1 Answer
I look at value in two ways.
The value of expected future cash flows is commonly PV = CF/(r-g)^t
PV = the present value
cf = cash flows (net income is normally sufficient)
r = the discount rate (the expected rate of interest that someone would get risk free. g = the expected annual growth rate of the cash flows t = time period (typically stock can be seen as a perpetiuity so it can be removed) This formula doesn't do a good job for taking in risk and such and there are more refined models to deel with that but for illistrative purposes of why would the investment be rational. So how could a rational person pay 40 million when current sales is 5 - 8 million. Well the first thing I see is that in 2009 it was 2.2 million then in 2010 its expcted to more then double that is a very fast growth rate. That reduces the size of the denominator by a significant amount making the expected cash flow for each period add more value. Now I may have miss remembered some of the formula though finance is what I'm educated in, I long left that as a career. However the concept of the value of the future discounted cashflows is the reason for high price to earnings ratios can occur. In the end though the investor needs to believe that the expected result will be true. A reason for them to be certain of the future cash flows for the investor is the key for the model to work.
