Key Benchmarks for Tech Firms: How Will Your Firm Be Valued?

In this article, we will examine key financial benchmarks and metrics that you should measure your tech firm against. We will do this against the backdrop of an exit-driven company valuation. However, this doesn’t mean it is only applicable to owners of firms looking to sell in the next few years. 

When a buyer looks to value a business for purchase, they want to understand how healthy the business is and the future growth potential (among other things). This means that the metrics and benchmarks leading to a healthy sale valuation are exactly the same as those you should monitor if you want to build a healthy, thriving tech firm. If you build like you are planning to sell, what you will have at the end is a healthy, thriving, valuable business. Whether you actually choose to sell or not is not important at this point. 

Key Valuation Metrics for Tech Firms

Bearing in mind that these metrics are important, whether you intend selling your tech firm or not, it is important for us to spend a little time defining what the key metrics are and what useful benchmarks might look like. 

Revenue Growth Rate, Gross Profit Margin, and Churn Rate are the headline metrics for company valuations in the tech sector. Though the secondary metrics may vary depending on the precise nature of where your firm sits within this sector, these headline metrics will always be important. 

Revenue Growth Rate is the measure of consistent, predictable growth within the company. In the most basic terms, this is what any investor is looking for. Even if they can see inefficiencies in how the company is run or factors that are limiting the growth, if they can see a track record of consistent top line revenue growth, your firm will have their attention. Obviously, this is also something any firm should aspire to, whether they want to exit or not. If you can achieve top-line revenue growth, it is highly likely that everything else can be managed to deliver profits in line with that revenue growth. 

Gross Profit Margin is the best indicator of the profitability of a service that a tech firm offers. For a buyer, this is a good indicator of the true value of the service in the marketplace. Again, it is a fairly blunt instrument, but it is still a key metric that most tech firms should focus on from an early stage in their growth journey. 

Churn Rate is a term many businesses won’t be familiar with. However, in the tech industry it is the one that founders will talk about most. This is particularly true if your tech firm uses a SaaS model. For SaaS firms, churn rate is a metric founders should obsess over, as it is the figure that will most notably impact both your long-term growth and profitability and the valuation multiple that your firm is likely to attract should you ever choose to sell. 

As a tech firm, if you can monitor and consistently increase each of these three key metrics, you will be on your way to running a healthy, high-growth company that, should you choose to sell, will be attractive to investors. 

Profitability Metrics

EBITDA is the most common form of valuation model for businesses that are being sold. As you are probably aware, EBITDA refers to Earnings Before Interest, Taxes, Depreciation, and Amortization. This makes it a good measure for profitability for any revenue that comes either in the form of a one off project or non-contracted revenue. 

The one exception to this would be Monthly recurring Revenue that is either contracted for more than three months or that can be exhibited by a very low churn rate (as may be the case with a SaaS tech firm). 

As a business owner, you should aim to be able to show that your EBITDA margin can hold steady over an extended period of time (years). As a benchmark, you should aim for this to be in excess of 20%. 

Cash Flow Metrics

There are many elements to consider in relation to cash flow. However, what any investor is going to look for is overall cash flow health. 

A positive cash flow profile means that you are getting paid regularly, and on time. However, it also means that your cashflow is positive rather than negative over a much longer time horizon. 

A business that can fund growth-related activities (whether that is investing in technology or employing staff) from free cash flow will be valued far more favorably than a company that has to take on debt to fund those same activities. 

A useful benchmark for tech firms to consider is in relation to the monthly cash burn and cash runway. 

Ideally, your firm should always have a monthly cash burn that is positive rather than negative. This is likely to vary considerably from month-to-month, but the goal here is to keep it positive. 

When looking at cash runway you should aim to have 12-18 months of operational expenses held in cash. Though this may seem excessive, it is a good guide to ensure that you always have cash to invest as needed, and that you have a buffer should things not go to plan. 

These benchmarks are good guidelines for any tech business to aim for, irrespective of whether an exit is planned. A business that has positive cash flow on a month to month basis and a strong cash runway is far easier and more rewarding to run for the founders than one that is always watching the cash balance when approaching monthly payroll. 

Financial Hygiene 

This is another great example of a financial best practice that will help you get a better valuation, but which will benefit any business. 

Clean, well-organized financial accounts, reports, and forecasts are the best way to exhibit the value in your business. If you can show investors how you have systematically reduced SaaS churn over the last 36 months or how you have achieved positive monthly cash burn for the last 48 months in a row, they will quickly see the value in your business. 

Similarly, for a business with no intention of selling, having this information easily available to your executive team will allow you to consistently monitor forward progress. 

We will always try to get the businesses we work with through our Virtual CFO service to always think about making sure that their business is ‘audit ready’ at all times. Though, of course, we would never welcome an audit - using this mindset to keep your standards of financial hygiene as high as possible, even when not required, will help to maximize the usefulness of your financial reporting so it can be used to accelerate growth. 

Conclusion

If you have firm aspirations to one day sell your tech firm, there is clearly far more to consider than what we could reasonably cover in this article. However, what we hope we have been able to illustrate is the general approach that should be followed, and how following valuation best practices can be of great benefit to all tech firm founders, not just those interested in a full or partial exit. 

If you run a tech firm and want greater clarity around your key growth metrics, why not schedule a call with one of our team?