When I worked in private equity, I reviewed hundreds of potential investment opportunities and every time I received information about a business, I always started with numbers. Of course, you should analyze the whole business, its market, its business model and strategy, its position among competitors, its operating capabilities and the quality of its management team but numbers need to be right. And although professional investors are a very diverse group of people, with different cultures and investment strategies, they all look very carefully at numbers. First, because their job is to create value for their « clients », who mandated them to manage their money and generate returns with it. Second, because numbers are a great way to start if you want to assess a company, to understand its reality and to predict its future. On the other hand, business owners who want to raise funds or sell company often have no clue about what investors look at and expect. They should know better. Here is a short list of numbers that investors will focus on before investing in your business. We will start here with Revenue, Growth and Earnings.
1. Revenue – The starting point
Revenue measures the level of activity of your business and tells about its maturity, its size and its commercial success. Every professional investor has a specific investment strategy and the level of revenue can be one of the criteria to select opportunities. So, depending on your revenue, you might interest or not certain investors. And as you may know, some VCs even invest in pre-revenue businesses. When looking at your sales, investors will often be interested in figuring out how stable they are, trying to understand what is recurring, coming from your existing customers, versus what is new. The objective is to assess your capacity to retain and engage customers over time, which is crucial for long term success. Investors will also evaluate the size of your market and your market share. If your market is too small, they could consider there is not enough upside potential. If it’s too big, they may think you are playing in an environment where it would be difficult for your company to strive. Regarding market share and market position, some investors will only consider market leaders, others will be happy with top 5 companies, others will support challengers or new entrants.
2. Growth – The dynamics
Growth rates can apply to different metrics such as your user base (or active user base), your revenue or your earnings and they tell about the dynamics of your company. Revenue and earnings growth are usually the most relevant to investors. A company that experience high growth is more attractive to investors as they see more potential value to be created in the near future. And the growth rate will have an impact on the valuation of your company. The higher the growth, the higher the valuation as it is easier to believe in an ambitious business plan if your business has proven its ability to grow in the recent past. Investors will look at yearly growth rates over the past few years but also recent monthly growth rates or Trailing 12 month compound growth rates. Investors will compare your company growth with your market and your competitors. If your growth rate is higher than your market’s, you are gaining market share, if it’s lower, you are losing market share. These are obviously not the same dynamics. But growth does not always matter as investors may consider other ways to create value, for example through potential margin improvement or external growth.
3. Earnings – The profitability
Earnings are critical to investors as they show the capacity of your business to generate profit and create wealth. The more profitable a company is, the more valuable it is. What about those tech companies with super high valuation and negative earnings? In that case, investors value a promising future rather than the present and bet that tomorrow the company will be larger and profitable. But the majority of investors are more comfortable with existing profit. There are different measures of Earnings and every investor has its preferred metric. EBITDA (Earnings Before Interests, Tax, Depreciation and Amortization), EBIT (Earnings, Before Interests and Tax) and Net Profit are the most popular. Investors will look at earnings but also margins (Earnings/Revenue). They will analyze their evolution over time and compare them with competitors or comparable companies. Some investors will only invest in best-in- class, that is to say companies with the highest margins in their market and others will be more interested in companies with room for margin improvement. They will not focus on the last actual earnings of your company but more on the target level of earnings that they believe your business can reach in the future.
To be continued. More numbers to come.