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What To Research Before Investing In a Private Company: Financials and Metrics (Part I)

Phil Haslett | August 03, 2015


This will be the first installment in a series of educational pieces that discuss what you should research before making a private secondary investment. This week, we'll talk about Financials and Metrics.


Financials

One assumption about private tech companies is that there's no available financial information, especially revenue. That's not usually the case: some digging through public news updates can often shed more light on the situation. The following private companies provide detailed updates on their finances:

Cloudera ($100 million in revenue in 2014)
Nutanix ($300 million in bookings run rate)
AppDynamics ($150 million in bookings in 2014)
Wish (“single digit billions” of transaction volume, 2016)

There are many others, too. Of note is that these companies publish their own numbers, and should be taken more seriously than articles that point to a "close source" for revenue numbers.

Some companies have also posted milestones that let us know approximately how many people or companies are using their services:

Practice Fusion (5,000 new active practices in 2015)
23andMe (one millionth customer in 2015)
Dropbox (400 million users in 2015)
Uber (one billionth trip in 2015)

Metrics

The most common metrics to track in the late-stage tech world are annual revenue and revenue growth. Annual revenue is simply the top-line cash coming to the company from its clients. It should not be confused with profit, which is the amount of cash that the company actually keeps from the revenue.

To compare a company's metrics against another, analysts often see what multiple of the trailing 12 months' (TTM) revenue the company is being valued at. As an example, Wish was last valued at about $3.7 billion, and had an estimated $450 million in 2015 revenue. This corresponds to a 8.2x multiple of TTM Revenue. A lower multiple is desired, as you're "paying" less to invest in the corresponding revenues (similar to value investors seeking low P/E Ratios in the public markets)

Armed with this multiple, we can compare this to other competitors in the sector (e-commerce), especially public companies:
Etsy: 2.4x
Wayfair: 1.34x

At first glance, Wish looks like a richer investment compared to Etsy and Wayfair. But we must consider growth as well.

Revenue growth looks at how annual revenue is increasing (or decreasing) year-over-year. The reason investors have been willing to invest in unprofitable tech companies is their ability to grow revenue to a point where the company can eventually generate cash flow. Successful tech companies exhibit triple digit revenue growth in their early years, and it tends to slow down (though still grow) in later, more established years as the company has dominated market share. Tom Tunguz, a VC at RedPoint Ventures, has some excellent analysis on the correlation of market cap to revenue growth.

With all this being said, keep an eye out for a few things:
Source of finance data: is it "rumored" in TechCrunch, or actually being announced by the company?
The right competition: are you comparing metrics to competitors, or companies in a different sector that may trade at different multiples?
Bookings vs Revenue: Bookings are when a company gets paid upfront for future services, whereas Revenue is realized when the company actually delivers the service. The difference is important, and you can learn more about it here from OpenView VC's blogpost.

Conclusion

Private companies offer much less than public companies when it comes to financial data. But do some digging! More and more private companies are sharing with the public their traction, employee numbers, and new offering initiatives. Make sure you compare these companies' financials to other competitors in the space, and always keep an eye out for strong revenue growth.

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