Valuation Guide: Revenue Growth
When determining a business’s worth, revenue is a critical factor because it directly reflects profitability and growth potential. For business owners considering selling, any type of growth might appear as a signal of increased value. However, for acquirers, the nature of the growth—how and when it occurred—is as important as the numbers themselves.
We’ll explore two types of revenue growth, rapid revenue growth and incremental year-over-year (YOY) growth, and how each impacts a business’s valuation.
Rapid Revenue Growth
Rapid revenue growth refers to a swift and substantial increase in revenue over a short period. A classic example might be a SaaS startup that experiences a high growth rate in its early stages, fueled by strong market demand and aggressive marketing strategies.
Advantages for Valuation
Attracts Investors Seeking Quick Returns
Rapid growth can signal to potential buyers that the business is on the verge of a significant breakthrough, making it an attractive investment.
Competitive Bidding and High Valuation Multiples
Businesses experiencing rapid growth often generate interest from multiple buyers, leading to competitive bidding and higher valuation multiples.
Market Dominance Perception
High growth rates create a sense of market dominance and consumer demand, which further justifies the elevated valuation.
Drawbacks of Rapid Growth
Sustainability Concerns
High growth rates are often difficult to maintain, posing a risk for acquirers if the business cannot scale effectively.
Operational Inefficiencies
Rapid growth can mask underlying problems, such as inefficient processes or stretched resources, which may become costly after acquisition.
Volatility Risk
Businesses with rapid growth are more vulnerable to market competition, regulatory changes, or economic downturns, which could disrupt future performance.
Incremental Year-over-Year (YOY) Growth
Incremental YOY growth refers to steady, predictable increases in revenue over time. This is typical for established businesses in mature industries, such as manufacturing or automotive.
Advantages for Valuation
Predictability and Stability
A proven history of growth makes the business attractive to long-term investors seeking reliability and is also indicative of lower churn/customer attrition.
Lower Operational Risk
Established business models reduce the uncertainty and operational risks for acquirers, making the investment safer.
Forecasting Future Growth
With a consistent growth history, future performance becomes easier to project, adding to the business’s appeal.
Drawbacks of Slow Growth
Perception of Limited ROI Potential
Acquirers looking for particularly quick returns may view slower growth as a disadvantage, leading to lower offers.
Vulnerability to Disruptive Competitors
Mature businesses are often at risk of being overshadowed by newer, fast-growing competitors that capture market share and innovation.
Additional Factors in Business Valuation
While revenue growth is essential, other factors also play a role in determining a business’s valuation:
Market Conditions
Market Dynamics
Businesses in fast-paced markets might see higher valuation volatility, as acquirers weigh the shorter lifespan of the investment against potential gains.
Competitive Threats
Disruptive competitors in the market could impact future profitability, making the business less attractive.
Type of Acquirer
Private Equity, Holding Companies and Strategic Acquirers
Private equity firms may focus on short-term profitability, valuing rapid growth higher, whereas holding companies and strategic acquirers might prioritize long-term sustainability, favoring incremental growth.
Investment Goals
The acquirer’s objectives—whether for a quick exit or long-term integration—will shape their perception of the business’s value.
Balancing Rapid Revenue Growth and Incremental YOY Growth
Both rapid revenue growth and incremental YOY growth offer unique advantages and challenges in business valuation. Rapid growth can boost short-term valuations and attract aggressive investors but comes with significant risks. Incremental YOY growth provides stability and long-term value but may not appeal to acquirers focused on immediate returns.
For business owners preparing for a sale, understanding how different growth profiles influence valuation and aligning their strategies with the right acquirers can maximize their business’s worth. By evaluating growth not just in terms of numbers but also timing, sustainability, and market conditions, sellers can position their business for a successful and profitable sale.
