The valuation of a tech company is a not-so-difficult topic that is often discussed in the medias, especially during a string of acquisitions such as the 2 last years in the game industry.

 

What are the main methods to valuate a tech/game company ? If you sell your company, how much can you reasonably expect ? Here’s an overview of valuation methods, taking Valve and your average indie studio as examples. Hopefully this will help smaller studios/publishers to understand the basic mechanisms to assess a company’ valuation.

The money valve !

 

Foreword : there’s a difference between the VALUATION of a company, and the PRICE a buyer will pay for it. Valuation depends on the intrinsic properties of the company (its people, its assets, its history etc.), whereas the price adds the buyer and the market to the equation : is the market bullish or bearish ? Is the buyer super motivated by the potential acquisition ? etc.

 

A. VALUATION METHODS

 

1st method: DCF / Discounted Cash Flows

Aka business plan modeling. This is one of the most accurate valuation method, though it requires an in-depth knowledge of the sector and similar companies, plus very granular metrics (revenues, ebitda, working capital, tax.) on a 3 to 5 years time horizon. Objective is to project cash flows generated by the company, compute costs, then the net revenues, basically enabling a direct ROI computation to amortize acquisition cost. This method works better for more mature business. Ebitda is public information for listed companies, but arguably one of the most jealously guarded metrics for private companies, making them very hard to evaluate.

 

 

2nd method: Comparables, using multipliers

For the numerous acquisitions in the indie & mobile studios space, this is an interesting method though, as it’s pretty easy to compare studios based on sales, experience, staffcount or download/MAU. For comparables, you find a metric and to get the EV (entreprise value) you can apply a “multiplier” that depends on the metric.

●        The most used metric is Ebitda (quasi net income), an excellent proxy for cash generation. Multipliers for game industry during covid where between x10 to x20, and have been divided by 2 since.

●        Sales & gross profits are used for businesses at growth stage, especially those with a negative-ebitda but that are highly innovative, invest a lot to conquer market shares and delay the “path to profitability” to a later stage. For sales, multiplier is usually x1 to x4 and for Gross Profits (gross profit=sales-production costs), it is logically between sales & ebitda multipliers. If the company is not publicly traded but has a monopoly or a known % of market share, you can estimate their gross revenues.

 

3rd method: Comparables, by history of transactions in the same sector

This works better in a space with lots of acquisitions, such as mobile studios since a couple of years. Beware though, the entreprise value (EV) of an acquired company can include a premium of around 30% of analytic valuation, to convince shareholders to sell. Coupled with the 2nd method, the screening history of transactions also gives a history of multipliers, which in turn provides a good metric for « hotness » of a market (lots of demand drive multipliers up)

 

4th method: Market capitalisation

If the company is publicly traded, it is more easy : valuation is roughly the amount of outstanding shares multiplied by the price of each share. The share price does include some level of anticipation by the market, so this measure can be quite volatile, and at time decorrelated from the real value of the company (ex : CDPR shaving half its valuation a few weeks after Cyberpunk 2077 release)

 

CDPR Market Cap

 

Other methods

1. Valuation based on expected return : For early stages startups or when market fit is not proven, valuation can be more difficult. For example VCs can valuate a startup based on expected returns of their initial investment (they invest 10M and expect x3 in 3 years, so if things go according to plan they will valuate the company at 30M 3y after).
2. Valuation of assets : For startups with a handful of rare talents that could get a $1M salary at google, you can add up the costs of getting such talents together, even when the first line of code has not been written. Sleeping IPs (eg that don’t generate money right now) or patents can have also a good value.
3. Book value : this is a purely an accounting method that doesn’t really paint an accurate picture of a company’s true value

Usually a combination of methods is employed to determine a valuation range by triangulation.

 

B. FACTORS IMPACTING PRICE

Factors that increase price

1. First of all, if a company is targeted for acquisition, there’s a~30% acquisition premium to nudge shareholders into selling. This premium will vary based on agressiveness of acquisition.
2. Tangible or intangible assets. In the tech world, it can be a back catalog of IPs, patents etc.
3. Unfair advantage : strong barrier of entry (aka « walled garden »), a monopoly, a strong brand premium pricing strategy and high operational margin (like Apple)
4. A strong culture of innovation, a solid and reputable management team
5. A big addressable market that is growing
6. For indie studios : no game BUT a splendid number of wishlists is a good signal as it will convert under various thumb rules.
7. Boiling M&A market or an overall market growth, like games industry during covid, increase multipliers (though it also can be heterogenous depending on geographic zones as US multipliers are significantly higher than EUR)
8. The way the buyer is financed and the way the deal is structured (with earn-out, partial payment in buyer’s shares etc.)

Bullish market increase multipliers

Factors that decrease price

1. Historical shareholders with a too much power at the captable.
2. Negative business signals : excessive debt, low margin, high volatility of revenues, prior downround fundraising, founders who leave etc.
3. Dependancy on a few revenue streams and unclear go-to-market plans.
4. Lots of paid revenues (=unsustainable business model)
5. Dependancy on private platforms with monopolies, like any GAFA or Roblox, who can change revenue structure unchallenged.
6. A niche or shrinking adressable market
7. A bearish sector, like the game industry post-covid.
8. For indie studios : company with less than a handful of millions of net income (eg the overwhelming majority of indies) are considered small and will bring the multipliers down due to lack of liquidity.