Disclaimer: this blog post is primarily aimed for startup or "scale-up" employees of Business-to-Business (B2B) software companies (i.e., companies that build software products and then sell those to other companies, most commonly through a SaaS subscription model). Furthermore, my experience is mostly in the developer tooling space, so there's a bit of a bias towards that type of company here.
Early on in my career, I struggled to understand the "business updates" that were provided in the company's monthly "All Hands" meeting. I kept hearing terms such as "ARR", "YOY Growth", "CAC", "burn rate", "churn" and others. However, none of this really helped me realize the potential value of my stock options. It wasn't until a few years later that I started to grasp these concepts properly, so I decided to put some of what I've learned into a blog post to help others as well.
The first thing to understand about valuing your stock options is that in order to do it well, you need to somehow value the company as a whole. Then, you can take the full estimated valuation, divide it by the total number of available shares and figure out how much a single share could be worth. Note, however, that:
- Further funding rounds (including a potential IPO) will most likely lead to further dilution of the company's shares, which means that the percentage of the pie that you own will decrease. If the business is doing well, this shouldn't be a problem since the piece of the pie that you own should still be worth more even after dilution takes place.
- You probably need to ask a C-level (like your CEO or CFO) what the total number of shares is. This is, in my experience, not a number that's written down somewhere but you should be able to get it by asking.
Now, let's try to better understand what the potential value of the company could be.
What Is the Value of a Company?
- If the company is acquired, how much the acquirer is willing to pay for the company will greatly depend on what the acquirer plans to do with their new asset (and on who has more leverage during the sale process of course). As an example, being acquired by a private equity firm is extremely different from being acquired by a big tech company.
- When a company raises a funding round and sells some of its shares, the valuation is determined by a lot of factors. However, ultimately, the valuation depends on what the venture capitalists are willing to value the company at.
- If the company is public or going public ("IPO'ing"), then its value will be determined by the collective agreement of the public markets (i.e., millions of computer algorithms and many individuals' combined opinion on how much the company is valued at).
With all this in mind, the two main metrics to look at when valuing a private B2B startup are its yearly revenue and its revenue growth year-over-year (YoY). I consider profitability slightly less important just because most VC-backed companies don't yet make a profit and have a reasonable amount of burn (well actually, lots of companies have been burning more than they should as of late but I think that is mostly getting corrected now). Of course, profitability is important and the business needs to operate with healthy margins. But, for rough estimations, revenue and year-over-year revenue growth should suffice for getting an idea of the valuation of the business.
These metrics are typically available to all employees within a company but might not be shared frequently. As such, it might be up to you to ask about them in the company's All Hands meeting. In my experience, employees are very keen on asking the CEO "When are we going to IPO?". Obviously, the answer is very complex and it doesn't usually help people a lot. Instead, I recommend asking for some of these metrics as they will help you understand how the business is doing.
But, how can you take revenue and YoY growth and come up with a valuation? The most effective way is by comparing your company with similar public companies. For instance, in the case of SingleStoreDB (where I currently work), I often compare it with MongoDB, Snowflake and Elastic (there was also Cloudera before but a PE firm acquired them and made them private again). However, comparisons with existing public companies is not always possible, and so you may also have to look at previous acquisitions in the space. This is much harder because when private companies are acquired, business metrics are not usually shared publicly.
As of the writing of this article, let's look at the multiplier of yearly revenue to market cap (valuation) of various SaaS companies in the developer tooling space (the industry that I'm most familiar with).
YoY growth of developer tooling SaaS companies
|YoY Growth ↓
|Up a lot (17%) since Apple Vision Pro was announced
A few notes on the above table:
- The yearly revenue column refers to the total revenue of the company during their last full fiscal year. Most of these companies had their last fiscal year end somewhere around February to April 2023 (this blog post is being written in June). However, notice that the valuation column is from June 25th 2023. So, there is a very large disconnect here. Take the data with a grain of salt, especially since some of these companies have recently published Q1 earnings report for their new fiscal year and that has affected their stock already.
- It'd probably be better to use forward projections of yearly revenue and compare those to your startup's ARR estimations. This way, you can avoid the very large disconnect mentioned in the previous bullet point.
- We can see that high revenue to valuation multipliers are reserved for companies that are still showing a lot of growth. Wall Street cares a lot about growth, and those companies basically have a lot of future revenue baked into their current valuation.
- This is an extremely simple representation that aims to show how important YoY growth is. CAC (Customer Acquisition Cost), Customer Lifetime Value (CLV), TAM (Total Addressable Market) and profitability are also really important.
Just putting together this table has been really educational for me. I can now more easily figure out how much my employer's valuation could one day be, since as an employee I know what our yearly revenue and YoY growth are. But we have to be extremely cautious! There are many other factors at play here such as:
- Whether the company is operating in a "hot space". For instance, Unity listed above, had its stock roar after Apple Vision Pro was announced. This announcement effectively increased Unity's TAM and so their valuation jumped a bit.
- The company's profit margins need to be healthy. I've mentioned this before but obviously investors don't like it when companies need to burn too much to increase their revenue a lot.
- The stickiness of the business and how easy it is to sell to new customers. Are customers churning a lot? Or is it too hard to acquire new customers? CAC and CLV will give you indications for this. The less you need to spend to acquire new customers, and the longer they stay (or the more money they pay you while they stay), the more valuable your company is.
- Whether the company is making a lot of money through professional services or not. For instance, Appian listed above, has roughly 27% of its revenue coming from professional services. That certainly does not help their valuation. If your company requires a lot of human-hours to service its customers, compared to companies whose customers mostly self-serve their software, it's likely that your company's valuation will be inferior to theirs.
Summing It Up
In this blog post, we mostly looked at how you can try to value the company that you work for. In order to actually be able to "value" your stock options as a startup employee, you need to look at a few more things that just their potential value. A couple of important things are the exercise price (how much it will cost you to convert those options to shares), and the taxation implications of both the exercise and the future sale of those shares. In some countries, it could be a good idea to exercise options early on, even if you're unsure about their potential value (since the risk is very low).
I don't really have a heuristic or simple formula to provide here, but you can probably look at your stock options and consider them for a percentage of their total expected value (this percentage should be higher the closer you are to IPO). In other words, when you think about your total compensation, you can presume that the stock is worth $0 if it's a very early stage startup. You should join these companies for the challenge and learning opportunities, not for the potential value of the stock down the road. The chances of there being a liquidity event (IPO, acquisition, secondary rounds) is quite low here. On the other hands, if it's a later stage startup, you can probably assume that the stock will be worth 50% of what you can value it at.
Hopefully, this blog post has been a useful first step for startup employees who are looking to make sense of the potential value of the company they work for. I know it took me much longer than I would have liked to properly grasp all these concepts, so I want to help others get there more quickly.
I would really appreciate any feedback on all of this, and to hear from others on what they still don't understand about stock options in general. Feel free to reach out on Twitter!