Thanks for the post, it feels like you are bringing business valuation back to the basics.
EBITA and FCF are for sure the key metrics of a healthy business.
The only problem is - what do they say about the future ? Valuation of startups by Private investors is supposed to indicate a future value of the business, as valuing them on the current numbers (Published or Private) does not reflect what they could be .
This is very difficult to get right as it is, maybe made worse in the past by all the cheap capital.
With the current levels of cost of capital, Do you see this changing ?
How about setting up a roadmap of future cashflow and net profit (Goals) with the startups founders and make valuation a dependent function of the same and have the valuation change periodically ( capital raise or not) as a way to enforce the goals.
Even if this was done somehow, how do you factor pivots and unpredictability of asset value for the investors.
I operate in a very different sector of the economy than your high tech folks. (I am a master carpenter, builder and author of five books, primarily about construction company management, for small volume builders).
So I was startled to learn from you that your glitzy hi-tech guys are immersed in the same fuzzy brained thinking that so often undermines my guys -- artisan builders with small companies. They are often pushed by the consultants they hire to focus on "growing" and to equate growth with revenue expansion rather than with growing the kind of financial strength that is realized by creating a lean and profitable operation, building up capital and successfully deploying the capital into profitable investments.
In my view, net revenue equals financial success. Nothing else does. I am even dubious about gross profit margin as a measure of success. I once heard a prominent industry consultant assure her audience of remodelers that if they produced 40% gross profit margins they were doing well. A member of the audience (a reader of my books as it happens) piped up and said something like "I don't get that. If your gross profit margin is 40% and your overhead is 38%, how in the heck does that equate to financial success." The speaker blew him off. Btw, Warren Buffett is also dubious about GPM as a measure of value of a company. It so obviously is not!!!
In our industry, building up of capital is crucial to long term survival -- not to mention achievement of financial freedom. When the economy goes into recession, construction goes into depression. From what I have seen, the ridiculously low survival rate of construction companies (less than 1% last over a decade) is due in good part to getting the big head during boom periods when revenue is growing, recklessly deploying possible profit into expanding overhead -- think $80K pickup trucks , or what I call the the "shiny truck syndrome".
What's the equivalent of shiny truck syndrome in your industry? David Sacks and his All In brethren hint at what it might be. They decry Founders continuing to throw capital around recklessly. For Chamath and David themselves it seems wine for one and fancy sweaters for the other. They tease Freidberg for being careful with money. Freidberg is the guy I would trust with my money.
Thanks for your thought provoking article.
David Gerstel
DavidGerstel.com -- Clear Thinking for Construction Professionals
Very interesting posts, this one and the previous one, Nikhil !
Hi Nikhil,
Thanks for the post, it feels like you are bringing business valuation back to the basics.
EBITA and FCF are for sure the key metrics of a healthy business.
The only problem is - what do they say about the future ? Valuation of startups by Private investors is supposed to indicate a future value of the business, as valuing them on the current numbers (Published or Private) does not reflect what they could be .
This is very difficult to get right as it is, maybe made worse in the past by all the cheap capital.
With the current levels of cost of capital, Do you see this changing ?
How about setting up a roadmap of future cashflow and net profit (Goals) with the startups founders and make valuation a dependent function of the same and have the valuation change periodically ( capital raise or not) as a way to enforce the goals.
Even if this was done somehow, how do you factor pivots and unpredictability of asset value for the investors.
hi Nikhil,
I operate in a very different sector of the economy than your high tech folks. (I am a master carpenter, builder and author of five books, primarily about construction company management, for small volume builders).
So I was startled to learn from you that your glitzy hi-tech guys are immersed in the same fuzzy brained thinking that so often undermines my guys -- artisan builders with small companies. They are often pushed by the consultants they hire to focus on "growing" and to equate growth with revenue expansion rather than with growing the kind of financial strength that is realized by creating a lean and profitable operation, building up capital and successfully deploying the capital into profitable investments.
In my view, net revenue equals financial success. Nothing else does. I am even dubious about gross profit margin as a measure of success. I once heard a prominent industry consultant assure her audience of remodelers that if they produced 40% gross profit margins they were doing well. A member of the audience (a reader of my books as it happens) piped up and said something like "I don't get that. If your gross profit margin is 40% and your overhead is 38%, how in the heck does that equate to financial success." The speaker blew him off. Btw, Warren Buffett is also dubious about GPM as a measure of value of a company. It so obviously is not!!!
In our industry, building up of capital is crucial to long term survival -- not to mention achievement of financial freedom. When the economy goes into recession, construction goes into depression. From what I have seen, the ridiculously low survival rate of construction companies (less than 1% last over a decade) is due in good part to getting the big head during boom periods when revenue is growing, recklessly deploying possible profit into expanding overhead -- think $80K pickup trucks , or what I call the the "shiny truck syndrome".
What's the equivalent of shiny truck syndrome in your industry? David Sacks and his All In brethren hint at what it might be. They decry Founders continuing to throw capital around recklessly. For Chamath and David themselves it seems wine for one and fancy sweaters for the other. They tease Freidberg for being careful with money. Freidberg is the guy I would trust with my money.
Thanks for your thought provoking article.
David Gerstel
DavidGerstel.com -- Clear Thinking for Construction Professionals