ARR multiple
Why it matters
The multiple turns a revenue figure into a price, so it sets what a founder receives in a sale and how much of the company is given away in a raise. At €1 million of ARR, the difference between 3 times and 6 times is €3 million of value.
In a raise it also decides dilution. If a company is valued at €4 million before an investment, then €1 million of new money buys 20 per cent of the company (€1 million out of €5 million after the investment). A higher multiple means the same money costs less ownership.
It also gives owners a list of what to work on. Growth, retention, margin and customer concentration are all things a team can improve, and buyers pay for the trend as well as the current figure.
How to apply it
- Count recurring revenue only. One-off project fees, set-up charges and hardware sales do not belong in ARR.
- Compare with recent sales of businesses of a similar size, growth and sector, not with headline multiples of large listed companies.
- Treat the multiple as an opening position in a negotiation, not a fixed price.
- Work on the drivers a year or more before a sale or a raise, because buyers pay for the trend as well as the current figure.
What it is
An ARR multiple is a shortcut for pricing a subscription business. Take annual recurring revenue, the yearly value of contracts that keep renewing, and multiply it by a number that buyer and seller agree on. A business with 1 million euros of ARR valued at 4 times is priced at 4 million euros.
The result is normally an enterprise value: the value of the operating business before cash and debt are counted. What the owners take home after debt and cash is a separate calculation.
Common mistakes
- Applying a headline multiple from a large listed company to a small business.
- Counting one-off fees, hardware or services in ARR to inflate the base.
- Treating the multiple as a fixed price instead of an opening position.
- Confusing enterprise value with what the owners take home after debt and cash.
- Starting to fix churn only when a sale is being prepared, when buyers have already seen the trend.
Why the multiple moves
No fixed multiple exists. Buyers pay more for revenue that is likely to continue and grow. The main drivers are:
- Growth: a faster compound growth rate earns a higher multiple.
- Retention: low churn and high net revenue retention show that customers stay and spend more over time.
- Margin: a business that keeps most of each euro, see gross margin, is worth more than one with heavy delivery costs.
- Concentration: a business that depends on one or two customers is worth less per euro of ARR.
- Market conditions: the same business gets a different multiple when investor appetite changes.