Pricing vs Valuing Companies - The EV/EBITDA Multiple

Live from Schenectady, New York, it's SaaS Talk with the Metrics Brothers, Growth and CAC.

And I'm Growth, better known as Ray Reich, the founder and CEO of Benchmarkit.

And I'm CAC, better known as Dave Kellogg, independent consultant, EIR at Balderson Capital, and the author of CalBlog.

And together we are the Metrics Brothers.

And we go together like tapas and sangria.

Ah, back to food and drink, huh, CAC? What were you in Spain or something?

I was indeed, Ray. Balderton had their biannual CEO summit in Mallorca.

Mallorca? Isn't that some fancy resort island and like in the Mediterranean?

It is. It is. In fact, when I told the customs agent I was going there for work, they almost strip searched me because it's like nobody goes to Mallorca for work. It's like I am, I am.

Well, I am so excited to see that VCs are still having good partner meetings. But since we're talking about VCs, maybe it'll be interesting to talk about using financial performance metrics and how they're used to value companies like the enterprise value to EBITDA multiple—a specific idea of how people price versus value company.

What do you think about that? Yes, right. I think it's a great topic for today. By the way, it was the CEO summit. It wasn't just the VCs' luxuriating. They were going to portfolio. companies, CEOs, and founders. But yeah, I think it's a great idea. But before we do that, we should hear a word from our sponsor.

The Metrics Brothers is proudly sponsored by Benchmarkit, the B2B AI and software industry's largest, broadest, and most contextualized benchmarking index. Dave Kellogg and Ray Groth-Rite have put the Metrics Brothers podcast on hiatus for the remainder of 2026. All episodes we have ever recorded are still available on your favorite podcasting app. You can reach Dave @Kellogg and Ray on LinkedIn @RayReich. Thank you so much for listening to the Metrics Brothers podcast. Okay, Dave, before we dive into this episode, I think we need to remind people of our financial disclaimer.

We do, Ray. First, there's always one at the end of every episode people should listen to because it's informative and funny. But we'll preface this by saying, look, we're going to talk about SaaS metrics today that investors use to value or price companies. So we should remind people basically, Ray, that we don't give investment advice. If we did, it was probably wrong. And this is for information and educational purposes only. And finally, that all data points we reference today will be kind of current as of our date of recording to the best of our ability and coming from 2 sources primarily. One is Meritech Public Comps, the other being an Adventist survey of SaaS companies.

Okay, everybody should listen to the end of the podcast disclaimer because it's not only Educational. It's quite entertaining, Dave. But let's get into the outline of this episode. At the end of the day, we're trying to talk about how do you determine what is a SaaS company worth, correct?

We are, Ray. And let me start with asking you, what's your house worth?

Well, I don't know if I want to share it here on the podcast, but I can tell you that there's a number and I would put it in dollars.

Yeah, yeah. Sorry, I didn't actually mean literally, right? Conceptually, what's your house worth?

Oh, I got it. Well, it's, it's whatever someone's willing to pay me for it, Dave. There we go.

Thank you, Ray. I wasn't trying to get personal with you here on the show. Yes, that's one way to determine what something is worth, Ray, right? What someone is willing to pay for it. When we're talking about companies, there is another way to determine what it's worth, which is more intrinsic, which is what it's worth based on the value of its future cash flows. And by the way, even your house, you could rent it and it could generate future cash flows. So let's talk about the inspiration for today's episode in that vein. Which was a recent April paper by a Morgan Stanley analyst named Michael Mauboussin, probably pronounced Mauboussin for American English. I speak French, so I want to say Mauboussin. But in any case, the title of this paper is Examining Valuation Multiples: What They Miss, Why They Differ, and the Link to Fundamentals. And this paper goes into considerable depth. It's 26 pages long. We are just doing the basics. Finance nerds should read this paper, you will love it. And he just makes one pretty simple distinction, which I really like, Ray, which is the difference between what he calls pricing a company versus valuing a company. Do you want to explain to people what he means by that?

Well, pricing, you know, is what are others willing to pay? And if you think about that as far as companies' value, right, it's, hey, how much are they willing to pay for a share of the stock? That's why we look at the price the stock times number of shares outstanding to get market cap, right?

Sure, yeah. So that's pricing. There's pricing and valuing. And let's talk about pricing. What's a company worth? And market cap is the, the metric, uh, and market cap is basically price per share times the shares outstanding. And just to make this real, Ray, um, let's look at 3 companies. Salesforce, its market cap today is $238 billion, a lot of money. Zoom, despite being the COVID high flyers, worth a paltry, relatively, $18 billion, still a lot of money. And BlackLine, one of my favorite kind of niche SaaS applications in account reconciliation, is worth $3 billion today. But Ray, do you wanna talk about cash and how it can get in the way when we talk about these, this company, this notion of company worth?

Yeah, because you mentioned the market cap of 3 companies, but there's an example, Nextdoor, and I think there was a, In February, there was an information article about Nextdoor. They had a $662 million market cap, Dave, but they also had $540 million of cash in the bank. So I'm like, well, wait a minute, how much is the company actually worth if they have $540 million? And that was $122 million. And that is known as the enterprise value, which is you take your market cap, you subtract the cash, And you add debt, correct? That's how you get to enterprise value.

It is. And it's certainly, as Ray demonstrated, it's a better measure of worth of that business than market cap. 'Cause as it turns out, what, 5/6 of Nextdoor's valuation at that time was just simply the cash they had in the bank. And in this case, you almost had to get a residual value, right? After the cash, what is the actual business worth? And the answer was only $122 million. So that's why people use enterprise value, 'cause we will kind of want to cancel out the noise introduced by large amounts of cash and/or large amounts of debt. Let's do some real examples here. Back to our same 3. Salesforce, its enterprise value is $233 billion compared to its market cap of $238 billion. So virtually the same. Zoom, its enterprise value is $11 billion compared to its market cap of $18 billion. That's a big difference. Why? Well, they were such a high flyer. They raised a lot of money during the good times. and they have $7 billion of cash, probably also generated from operations, sitting in the bank. Blackline, their enterprise value is actually higher than their market cap. It's $3.4 billion versus $3.3, suggesting from the formula that they're carrying debt greater than the amount of cash that they have. So, but ultimately, Ray, this is still not that useful. You wanna pick up here? You want me to keep going?

No, why don't you keep going? 'Cause as we were preparing for this episode, you did talk about the comparison to real estate. So let's use that real estate comparison.

Okay. Yeah, I love that example. So let's just pretend we're trying to figure out how 2 houses are valued. And I tell you they're both worth $1.5 million. And then I tell you one is in our favorite city, Schenectady, our production location in theory. And the other is in Manhattan where you live, right? And we need some way to normalize that because I know I've got a $1.5 million house in Schenectady. I've got a $1.5 million house in Greenwich Village.

Right.

Not that you're there, but in Manhattan, that's the one I've picked for this example, real apartment. If I normalize them, what is the right metric to normalize those 2 prices? And in real estate, the answer is square footage. So we're going to say, hey, wait a minute, what are they worth on a per square foot basis? Well, that Schenectady house is 6,500 square feet. It's massive. So $239 per square foot. That Greenwich Village apartment is only 900 square feet. So $1,700 per square foot. So basically a 6 to 7x difference. in price per square foot, but they have the same price, which begs the question, if we're going to normalize real estate by square footage, what do we normalize a company by?

Well, this is not HGTV, so let's talk about that, because I kind of think about the cloud and SaaS marketplace, and one is size, so it could be revenue or ARR, but then there's this concept of Valuing it based upon profitability, i.e., the square footage. But you have a couple different choices. You have EBITDA or free cash flow. What do you think about which of those is the best to use?

Yeah, so, so I think, by the way, all of the above, Ray, are really the equivalent of square footage because we're just using square footage as the normalization metric. And, and the question is, do we want to normalize based on size— how big is it— or do we want to base it based on profit, like how profitable it is? And then you make that decision and you pick 2 good metrics. If you're going to do size, revenue and ARR are clearly the top 2. And if you're going to do profit, EBITDA and free cash flow are the top 2. And I'd argue that first we should look at profit today because our episode is on EV to EBITDA and that is a profit-based valuation. And that, look, I think you and I would agree that free cash flow is a better measure. We'll come back to that. But I can tell you in the private company SaaS world, EBITDA far and away is the more commonly used metric. And since a lot of the companies in our audience are either owned by PE already or might be selling to PE in the future, I think we should focus on EBITDA. So we'll come back and touch on cash flow, but let's do EBITDA first. Right.

Okay. Well, let's talk about some of the pros of EBITDA. And you mentioned one, private equity people use it. But what, what are some of the other pros?

Sure. And let me remind people what it stands for. So EBITDA is earnings before interest, taxes, depreciation, and amortization. It's an acronym, in effect. Ray hit the first pro, very commonly used in PE when they think about buying and selling companies. Because of that, it's used in PE for setting management targets. You'll meet management teams whose bonuses are hooked to EBITDA, right? And that's no coincidence. One other odd thing I like, not everyone buys this argument, but one thing I like about EBITDA is PE firms typically buy the entire company. So I don't really care how much or how leveraged the last owner was, how much debt they put on you and how much interest that is, the effect of that interest on your profitability. Because I'm going to buy the whole company. And from my perspective, whether I write a check for $200 million and buy the whole thing, or write a check for $100 million and borrow $100 million, that's a purely financial decision in my mind. So I'd like to separate that decision because I'm buying the whole company. How I— what I pay for it is one question, how I finance it is another. And I feel like by using EBITDA, I'm excluding the other guy's cost of interest, which makes sense to me, because I'm going to model that for me. So I actually think in some ways it's a pure metric because if you're buying the whole thing and you could easily write a check for either the whole thing or just lever it up, then why do I care about how much interest you're paying? Right. That's going to be my decision.

I'm going to ask you some of the downsides or cons of EBITDA. But one for me is it's not a GAAP-defined term. It can be gamed, right?

Correct. It's definitely not standardized. It's not GAAP-defined. There's adjusted EBITDA and community-adjusted EBITDA, the old WeWork example. Right. So, so people game the heck out of EBITDA. But, but, but that's the first problem. The second is more fundamental, which is, you know, you're going to be excluding amortization, right? That A is amortization. And, you know, sales commissions in a SaaS company get amortized. Stock-based compensation gets amortized, right? Stock-based comp never hits the income statement, but it will hit the shareholders in terms of dilution, right? Because more shares get issued. Ditto for capitalized R&D. So you're excluding kind of very real expenses That you may capitalize. And first, by the way, some people in their EBITDA will not— they'll do— they'll take the GAAP sales expense, not the amortized one. So right there you have confusion. Like when I look at EBITDA, I'm like, okay, well, how are you treating stock-based comp? Usually that's backed out. Sales commissions, sometimes because they're closer to an operating expense, are rolled in. So, so, so welcome to the confusion of EBITDA. Ray, I know you know that traditional investors hate EBITDA, so I'll let you do the rant here.

Well, I think 2 of the most traditional, i.e., older investors are Warren Buffett and his partner Charlie Munger, even though Charlie's no longer with us. But Warren was known to say that by trumpeting EBITDA as a financial metric, it really is a pernicious practice. In fact, he's saying implies that depreciation is not truly an expense because it's a non-cash charge. What he says that really impacts the value of the company. Then Munger said in his famous kind of salty way, if someone says the word EBITDA, you should replace it with the words bullshit earnings.

Yeah, Charlie didn't put too, too fine a point on that there, did he?

But private equity people don't really care about the objections. Why is that?

Well, I don't, I don't know if they care. I think they don't care, Ray, because I think What Buffett and Munger were talking about is when management teams kind of tout EBITDA to investors and they say, look over here, don't look at net income, look at EBITDA, look how profitable we are. And that's where those objections ring true to me. I'm not sure, you know, when a PE buyer is buying a software company, they're not listening to management tout anything. They've built their own financial model. They have full financials. They're calculating their own metrics. They're defining EBITDA the way they want it defined. So they're definitionally happy with it. So I think a lot of the objections go away. I think the PE people use it for 2 reasons. One, because other people, other PE people use it, right? That's a great reason to use it. But secondarily, because in their world, I think it's actually not a bad metric for profitability. And it's better than net income because you're getting rid of depreciation. You're getting rid of taxes, which will vary based on how much profit you have and other things. And they're getting rid of amortization. Which for some things ring truer than others. Like for stock-based comp, it does ring truer. One, I control directly how much stock I give management, right? I'm not an investor who's at the whim of some board granting shares to employees. I control that directly. So I don't want stock-based comp in there. And I'm less clear on capitalization of R&D and other things that they probably look at cash as well there. But long story short, I think when it's being touted by management to uninformed investors, it's kind of evil. But PE people are the opposite of uninformed. Like, there's never anyone more informed than a PE person thinking of buying your company.

Well, in these last 5 minutes of the episode, let's talk about the enterprise value to EBITDA multiple and kind of what's happened to that over the last few years at a median. And then let's see if there's a better way to value companies.

Yes. So look, one of the biggest downsides of EBITDA in my mind for you and me is it's not really included in public company SaaS benchmarks. Like my favorite source, Meritech, doesn't have it. I think some of the other ones I looked up doesn't have it either. So it's weird. In the PE world, it is the go-to metric. And we have survey data here. Look, my rule of thumb, Ray, is that PE people typically like to pay 16 to 20x EBITDA for a company. That has gone up during the, you know, the ZIRP times. It got up to 30x at median. But if you look at the historical average, it runs in my range of 15 to 20x. So I think the short answer is if you want to know what a PE person is likely to want to pay for your company, it's 16 to 20x. And if you get a big more going, you might get it up to 2025, uh, if you're lucky. Um, I would also point out there's what I call the indifference equation, which is 5x revenue equals 15x EBITDA at 33% EBITDA margin. And, and I think that's one of those kind of fundamental simple truths that founders should remember.

Okay, here at the end of the podcast, let's pivot to a metric that I know I like better than EBITDA, and that's free cash flow. And it's also one of the most popular ways to calculate the Rule of 40. Right. You take your growth rate plus free cash flow margin. So is there an equivalent where we can use free cash flow, Dave?

Yeah, I think public company people use enterprise value to free cash flow much more so than enterprise value to EBITDA. You'll find it in Meritech. As you mentioned, free cash flow is kind of won out as the profit metric in the Rule of 40. So I think if you're a public company SaaS and you want to look at something, or even private, you can do free cash flow. And to go back to our same 3 companies, Salesforce is currently valued at 20.1x its free cash flow. Zoom at 7.8x its free cash flow. There's an interesting thing about these metrics. BlackLine has a non-meaningful one. Why? Because they have negative free cash flow. And this is one reason people calculate off revenue, because when you're comparing a set of companies, some of which aren't profitable, this metric falls apart. The median in Meritech's set is 29x and some outliers. Klaviyo is trading at 52x free cash flow. So very, very highly valued. Think $2,000 a square foot. Right. And Expensify is selling at 5.5x free cash flow, um, which is very lowly valued. You know, think, uh, you know, $100 a square foot.

Yeah. What's interesting, you talked about people also use that kind of enterprise value the next 12 months revenue, and Salesforce is at 6.1x. But what's interesting is BlackLine, which has a negative free cash flow, their enterprise value to revenue is 5.2x. which is 2 times greater than Zoom's 2.4x, and they have an enterprise value to free cash flow of 7.8x. So it's not always directly correlated, Dave.

Yeah, it's definitely not. I mean, they're measuring different things. I mean, Zoom is most definitely in the penalty box, um, with investors, uh, because that, that EV to ARR— or sorry, EV to revenue— is really, really low, uh, where the median there is 5.2x. So, but yeah, that's why we look at different metrics, right, to see different things. And you can see that basically I think for BlackLine, 'cause it's still a relatively small company, people are betting on its ability to produce profit in the future. That's why it's getting a respectable revenue-based valuation.

Yeah, and we won't even— I'm sorry, go ahead. But I thought we might not even mention the last 2. Palantir, right? The AI train. They're at 18.9x enterprise value next 12 months revenue. And poor Domo is at 1.1x.

Yeah, in the doghouse. Okay, so I know we only got a minute or 2, or 2 minutes left here, Ray. Let me— let's talk about the second way to value companies. Because in Mobusan's paper, I think he, he makes an excellent point. It doesn't take long to communicate. But, but way one, where we spent the vast majority of the episode, is to what, what are other people willing to pay for this thing? And we talked about what worth is. It's really enterprise value, not market cap. And then we talked about different ways to normalize it based either on size or profit. Because EBITDA was our focus today, we tried to spend most of our time on EBITDA. But the other way to value companies is through the present value of future cash flows, which is something all MBAs learn and sounds very bottom-up. We're going to build a model of the company for n years, typically a 3 to 5 year model, right? And we're going to see how much cash is coming out of it. And then we're going to do discounted cash flow analysis where we get the present value of all those future cash flows. And there's 2 issues with this. One, somebody determined, and Mubusa has the source, that 75% plus of the resultant value in such models come from outside the explicit forecast period. So they model 3 to 5 years in detail and then assume some constant for all futures, some constant growth rate and free profitability. And like just the way the math works, 75% of the value is based on those long-distance, those long perpetual assumptions. And the other is they'll often include in the valuation an EV to EBITDA model. And the result, MobySense says, is basically you have multiple analysis dressed up as a discounted cash flow model, which is something that had never occurred to me before. And I thought was super interesting.

That is— we, we need to include the link to, uh, Mauboussin's paper in the summary of this podcast. So for those who want to read it, please, please just click on the link.

Yeah, in the meantime, you can just Google valuation multiples, what they miss, why they differ, and his name, Mauboussin, M-A-U-B-O-U-S-S-I-N, and you'll definitely find it. And it is publicly available.

Dave, I really enjoyed this because I, I read a couple papers I hadn't read before. I learned some new things, so I hope the listeners in the audience enjoyed this as much as I did. Thank you.

Yeah, me too. Thanks a lot, Ray. See you next time. Okay, bye-bye now. The Metrics Brothers: AI, SaaS, and More is a production of The Metrics Brothers Growth and CAC and a member of the Benchmarkit Podcast Network. By accessing this podcast, you acknowledge that The Metrics Brothers make no warranty, guarantee, or representation as to the accuracy or sufficiency of the information provided Or the humor content of the jokes told.

Ahem, Ray.

Information, opinions, and recommendations presented are, according to our spouses, probably wrong and provided for information purposes only. This podcast should not be considered professional, or for that matter, unprofessional advice. We disclaim any and all liability for any direct, indirect, indirect, misdirect, incidental, special, ordinary, consequential, inconsequential, or other damages arising out of any use of, or God help you rely upon the information presented here. Ray Grothreich is based in New York City and available on X @RayReich. Dave Kellogg is based in Silicon Valley and available on X @Kellogg. Schedectady, which is French for unspellable, is not our actual production location. Thanks for listening.