Monday, November 22, 2010

Is Enterprise Value per employee a good yardstick for valuation?

I wanted to fit a distribution to the EV per employee metric I took from tens of 409A valuation data points. I constructed an excel chart using the "frequency" function to count the EV per employee metric as a histogram and then observed the shape and size of the histogram.

While there is some right handed tail because of skewed distributions due to biotechnology companies and some extraordinarily valued companies, I find that most valuations lie between $600K and $1.2MM per Full Time Equivalent (FTE). I call it FTE because these companies have employees all over the world under differing wages. The mean seems to be around the $1MM per employee mark. Since the shape of the distribution is substantially NORMAL, this arithmetic mean or average has a significant meaning. And as per normal distribution rules, 67% of data points seem to lie within 2Sigma from the average value, pointing out that EV per employee maybe normally distributed in the VC world. Remember these valuations are across both non-revenue and substantial revenue generating venture-financed, closely-held companies. I was talking to a VC partner one day and he mentioned that a $1MM valuation per engineering employee is a reasonable assumption. This chart seems to be bear witness to that empirical rule. I wonder if the VCs rely more on such empirical rules as a yardstick than do a cash flow analysis (which is admittedly difficult to do for a fledgling business or idea).
While there are empirical rules, it may also be that the valuation range of $600K to $1.2MM per employee may be the most valid range for small, privately held technology companies. At least, a significant sampling of 409A valuations seem to indicate this.