Small firms should go global for a shot at better valuation multiples

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I was recently watching a presentation delivered by a Tepper School of Business Alum (my alma mater) and was throughly impressed by how much growth and expansion is happening in emerging markets. The speaker mentioned the importance of local knowledge using a nice anecdote - grasshoppers are considered pests, say, in the US and China, but is considered a tasty delicacy in northern Thailand. Venture-financed firms today need to have a global plan with a global marketing workforce. With IPOs and M&As in emerging markets having higher multiples, it is extremely profitable to add a global component to your business as it could push up the value of your company. More than half the world's population live in countries whose GDPs are growing at a rate greater than 7% . There are 60 million babies, say, in India that are NOT on diapers. Does anyone smell an opportunity here? Another example given was only 25% of population in Eastern Europe and Russia have a washing machine - seems like a huge potential here as well. By 2020, Africa will have more mobile phones than North America - mobile applications in Swahili, anyone? Another interesting factor - more than 2/3rd of world population is non-bankable. Maybe micro loan and micro insurance companies are the next biggest things in financial services.
The point I want to communicate is that purely North American based companies - start-up or otherwise - will command conservative valuation multiples. Valuation multiples are largely based on market share, operating margins and sustainable free cash flow. Today, we have a sizable IPO/M&A market in emerging markets to use for comparison purposes. Selling to conservative consumers in these economies also forces a firm to operate in a lean and efficient environment - key ingredients that command higher valuation multiples.
As competition in developed economies becomes more costly, small businesses, by their very nature, face operating costs that may become unsustainable. Developing economies enable an organization to learn how to become lean and efficient in the delivery of services to extremely competitive customers. Technology, by definition, helps deliver such services and therefore technology companies have a greater obligation to reach out globally. That key learning aspect is critical for the growth of a small business, especially venture-financed technology companies, in the US. While health care reforms and labor reforms will aid a little bit in managing small business budgets, the key is to understand that flat to negative growth is here to stay in saturated and demographically disadvantaged economies such as the US and western Europe.

Size Matters

If you want better multiples when valuing your firm, you need a larger sized firm. Studies have shown that smaller websites and web-based businesses sell for lower multiples (between 0.5 and 2 times revenues) whereas larger websites/web-based revenues sell for 3-10 times revenues. Yes, there are still some businesses that sell for as high as 9 or 10 times revenues. A security software firm sold for 9 times revenues in 2007. A game & entertainment software developer trades for 33 times revenues even in these depressing markets. Bottom line is that there is still value to be discovered and better values to be got by building the right mix of business. For start-up firms, it is better to look at a strategy of building larger businesses as your exit multiples would be a lot higher.