Startup Valuations as Rule of 40 and Market Sentiment Multiples

David Cummings

Jan 14

One of the hottest topics lately is valuations. With the public equities down dramatically over the last year and most startups deferring as long as possible to raise another round, it's hard to know what's market out there. Of course, some deals are getting done and the startup funding world is still turning, albeit at a slower, more jerky pace.

On the public market front, the BVP Cloud Index shows cloud stocks trading at an average revenue multiple of 6.3x with an average growth rate of 29%. The median forward revenue multiple is 4.82x (using the expected revenue for the next twelve months). At the peak of the market on February 10, 2021, the median forward revenue multiple was 15.95x. Thus, we've seen a 70% drop in valuations.

On the private market front, I've heard of deals all over the place from 2x to 10x+ revenue run rate, often driven by how desperate the startup is to raise money to how desperate an investor is to put money into a startup. The days of 50x or 100x run rate valuations are long gone (ignoring outliers like Figma or OpenAI).

So, what's a generic valuation formula in today's market? Absent more data, here's a formula to ballpark a number:

Revenue Run Rate (most commonly annual recurring revenue)

Multiplied by

Rule of 40 Score

Multiplied by

.2 (market sentiment, in this case 20%)

Some examples:

$20M ARR x 50 Rule of 40 Score x .2 = $200M
Because of the high Rule of 40 Score, the startup gets a valuation of 10x run rate
$10M ARR x 20 Rule of 40 Score x .2 = $40M
Because of the normal Rule of 40 Score, the startup gets a valuation of 4x run rate
$5M ARR x 10 Rule of 40 Score x .2 = $10M
Because of the low Rule of 40 Score, the startup gets a valuation of 2x run rate

Rule of 40 Score is basically growth rate plus profit margin as numeric values. The easiest way to get profit margin up (or less negative) is through layoffs, and we've seen huge numbers of them lately.

Much like "animal spirits" from John Maynard Keynes, market sentiment here is subjectively and fluctuates regularly. While this formula isn't perfect, it's directionally useful in today's market.

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