Entry at a high revenue multiple is a bet on growth outrunning the fall in that multiple: the formula, the growth it demands, and what a strong plan returns once the multiple halves.
ARR has to grow by the ratio of the entry multiple to the exit multiple just to return the money: buying at 15.0x ARR and selling at 8.0x needs 1.88x ARR growth to break even. To make 3x after 10 per cent dilution it needs 6.25x, or 44.3 per cent a year for five years instead of 27.2 with no compression. Multiple compression costs 17.0 points of growth a year.
Worked in full in The Growth Equity Investor by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Growth companies are bought on revenue multiples that assume the growth continues, and sold on multiples that reflect the growth that is left. The fall between the two is the single largest drag in most growth equity underwriting, and it is easy to measure before the deal rather than discover at exit.
| Input | Value |
|---|---|
| ARR at entry | 40.0 |
| Entry EV/ARR multiple | 15.0x |
| Entry enterprise value (no net debt) | 600.0 |
| Stake bought, cheque | 20%, 120.0 |
| Share of the stake retained at exit after later rounds and options | 90% |
| Exit EV/ARR multiple | 8.0x |
| Holding period, target multiple | 5 years, 3.0x |
With no net debt and no interim distributions, the investor's multiple breaks into three factors:
MOIC = (exit ARR ÷ entry ARR) × (exit multiple ÷ entry multiple) × retention
Rearranged for the growth required: ARR growth = target MOIC × entry multiple ÷ (exit multiple × retention). In Excel: =Target*EntryMult/(ExitMult*Retention), and =Growth^(1/Years)-1 for the annual rate.
Step 1: the break-even. At 8.0x the company must be worth the 600.0 paid, so ARR must reach 600.0 ÷ 8.0 = 75.0: 1.875x the entry ARR, or 13.4 per cent a year. Add the 10 per cent dilution and break-even rises to 83.3 of ARR, 2.08x, 15.8 per cent a year.
Step 2: the target. A 3x on a 120.0 cheque is 360.0 of proceeds. With 18 per cent of the company at exit, that requires an exit enterprise value of 2,000.0.
| Exit multiple | Exit EV needed | Exit ARR needed | ARR growth | Annual growth |
|---|---|---|---|---|
| 15.0x (no compression) | 2,000.0 | 133.3 | 3.33x | 27.2% |
| 8.0x | 2,000.0 | 250.0 | 6.25x | 44.3% |
The multiple falls to 0.533 of its entry level, so the ARR requirement rises by its inverse, 1.875. Over five years that is the difference between 27.2 and 44.3 per cent growth every single year.
Now take a strong but decelerating plan: ARR growth of 50, 45, 40, 35 and 30 per cent. ARR goes 60.0, 87.0, 121.8, 164.4 and 213.8, a 5.34x increase and 39.8 per cent a year.
| Exit multiple | Exit EV | Proceeds (18%) | MOIC | IRR |
|---|---|---|---|---|
| 15.0x | 3,206.4 | 577.1 | 4.81x | 36.9% |
| 8.0x | 1,710.1 | 307.8 | 2.57x | 20.7% |
The check: 5.34 × 0.5333 × 0.90 = 2.57. The company delivers an outstanding plan and the investor still misses its 3x, because the plan is exactly what makes the multiple fall: a company growing 30 per cent at exit will not be valued like one growing 50. On this plan the exit multiple must hold at 9.36x for a 3x.
| Exit multiple | Exit ARR for 3x | Growth for 3x | Annual | Growth for 2x | Annual |
|---|---|---|---|---|---|
| 6.0x | 333.3 | 8.33x | 52.8% | 5.56x | 40.9% |
| 8.0x | 250.0 | 6.25x | 44.3% | 4.17x | 33.0% |
| 10.0x | 200.0 | 5.00x | 38.0% | 3.33x | 27.2% |
| 12.0x | 166.7 | 4.17x | 33.0% | 2.78x | 22.7% |
| 15.0x | 133.3 | 3.33x | 27.2% | 2.22x | 17.3% |
Each step up the table costs between about five and nine points of required annual growth, and each turn lost costs more growth the lower the exit multiple already is. The illustrative multiples are not market levels; set the exit multiple from where comparable companies growing at your exit-year growth rate trade, not from where your entry comparables trade.
Reverse the logic and you get an entry price. Fix the growth you believe and the exit multiple that growth will command, and the formula tells you the most you can pay, which is the approach of what entry valuation a growth investor can pay and still make 3x.
The exit multiple is the input that decides the answer, and it is also the one most often copied from the entry comparables. A better discipline is to describe the company as it will be in the exit year, with its growth rate, its margin and its retention at that date, and to ask what buyers pay for that profile. A company that has slowed from 50 to 30 per cent growth but now earns a margin will be priced on a combination of the two, which is why the Rule of 40 is often used as a bridge between growth and valuation. Then run the formula twice: once with that multiple and once a turn or two lower. If the deal only works at the higher one, the investment is a bet on the multiple, not on the company.
Required ARR growth is the target multiple times the entry multiple, divided by the exit multiple and the share retained. From 15.0x to 8.0x, break-even needs 1.88x ARR and a 3x needs 6.25x. Underwrite the exit multiple first; the growth plan only tells you whether it is reachable. The book's own figures for ownership and follow-ons are reworked in the free workbook for this book.
The fall in the valuation multiple, usually EV to ARR or revenue, between entry and exit, because growth slows as the company scales. In the illustrative case the multiple falls from 15.0x to 8.0x, which alone multiplies the investment by 0.533. ARR has to grow 1.88x over the hold before the investor is even back to cost.
Exit multiple = target MOIC times entry multiple divided by ARR growth times retention. With a plan that grows ARR 5.34x, a 15.0x entry and 90 per cent of the stake retained, a 3x needs an exit at 9.36x ARR. At 8.0x the same plan returns 2.57x.
Only if it lasts. The plan in the illustrative case grows ARR from 40.0 to 213.8, 39.8 per cent a year, which most companies never achieve, and still misses a 3x because the multiple halves. The question to underwrite is the growth rate at exit, which sets the exit multiple, not the growth rate at entry.
This article is one calculation from The Growth Equity Investor. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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