Passive Income Stream Valuation Methodology–Part IV: YOUR Price Multiple

July 27th, 2008 · No Comments

Now that we’ve assessed all these numbers, we can determine if a venture is (or was) worth our time. If we’re working with the 1x multiple (or P/E of 1) we discussed in the last section and a $5000 income stream after expenses, which required 100 hours to set up, we’d basically see that we created $5000 worth of value with 100 hours of work, making $50 per hour. So if that $50 per hour is better than what we could have made otherwise, it was a good use of our work. Here’s an equation we can use to do these calculations:

Projected Income x Multiple = Worth
Worth / Hours to Develop = Hourly Pay

So, in this case, our calculation looks like this:

$5000 (income) x 1 (multiple) / 100 (hours invested) = $50 / hour.

The tricky thing, however, is that while you might only be able to sell the fruit of your labor for $5000, that doesn’t mean that’s all its worth to you. While an investor would be concerned whether he can sustain that level of income after buying the venture, you might have much more confidence in your ability to sustain it.

Here are a few of the basic factors that affect the value of a venture:

  • Longevity – Will the content you produce still be accurate, and will the subject matter still be interesting for a substantial amount of time?
  • Competition – Are you facing many competitors; are you likely to do so in the future?
  • Effort – Is your venture keyed on your effort? If so, how much? Could you outsource the maintenance work?

And some rules of thumb I might use for valuing ventures:

Multiple Description Example
1-3 Labor intensive sites in contested or transient markets. Blog for a gaming console platform (a transient subject since these things eventually become outdated)
2-4 Low labor sites in transient market Forum for a popular tv show
3-5 High labor site in a stable market Stock recommendations
6-8 Low labor site in a stable market Political wiki

Finally, another way to look at the value of a passive stream of income is by considering how much would you have to put in the bank to earn that passive income at the same rate. To make the $5000 in our example at a 5% rate, you would have to put $100,000 in the bank.

Obviously the $100,000 of cash is more valuable than our passive income stream venture, largely because it also has a $100,000 asset associated with it (the cash). Because our passive income venture isn’t as valuable an asset as the $100,000 cash (which is no-risk), but can still be relied upon (in an ideal world) to deliver about $5000 per year in income, we can safely value our venture at about a 10x multiple—roughly half the value of the cash. This is a “best-case” P/E. Basically if you invented the perfect income stream that produced its income as regular as clockwork and would continue to for the foreseeable future you might use a P/E of 10.

Now let’s put all this information to work. A multiple of 5x is often satisfactory for getting a rough idea if something was worth your time. It is likely that you will be able to get five years of earnings out of the venture before the market substantially changes or other factors force you to invest more development costs. So if you assume a 5x multiple is appropriate, this allows you to basically see how much time you should be willing to invest to develop it. Let’s look at this equation again:

Projected Income x Multiple = Worth
Worth / Hours to Develop = Hourly Pay

If I have a stream that I project will yield $5000 after taxes, at a 5x multiple we value that stream at $25,000. If I want to make at least $500 hour from my venture, then I shouldn’t pursue the project unless I feel like I can develop it in roughly 50 hours of work. If I’m willing to accept $50 per hour, then I can spend 500 hours developing it. Remember, your income in question should be post tax, but should be compared to your “day job” income post tax as well.

Here\'s where it gets REALLY interesting.

Here\'s where it gets REALLY interesting.

Remember also that these multiples are for ongoing ventures. If your final goal is to sell your venture, you should value it at a low multiple more realistic from buyer’s perspective—perhaps 1-3x income. However, if you are planning to hold your venture indefinitely, a higher multiple such as 5-8x income may be appropriate.

With these equations you can solve for the various variables, such as how many hours you should be willing to invest in developing the stream or how much it would have to yield to be worth it. Of course there is one more thing to consider in evaluating whether a stream is “worth it.”

Categories: Main blog narrative · Theory

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