What makes a tech company valuable?
There are a lot of things that make a “tech company” different from other types of businesses (small businesses, professional services, manufacturing, etc.) One of the most important from an entrepreneur’s perspective is how the company is valued especially during an acquisition. In most other circumstances an acquiring company will value your business based on discounted cash flows, revenue or EBITDA multiples, book value, or have an independent audit done. That is not how a tech company is valued because they bring something very different to the table.
Tech companies can command valuations that are much higher than their financials would lead most people to believe. That’s because what’s being acquired is not just the employees, a customer list, or a predictable stream of cashflow. Tech companies are valuable because they have figured something out that the giant firm acquiring them couldn’t.
Typically that “something” is either how to acquire customers in a certain segment incredibly quickly, the aggregation of data about certain customer segments, or a unique integration with the acquirer’s current product offerings. In each of these cases the value is not based on the tech company’s financial performance but on the ability of the tech company’s secret sauce to massively improve the acquirer’s bottom line.
Most entrepreneurs just aren’t thinking about their business in this way. They may look at opportunities to expand to more verticals or create more product offerings as they grow but all of that is sort of a given. What entrepreneurs should be searching for as they grow is what’s the secret sauce for my business? What value am I going to be able to offer an acquirer that would command an outsized valuation during an exit? Have I figured out a way to tap into a market they desperately want at a rate they’ll never be able to achieve? Do I have aggregate data on or a unique relationship with a particular customer base that can help the acquirer generate new revenue opportunities? Does my product offer something unique when bundled with their portfolio?
Put yourself in the shoes of the acquirer. If you could spend $100M to go after the same market, are you better off buying that tech company or are you better off starting from scratch and trying to crush them? If you don’t have an objective argument for the former, start searching for it.
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