How to value a tech company

23 April 2021 / Insight posted in Article

If you’re wondering how to value a tech company, you’ve come to the right place. Different types of businesses grow at different rates, but in the fast-moving technological space, a tech company’s valuation can vary massively. Innovation and technology go hand in hand, and as businesses continue to innovate, their value changes, which can impact the wider market. There are many different components that can influence the growth rates of businesses in the tech industry, but having a strong understanding of value is essential for investors, entrepreneurs, and even industry analysts.

In this article, we’ll dive into the dynamic world of valuing a technology company, exploring the key areas that need to be considered, regardless of your involvement. Whether you have skin in the game or you’re simply an interested onlooker, understanding how to value a tech company can be an interesting endeavour, one that can be more complex than you might first imagine. Our goal is to demystify the process as best we can, so you can better understand the impact of market trends and the importance of an effective growth strategy, each of which impacts how to value a tech company.

Introduction to tech company valuation

Knowing where to start when it comes to tech company valuations might seem like a daunting task, but once you understand the basics, you really won’t have much to worry about. While this may seem insignificant, the valuation of a tech company can massively impact things like share price, which can make or break a company entirely. 

To make things as simple as possible, we’ll first cover the basics. Tech company valuation is the process in which a tech-based organisation is valued and has its economic worth assessed. The company’s overall financial health will be carefully analysed, while experts will also look at the business model and its overall position in the market. This will result in a monetary value being assigned to the company, which will reflect its worth in the wider marketplace, particularly when compared to its competitors. 

The significance of valuation in the tech world

The importance of a tech company’s valuation cannot be understated. The valuation process is crucial for all associated stakeholders, both internally and externally. For investors and executives, it will have a clear impact on their future as a result of the share price, the future direction of the company, and forecasted revenue growth, all of which are key parts of the overarching business model. 

A low or reduced valuation can spell disaster for a company, dissuading potential investors and even resulting in shareholders attempting to jump ship. Shareholders are often worried about a sliding share price as there can be no way of knowing where it will finally stop, which is why even a small change can result in a mass exodus – this is similar to a ‘run on the banks’ happening during times of economic crisis. 

Key elements influencing the value of a company

Countless elements must be factored into the valuation of a tech company, which is why these processes can take such a long time. However, there are a handful of elements that are of particular importance, which is what we’ll now explore further.

Financial performance

As you might have expected, revenue and profitability are critical elements that play a significant role in a tech company’s valuation. The company’s ability to generate revenue and sustain profitability is fundamental, while a positive cash flow is essential for operational sustainability and expansion.

Growth prospects

If you’re looking to grow your business, you’ll surely understand the importance of a strong pipeline and capitalising on market trends. The company’s alignment with and ability to react to current and future market trends is critical, while market share is also a key consideration. Increasing market share or the potential to capture a larger share can contribute to a strong valuation, showing that the business has a bright future ahead.

User base and customer loyalty

While this might fly under the radar, customer acquisition and retention are important influencing factors. The ability to attract and retain customers is critical for sustained revenue growth while glowing customer feedback and satisfaction contribute to a positive company image. This boils down to keeping your existing customers happy while understanding your target audience and aligning your approach to meet their needs. This can be achieved through strong public relations and carefully targeted marketing strategies.

Why loss-making tech firms can still have high valuations

A loss-making tech company can still have a high valuation because it has a competitive edge. As is the case in many industries, you can outlast your competitors, even while making a loss, if you have enough financial backing. While your bottom line and profit margins will play a key role in your valuation, there is much more at play.

Losing money does not mean that your business is unsuccessful – sometimes, this is a key part of the overall business strategy. If your goal is to increase market share and capture as many customers or clients as possible, this may require you to make a loss. However, once you have gained this slice of the pie, you can then look to improve your margins with the introduction of additional products and services. A loss-leading strategy can still be a winning one.

Key drivers of tech company valuation

Ultimately, tech company valuation is a lot simpler than you might imagine. Having a fair share of the market is always important, while you should also aim to offer something that nobody else can. This USP is what will set you apart from the competition, allowing you to grow your business faster and with much more purpose. While talent is also a key driver that can have an influence, people often come and go, which is why this should be taken with a pinch of salt, especially if bigger companies are operating in the market.

When we look at how to value a tech company we also need to pay close attention to any value that’s contained within the organisation. Intellectual Property (IP) and innovation are key drivers to be aware of as they add value and help position the company as an attractive investment opportunity. The presence of proprietary technology and a robust portfolio of patents can enhance a company’s valuation for this exact reason. Additionally, a clear investment in research and development activities, as well as a strong innovation pipeline, contribute to a tech company’s value.

Showcasing potential: optimising your tech company’s valuation

To get the best possible tech company valuation, you need to play on your strengths. If you have a product or service that is a level above your competition, make sure that it’s as refined and polished as possible. If there are any snags or bugs, invest in overcoming these obstacles so you have the best possible chance of receiving a strong valuation. There is immense value in well-run processes and procedures – this can’t be overlooked. 

While you may be working on something that isn’t yet ready for market, this can still be a key factor. Investment in product development, especially if it aids with market penetration, is highly attractive and can add immense value. Being able to demonstrate the potential worth this could have to your company, especially concerning its position in your long-term plan, is something that analysts will look for. Play to your strengths and show that your company is looking to capitalise on market trends to reach new audiences and increase revenue.

Expert insights on how tech companies are valued

Studies show that investors and buyers, in valuing a tech company, look for the specific drivers that will underpin the long-term growth of your company and hence its value. Managing and understanding these key drivers is something that successful companies do well. The drivers include value proposition and brand, extent of owner reliance and strength of the management team. 

Great companies will be able to demonstrate a clear and compelling value proposition that is known to and valued by target clients underpinned by a scalable business model. Our research reveals that tech companies demonstrating a focus on these key drivers are more likely to have long-term success.

If you are looking for support with growth, investment or disposal, contact either Nick Winters or Paul Winterflood for a no-obligation discussion. We understand the dynamics of the tech industry and how investors and buyers will value your business. 

Get in touch with Moore Kingston Smith

If you want to better understand how to implement a growth strategy for business, get in touch with a member of the Moore Kingston Smith team. We have experts across a range of disciplines, so you can be sure that you’ll receive insights that relate to your overall business and financial goals. From tech company valuation and increasing your share price to better reaching your target audience while still serving the needs of your existing customers, we can help with an action plan that’s as unique as your company.

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