Technology Valuations and the Path to Profitability
In 2019, several high profile technology companies completed their initial public offerings (IPO), including Uber, Lyft, and Peloton. The market seemed poised for these IPOs; valuation multiples and growth expectations have soared in the last year. Some of these companies have billions in revenues, high customer retention rates, scalable business models and a competitive moat. The IPO total is reaching a multi-decade high and have raised billions of dollars in the public market.
One should note that many of these companies lose money and do not have a clear path to profitability. Some of these sky-high multiples are presented below (as of November 2019):
These tech IPOs have changed the landscape for early-stage tech start-ups. The following provides some insight for early-stage technology companies and their investors about the new world in which they find themselves.
Ingredients of the Next Big Thing
The new-age entrepreneur has been emboldened by the success of unprofitable unicorns and has embarked on a journey to find the “next big thing” without the need to solve the long-term profitability conundrum. The concept of budgeting and cost-cutting is becoming less important as companies prioritize growth.
Venture capital investors seem to believe early-stage tech start-ups can provide tremendous return on capital and incremental value to a potential strategic buyer, if the company pursues and achieves all or most of the following:
- Develops a new technology or expertise that may give a potential buyer the optionality to selectively grow in nascent areas of their business.
- Obtains new customers or successful pilot programs.
- Demonstrates the ability to have high customer retention rates.
- Has important strategic partners.
- Has a talented management team that understands the market forces and has an obsession over customer satisfaction.
What’s Changing in the Start-Up Space
Growth has always been the most important parameter in tech startups. Industry participants and consulting firms often publish the list of the fastest growing start-ups. The desire to be part of this elite group is extraordinary, and the recent change in the IPO landscape has only amplified the pressure on start-up founders. Such pressure can often result in mistakes and strategic decisions not aligned with the long-term well-being of the company.
Because of these pressures and the challenges tech companies have experienced post start-up, tech start-ups are staying private for longer. There are advantages to the pre-public stage, as private investors with significant accumulated capital are eager to invest in tech companies during the pre-IPO rounds. Strategically, the pre-IPO stage buys the start-up company some time because the questions about the company’s long-term profitability or even the path to profitability can be deferred until the company is ready for an IPO.
What It Means for Future Tech Start-Ups
The flood of private money to tech start-ups that are unsustainable or unprofitable will be interesting to monitor going forward. Some companies will figure out their model and go on to become successful, while others will fail or continue to fall short of expectations.
It’s important for private companies in the tech space to keep their eye on their ultimate objectives for their business. If going public is something you have in mind – there are some benefits to consider of being public after all – then it will be important to try to answer those pathway to profitability and long-term sustainability questions during your capital-raising stages. Just because investors aren’t asking that, doesn’t mean your management team shouldn’t continue to work through those considerations. The flood of private money maybe muddying up the IPO process a little bit for technology companies. But it’s worth noting that some of those recent tech IPOs may be coming with an important lesson for tech start-ups: the ease of which you can raise the private money is not speaking to your company’s post-IPO success.
On the investor side, private equity and venture capital firms and other strategic investors may also want to consider their objectives. How long do they want to hold the investment in the tech start-up? What kind of rate of return do they expect? If a company has growth but no long-term plan for sustainability, investors should consider how long the company will be sustainable and able to meet their expectations.
For More Information
For comments, questions, or concerns about any of the issues touched upon in this article, please contact Subu Parmeswaran at email@example.com.