Know your worth: How to value a tech business

Know your worth: How to value a tech business

This article was originally published by BDO in Canada

As Australia's technology sector continues to grow and the competition for capital intensifies, it's more important than ever for tech companies to obtain a credible market valuation that can help them meet their business objectives and compliance obligations.

Why is a formal valuation important?

Getting an accurate estimate of your business's worth sets the precedent for every step that follows. This is true whether your goal is to obtain financing or, on the other end of the spectrum, to plan an eventual exit.

If the value is too low, you could be sacrificing equity to obtain financing. Setting a value that's too high can be equally as damaging as an unrealistically high valuation can lower investor confidence in what is an otherwise sound business or idea. Entrepreneurs also run the risk of diluting their initial investor or underperforming, which can adversely affect future rounds of funding.

How do you measure your tech business's worth?

Early-stage valuations are highly nuanced and complex. For many entrepreneurs, the qualitative aspects of the business—including the business's journey and vision—can be difficult to measure and articulate. Value drivers can be unpredictable, and forecasts are more uncertain as compared to other industries.

Tech business owners should consider these valuation factors in particular:

Stage of the business

Where a business is in its lifecycle can determine which factors will have the greatest importance during a valuation. Where does your business sit in terms of its maturity? Has it already raised its seed money or Series A funding? Is your product at the prototype phase or has it been tested and launched?

For early-stage ventures, qualitative aspects, such as the strength of the idea or the potential of the investment opportunity, are often the most important. As the business becomes more sophisticated, quantitative measures, such as projections and historical financial performance, play a greater role.

The leadership team

The people behind your business are just as significant as the product or service you're offering. An established, experienced team with a strong entrepreneurial track record can offer less risk for potential investors.

A savvy investor or private equity firm knows that even the best idea can fail without the right leaders to execute it. Entrepreneurs must be able to demonstrate the strength of their team, determine the skill sets needed to achieve key milestones and identify gaps in their workforce.

Market size and trends

Consider the total market and your business's place within it. Does your idea align with current trends? Is the market size (and your potential market share) large enough?

Investors will be influenced by what's current in the market—and to an extent, so will your business's value. Your product or service may also have significance to a larger player who is seeking strategic acquisitions. A comprehensive understanding of where your business falls within the market can help you enhance your value and reach investors that align with your goals.

The business's financials

As with any valuation, numbers play a significant part in telling your business's story. Are there projections for future earnings? What are the growth expectations? What is the quality of your revenue—is it recurring or dependent on net new business? Investors are increasingly concerned with the ability to earn net revenue rather than top-line gross revenue, which may not be as profitable or easily leveraged.

Investors want to know how their funds will be used and whether the business has enough capital to reach its next milestone or financing targets. Your financial data should provide a realistic, easily digestible picture of past and future performance.

The investor perspective

To understand and communicate the value of your business, it's important to know the mindset of an investor or private equity firm. Before any money leaves their pocket, a potential investor will consider several questions, including:

  • What is my risk tolerance relative to the life stage of the business?
  • What is the capacity for growth within the industry or market space?
  • Who is leading the team and executing the strategy?
  • Do I have a full understanding of the business?
  • Do the financial records and general market trends support the forecast?

What should business owners and entrepreneurs do next?

Determining the true value of an early-stage venture is a blend of estimation and data. Challenges can arise if there are no historical earnings, if the business falls within a niche market, or if the business is based predominantly on intangible assets, such as intellectual property.

Entrepreneurs should consider the following:

Define your goals

While most early-stage businesses conduct a valuation to raise capital for growth, some may undertake the process to support tax optimization or the issue of stock options. Setting clear objectives from the start can help you determine which milestones your business needs to reach and how to enhance your value drivers later in the process. This also helps reduce tax risk or reporting complications, which can otherwise result in major business, financing, or deal issues.

Articulate your story

Business owners must go beyond the technical aspect of the business and communicate a larger story and vision. Sharing this journey helps to form a stronger connection with investors and provides them with a full understanding of what your business does and why it has value.

Be aware of disruption and market changes

While the market can be difficult to predict, it’s important to anticipate potential changes as much as possible. Stay in tune with the political, economic, social, and technological disruptors that could affect your industry and influence the value of your business.

Organise your financial records

Strong financial records add credibility to your valuation, as well as greater visibility into your cash flow rates and funding needs.

Engage an unbiased adviser

A professional adviser can provide you with a complete and realistic assessment of your business’s worth. An experienced consultant can help you prepare to negotiate with investors and navigate the opportunities and obstacles that come with raising capital, especially in today’s market. 

Understanding your needs

A valuation is your story to be told and we understand the significance of sharing that story with the world and the impact it can have on the future of your business. Our Technology, Media & Entertainment and Telecommunications experts work with tech companies across a broad range of industries and life stages to provide accurate value assessments. We tailor and scale our approach to meet your unique needs and help you gain insight into the investment community and potential financing sources. Contact us today.