Valuation of new-age unlisted tech companies

Abstract

The dot-com boom of the 1990s and the subsequent burst posed many questions on how best to value tech-enabled companies. Companies with new and never-before-imagined business models have been coming up and have been valued. Each startup that takes advantage of a new technology opens up doors to hundreds of unknowns making it ever more difficult to prescribe one model that can take up these inputs and spew out a valuation for all of them. To appreciate the variety among tech companies and underlying business models, let us take the example of some of the biggest names in tech: Facebook, a social network that doesn’t charge its users a cent yet is valued at more than USD 500 billion and Amazon, a retailer which earns a commission on every transaction (in its retail arm) and is valued at USD 900bn+. While it is important to realize the uniqueness of each business proposition, we must not exaggerate the role of tech, as outside of the tiny nuances, any intrinsic valuation boils down the three fundamentals – income stream, discount rate and growth. As startups are an exploration of the unknown, while the three fundamentals remain, finding them out with any measure of certainty becomes a challenge. It is true that tech can create tremendous business potential, however correctly measuring out that potential in terms of each of the three fundamentals is where the real art behind startup valuation lies. As far as valuation through multiples is concerned, since most tech companies are not EBITDA positive (let alone PBT positive), the traditional earnings multiples need to be replaced by revenue multiples. Further, exotic, non-monetary multiples that can best fit the underlying business models are also being increasingly used to aid valuations. This is because valuation for early stage companies require an approach significantly different from those of a typical income generating company. Absence of financial metrics and the uncertainty requires one to go beyond the numbers and dive deeper into the qualitative aspects to determine the true potential and the ability to harness that potential.