Valuation Of Emerging Technology Businesses
By: BuyTradeBiz.Com
Typically traditional business valuations are based on income, assets, cost approach and historical performance. Emerging technology companies present a significant valuation challenge, since they typically have limited revenues, few fixed assets, and a history of losses – and a short history at that.
There are several unique aspects to valuing a technology company. The factors typically present in a traditional valuation are either not present or provide very little insight in a technology company valuation. Typical valuation methodology looks to assets and/or income for value and involves income, assets and cost approaches. Operating businesses are usually valued based on an expectation developed from their historical performance. On the contrary, technology companies many times have limited revenues, no history to speak of, and a track record of financial losses.
Often the technology company will represent the first of its kind of business. Therefore, it is difficult to find a peer group or competitors to benchmark performance. So, investors in technology companies usually look toward the future with an expectation of explosive growth. Here are some other factors that impact the process of valuing a technology company vs. a traditional business opportunities:
Lack of Fixed Assets and Inventory – Technology companies do not invest significant dollars into land, buildings, or other fixed assets and derive most of their value from intellectual property. Since the products or services produced by the company are electronic bits & bytes, there is no inventory to speak of.
Projections are Key – The valuation of an emerging technology company is based on the projected future stream of income from its intellectual property. Projections include assumptions regarding demand for the product or service, revenue growth, competition, alternative technologies, the economy and many other factors. However, such assumptions, if based on market research, known facts and sound logic can be a basis for value.
Cost Of Capital – Another difficulty in the valuation of technology companies is determining the cost of capital. Many technology companies are dependent upon equity financing causing the cost of capital to approximate the cost of equity. Some technology companies issue hybrid securities, such as convertible bonds. Technology companies may have bank debt, making it hard to rate. In general, estimating the cost of capital from historical data is more difficult with technology companies that have short histories.
Management Strength – Investors often have their own methodologies for valuing technology companies. Some may evaluate certain factors and assign values to them. While a good idea may have value, without good management it may not be successful. Strong management may be worth more than any other characteristic. Industry contacts and relationships are important factors. Demand and an analysis of the marketplace must be evaluated. Finally, the feasibility of the product itself must be considered.
Intellectual Property – Most of the use of capital in a technology company goes to building up the company’s intellectual property. So the appraiser has to pay close attention to the built up intellectual property in order to assign value to it. Unless there is a proven track record of revenue, the appraiser has to research the market and evaluate the potential for the product before assigning value.
Given these challenges, it is clear that the valuation of technology businesses for sale should be performed by an appraiser familiar with current trends, data sources, market transactions and market participants.
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