How Technology Businesses are Valued (Overview & Formulas)
Businesses are valued differently, based on multiple indicators, and include assets such as equipment, inventory, office space, and location. Taking these into consideration, the resulting sum can be a starting point for selling the business. But that’s in the worst-case scenario, and it’s not applicable to all companies, including tech companies.
The concept of a tech company in the 21st century applies to multiple activities and fields, which in their turn determine how the company is valued overall, making multiple company value formulas applicable. In the majority of cases, the value formula is calculated depending on the buyer’s approach, while in some other cases factors like competition, human resources or inventions count more than previous revenue or expertise.
Important Factors For Tech Business Valuation
The most important things that impact the way a tech business is valued are predictable and easy to learn. On the other hand, how much each of these factors counts in the tech business valuation process can surprise any business owner. To put more light on this topic, here are the most important factors according to our research:
Valuation context - It is important to know at what stage of your tech business the offer comes. If the business is in good shape, or if it’s crossing, not the best period. It also matters if the offer comes from a larger competitor that invests in the company’s expansion, or if the company will be sold to a new-entry entity. The same things count if the offer comes from the business owner to the counterpart.
Business market experience - Taking into account that most tech businesses are sold at the startup level for good money, it may be a good idea to reconsider if the business is worth being sold at such an early stage. If the business is young and has good chances to stay and evolve on the market then the price will be higher, but at the same time, it may be frustrating to sell such a promising product. Generally, if the business has a respectable age and is still growing, then selling it at its peak might be the best option.
Tech Subsector - The wideness of the tech sector plays the largest role in this point. SaaS or IoT may have astonishing potential and prices, but a solid Biotechnological company, especially in the context of a pandemic may bring the best profit, or it can be the best investment.
Assets value - There are tangible and intangible assets that a company owns. For other industries than tech, tangible assets value more than intangible assets, but in tech, things work the other way around. Reputation, branding, and human resources make a company more valuable if they come together with the company.
Owner Dependence - If a tech business is fully dependent on its owner, then this is a serious risk challenge the buyer should assume once it is in control of its product. To make the transformation process smoothly, it is recommended that the previous owner make the transaction step by step. Also, the more the business is associated with specific names within the company, the higher the risk of losing touch with the customers.
- Business climate - Business climate depends on the geographical, political, and economical factors that all three together build conditions for a favorable or unfavorable business climate. The pandemic for example has changed a lot in the tech market. Some companies have registered considerable growth in profit while others decided to merge with other companies for competitive advantages. But this cannot be generalized, since tech has evolved differently in different locations.
Tech Business Valuation Formulas
There are several types of valuation for tech companies that are often met in international practice, but each of these methods is highly impacted by decisive factors:
#1 Net Asset Value: equipment+inventory-(debts+liablilities)
As it was mentioned earlier, this formula can give a starting point of negotiations for selling a company, but in the case of tech companies it doesn't work too much since equipment and inventory are tangible assets that do not make the core value of a company. However, subtracting debts and liabilities is always important, since they are almost always the main expenses a company has, including in the tech industry.
#2 Revenue Value: Avg Yearly Revenue x 0.5or more
Calculating the average yearly revenue is simple, and every company does that at some point or another. The difficult task in this formula is to identify the industry the business belongs to and find the right coefficients for multiplying. Households have the 2.56 coefficient, while food and processing 1.3. It’s not something a business has to choose, but it’s a fixed number. If it is chosen Price-to-Earnings, Price-to-Cash Flow, or Price-to-Sales the numbers are always different, and this complicates things when choosing the industry-related coefficient. Also, sub-sectors in tech count when it comes to this formula. Software and Programming, for example, have different P/CF compared to Consumer Electronics. But, both sub sectors are a part of the tech industry. That’s why it’s important to pay attention when using this formula.
#3 Discounted Cash-Flow Calculation
This is one of the most complex formulas and relies on business annual cash-flow analysis that is projected into the future and afterward discounts the value of future cash flows to today. It is easier to find a net present value (NVP) calculator that helps to do all the calculations.
#4 Entry Valuation: Office+Equipment+Inventory+Employees+Consumables+Trainings
This formula calculates the costs of raising a business from scratch to the level it was at the moment it entered the market. It includes office space, all consumables and equipment, and also the effort of finding the team and upkeep employees (salaries, bonuses, training). It sums up all tangible and intangible assets and costs but does not include taxes, revenue, branding, reputation, or any data that relies on these numbers. In addition, this is one of the least applicable formulas for tech companies.
All in all, every formula mentioned above excludes some indicators and includes others to suit best each business and situation. Best practices recommend using at least two formulas rather than one when calculating a company’s value because getting a price range is more realistic compared to a fixed price. On a side note, you can contact valuation companies directly thru TechBehemoths