Monitoring the Value of Tech Company Investments

November 16, 2017

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At Smythe Advisory, we are often asked about investing in tech companies and how to best monitor these investments.

As a minority investor, it is likely that you do not have access to the detailed information necessary to perform a full valuation on the tech company. If this is the case, you have a few options that we outline below:

  1. Your first option is to use whatever information is available and compare it against the expectations when the investment was made. At the most basic level, value is a function of potential financial returns and risk. The greater the financial potential, the greater the value. The higher the risk that the potential returns will not be achieved, the lower the value. Whenever a company raises money, investors will (explicitly or implicitly) translate their assessment of potential returns and risks into the price they are willing to pay.

    All things being equal, as a company moves through the development of the technology, if all the development milestone targets are hit as expected and the financial potential does not change, the value of the company will increase over time. The reason for this is that the risk decreases every time a target is achieved.

    If the potential remains the same compared to when your initial investment was made, but targets start being missed, then it becomes a question of risk. When targets are missed, it is often assumed to be a red flag that the risks are greater than originally expected, so valuations are assumed to drop. However, this is not always the case. Depending on the aggressiveness of the target and how far along the development curve the company is, compared to when your original investment was made, there is a chance that the risk profile has still decreased or remained constant when compared to your original investment. The assessment of value is at a given point in time, so when you monitor movements in value, it is important to compare the current results to the expectations at the time of the baseline comparison.

  2. A second option is to see if the company has raised any further financing since you made your investment. This can serve to validate your assessment of the progress the company has made.

    Be careful though, as tech companies will often issue different share classes with each capital raise. Each class of shares has a set of rights and restrictions which govern the shareholders’ rights. These share rights could serve as a cap on future potential (e.g., maximum annual dividend entitlement) or serve to mitigate risk (e.g, special voting rights, priority distributions in the case of liquidation). If your class of shares is different, then the potential and risks attributed to your ownership stake in the company will be different than the new investors. To assess the value of your investment, you must compare the differences in share rights and adjust the value of your shares accordingly.

  3. A final option, which is likely the least accurate and most difficult, is to find valuation information for comparable companies. There are many valuation rules-of-thumb in the tech industry based on multiples of users or revenue; however, it can be difficult to translate those comparisons into the specifics of your investment.

For investors in private tech companies, it can be difficult to accurately determine the value of your investment in the absence of a liquidity event; however, there are steps you can take to monitor whether they are moving in the right direction. If you would like to know more about the value of your tech investments, please get in touch with one of our Chartered Business Valuators.

 




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