This blog post describes four reasons why tech is highly valued compared to other businesses: Scalability, speed, operating margins and limited capital needed. I have two business categories at focus in this article: software-based businesses and high-tech equipment businesses.
At the end of this blog post is also four additional and necessary pre-requisites needed to conclude why tech is highly valued.
Scalability is a reason why tech is highly valued
A business with massive potential has a higher value than a business that expects to operate as is.
Software based services are usually very scalable once a attractive product or service has been built. The same service is sold to many users from a centralized production with no physical products, with limited distribution cost and low implementation cost. That is a key reason why tech is highly valued.
High tech equipment can sometimes also be attributed a high scalability value despite the need to produce and distribute each and every product for customers. High entry barriers from complexed products or other unique characteristics that limits competition can make physical products highly scalable. At least relative other physical products and during a certain time period.
Think of a discounted cash flow which is a common valuation method: A strong cash flow forecast gives a higher value than a low cash flow forecast in any comparable period.
Businesses with strong growth potential has been given a higher value than a moderately growing business. That is reflected in higher valuation multiples.
You may also read How to Value a Business if your curious about different valuation methods.
Speed matters to value
Growing businesses create resources for the continued business development. The quicker the earnings, the quicker one can reinvest in the business.
Money that are earned quickly has a higher value than money in a distant future. Money that is earned early in a process can be quickly re-invested for additional growth, hence speed matters.
Slow growth can be important for product development, quality control and to build a great organization. However, slow growth that gives a slow earning growth is less valued than a fast-growing business where new earnings can be quickly reinvested in additional growth.
Software-based businesses has the potential to grow fast once the product has been developed. That’s why venture capital investors emphasize to start selling as soon as a Minimal Viable Product has been produced. To test the customer appetite and the scalability competence of the organization. The next success milestone as the business take off is the continuation of sales growth.
A business that can prove earning growth early in a process, and a continued earning growth thereafter, has a high value. The opposite would be a business that focus on trimming its product, its organization, its production units and/or its sourcing and distribution processes. The potential to grow early and fast only with a Minimal Viable Products is a key reason why tech is highly valued.
High margins are key why tech is highly valued
A software business has limited needs for sourcing, production and distribution compared with businesses with physical products. Products and services are delivered digitally from one or two operation units in an almost endless scalability. This is the single most important reason why tech is highly valued compared with physical trades like retail or manufacturing businesses.
Hospitality and service businesses suffers high staff and rental expenses with also makes them less profitable that software-based businesses.
Limited capital needed is also
Investments in stock, inventories and real estate is very low comparted with manufacturing businesses and hospitality businesses comparing similar earnings. That is why tech is highly valued compared with many capital intense businesses.
Finally, this is also necessary
Industry type, market potential, execution skills and track-record are soft factors that are important when determining a value. Checking the boxes in these four pre-requisites is also a necessity when to conclude why tech is highly valued. A great tech product will struggle to reach a high value despite scalability, speed, margins and limited capital needed should any of these four pre-requisites be missing.
Investors focus on certain industries that has high market potential on a global basis. Local physical businesses are hard and capital intense to grow. Investors also look at the leadership for execution skills and track record.
Focus to excel in an attractive industry, with great market potential, execution skills and track-record is a great start. Making a software-based offering or high-tech under these circumstances is when and why tech is highly valued.