Beauty is in the eye of the beholder.

The origin of that saying is debatable. Some attribute it to Shakespeare, some attribute the exact phrase to Margaret Hungerford in her 1878 novel “Molly Bawn,” and still others claim the essence of the quote dates back to the fourth century B.C. and Plato. In the end, nobody really knows. 

Which makes this saying very similar to technology company valuations. 

Tech startups, pre-revenue companies, negative Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) companies, and young companies just a few years old are nearly impossible to value with any degree of accuracy. Evidence for this statement rests in the many examples of inflated and outrageous valuations of technology companies over the last five years. 

Consider the payments company Stripe. In March of 2021, the company was valued at $95B post-funding. The company’s secondary market valuation climbed to around $200B in January 2022. By July of 2023, the company’s valuation had plummeted by over 73%. 

Instacart, a grocery order, delivery and pickup company is another prime example. Two years ago the tech company was valued at roughly $39 billion. Currently, the company is shooting for a $9.3 billion valuation—a 76% slash in value over just 24 months. 

Financial technology (fintech) companies Klarna and Chime have followed similar paths. Klarna’s last valuation in June 2022 was at a whopping 85% reduction from its valuation in June 2021. 

These are just a few examples of the overhyped tech valuation market which has collapsed with the onset of higher interest rates. 

When selling a tech business one of the primary considerations is the valuation. Do you use EBITDA? Or revenues? Or, if valuing fintech or a payments platform, what about Gross Transaction Volume (GTV)? Or, for an e-commerce business, how about using Gross Merchandise Value (GMV)? What about Lifetime Value (LTV) of a customer? The metrics are plentiful. But what good are the metrics if the company is not profitable? How does GMV, or LTV, or GTV apply to profitability?

And therein lies one of the chief difficulties in tech valuations: forming a credible and justified valuation with metrics that make sense. Without a positive EBITDA how do you use an EBITDA multiple? You don’t. A negative times a positive will always equal a negative. So investors and analysts have found other numbers to use, such as GMV, LTV, and GTV. 

Why is valuing a tech company so much different than valuing a “normal” business? It’s because a lot of tech companies are not profitable or barely profitable when they are seeking a buyer. It’s almost expected that the company is not profitable. They may have revenues, but not profitability. Refer to the negative EBITDA situation above: Tech companies find buyers even when the company is not necessarily profitable. Why? Because the money is there. 

Consider this quote from Investopedia:

“Tech start-ups reliant on venture capital and wealthy tech investors have had to recalibrate growth plans as that funding has plunged, the Financial Times reported earlier this year. In addition to finding other sources of financing, many startups have begun laying off workers as they try to conserve cash.”

Tech valuations have been propped up by a flood of cash from venture capital and wealthy investors that sink millions into good ideas even if they are not profitable. This is why we are currently in a tech valuation bubble that is bursting. By the time the money looks up, it’s already raining. 

If the company is profitable, then EBITDA and revenue multiples can be applied. What that multiple is depends on the sector the company operates in, as with any other business. Certain industries have higher multiples than others, and certain tech companies carry higher multiples than other tech companies. Fintech, for example, is big right now. Mobile payments are gaining traction around the world, and this demand brings higher multiples. E-commerce is also very popular; online shopping is clearly a trend not slowing down anytime soon. 

Tech is sexy, so when the company is not profitable investors look to the concept and space. They look at other metrics rather than profitability to justify value. This is particular to the tech space. When other types of businesses are not profitable, there are not typically buyers lining up to take a look. Yet this is not the case with tech companies. Because, again, beauty is in the eye of the beholder. 

I have a tech company client right now that is a prime example of this concept. Let’s call this company “Quantum Marketing.” 

Quantum Marketing is a pre-revenue tech company focused in the influencer marketing space. They have developed an artificial intelligence-driven (AI) algorithm that automates influencer marketing campaigns, creating a self-service platform for building social media influencer marketing campaigns in real-time while more precisely reaching the client’s target audience. It is a disruptive marketing technology (martech) for influencer marketing. 

But Quantum Marketing is not producing any revenue. The company is currently just the two people who created the platform, and they do not yet have the manpower to onboard new clients and provide customer service. A pilot program did prove efficacy, and there is a backlog of potential clients, but there is no patented IP. The “secret sauce” is in the programming of the algorithm and the utilization of AI. Without any revenue, tangible IP, or any patents or pending patents, how does one gauge the value of this unique martech platform? 

That’s the million-dollar question. 

When we listed Quantum Marketing we did so WITHOUT an asking price. We knew there was value in the technology. We knew—and had evidence—that it worked. We knew we had a backlog of potential clients. But we did not know what it's worth, and neither did the sellers. 

I have found this technique to be rather unproductive in past ventures. Over the last 10 years we have taken a handful of businesses to market without an asking price, most with little success. Buyers do not like having to put up the first offer. They want to first see what the seller expects in order to bargain down the price.

But with our client we took the approach of simply admitting we do not know what it's worth so we should allow the market to dictate value. The market will always speak to you. The sellers agreed, so that’s what we did. In order for this to work, sellers must be realistic with expectations, and buyers have to operate in good faith.

The tactic proved effective this time. We had a deal in progress with Quantum Marketing in short order. The acquirer was a publicly traded micro-cap technology company we will call Horizon Nexus. This company was a digital marketing company with multiple verticals. Their customers were small- to medium-sized businesses, or SMBs. They prided themselves on “bridging the gap between consumers and brands” by bringing data analytics, digital marketing, and advertising solutions to small businesses. 

Horizon Nexus was looking to add to their existing tech stack and services, and also wanted to keep the two principal owners in place—Quantum Marketing fit precisely with what they were looking for. This was an acquihire structure. The synergies that would be generated by Horizon Nexus integrating Quantum Marketing were projected to produce over seven figures of revenue in a short period of time. 

The overall deal structure looked like this:

• Asking price: $3.5mm
• Cash: $500,000
• Stock: $1.8mm 
• Seller note: $1.2mm
• Employment agreement for both owners: $200,000 per year. 

This was a great deal. Unfortunately it fell apart due to Horizon Nexus’ stock plummeting nearly 90%. The fall started just as due diligence began to move forward. After 45 days or so of continually falling stock prices, the Board voted to terminate the deal. We went back to work.

Since then we have yet to find a buyer, but we’ve had several talks with several prospects. There remains a steady stream of traffic on this business—people love technology companies. Not having any revenues has not scared anybody off, nor has not being profitable. But try pitching a buyer on a clothing retail company that has no revenues, nor is profitable. Time that conversation and let me know how long it lasts. 

Despite the traffic we’ve generated, we have not been close to getting a deal. Each of these prospective buyers is a long, long way from the Horizon deal valuation, with most not even putting an offer on the table. One buyer said pre-revenue tech companies are worth nothing. Literally, $0. 

So, what makes a company worth $0 to one buyer and $3.5mm to another? Simply put, the buyer. Beauty is in the eye of the beholder. Horizon Nexus saw a great deal of value with projected tremendous growth by integrating Quantum Marketing into their operations. 

Conclusion

Before selling a technology company, consider the valuation being used. Is this company profitable? If so, great; this is less of an issue. Is the company not profitable? If so, great, because tech companies will still sell EVEN IF THEY ARE NOT PROFITABLE, but only if the valuation makes sense. Astronomically inflated valuations are not gaining traction like they were in the days of near 0% interest rates and cheap money. 

Consider the buyer, too. The buyer will determine whether the valuation is in-line or inflated. A synergistic industry buyer, whether they buy the tech or not, can provide valuable insight into what the market is saying about valuation. 

And remember…

Beauty is in the eye of the beholder. 

SHEP CAMPBELL

SR. BROKER, MERGER & ACQUISITION SPECIALISTS.