Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 108

Valuations in the tech sector: what’s the deal?

Uber - $US50 billion + (and rising quickly)

Snapchat - $US15 billion

AirBNB - $US20 billion - $A6.5 billion

Freelancer - $A500 million

For anyone familiar with valuing assets in any sector other than early stage technology, there is an understandable confusion and mistrust about the numbers listed above. The golden rule of valuations is ‘what someone else is prepared to pay for it’ and regardless of what analysts in other sectors believe, investments are being made at these valuations, right now.

Have these investors taken leave of their senses, or is there something else going on?

A parallel can be drawn to the residential property market, where houses sold a year ago are back on the market at significantly higher levels. With property, there are both external and internal factors at play. We understand these and we can explain them, even if we shake our heads at the extent of the changes.

Technology valuations are also driven by both external and internal factors, which are less understood. Why? Residential property has been around for a long time, tech has not. It takes time and a lot of transactions for the valuation methodologies to appear and to be well understood.

External factors driving valuations

External factors can always be brought back to supply and demand.

From a supply viewpoint, there are more companies than ever starting to appear with disruptive business models. Dropbox did not exist six years ago, but now has a valuation of approximately $10 billion and expected 2014 revenue of at least $200 million, perhaps closer to $400 million.

But for every Dropbox, there are 100 other companies that won’t make it. How do you pick the next Dropbox? Insider tech investors know you can’t. The investment approach is far more about filtering out those who aren’t going to make it, rather than trying to pick the one company that will.

The chart below shows the valuation increments over the last 12 months of major tech companies:RW Figure1 050815

RW Figure1 050815

 Such incredible valuation changes are driven by two main demand-side factors:

A. Venture capitalists (VCs), in Silicon Valley in particular, are looking for the next Uber (using the current example). They need to invest in just about everything, and once the ‘Uber’ in their portfolio appears they are then looking for a 200 to 400 times return on that investment.

This is generally known as ‘FOMO’ – Fear of Missing Out.

B. The volume of cash now available for early stage investment from VC funds, based on a series of successful exits. This includes the Facebook IPO, Linkedin, the $6 billion that was part of the Whatsapp deal and a series of other high profile transactions.

It is estimated that last year, Silicon Valley VCs invested approximately $46 billion in early stage ventures. They are looking for between $100 billion and $200 billion back, based on their current investment approach.

Will they get this kind of return? They might. If they do, next time around they will invest $200 billion and look for $400 to $800 billion in return, and so on it goes. At some point the bubble will burst and there will be a correction. It is reasonable to expect there to be a reset of the external factors driving valuation in the next few years.

Internal factors driving valuations

The business model is the primary internal factor driving valuations.

Many people have done a business or accounting course and all of the profit calculations were based on the manufacture and sale of widgets. Even the advent of the services based economy has not shifted this.

To understand the technology based business model, a fundamental shift is required to look at profitability from the viewpoint of the customer, rather than the product. While many industries such as fast-moving consumer goods (FMCG) and banking have been doing this internally for some time, it is not part of their external reporting to shareholders.

To understand how a technology business model makes money (or to establish if this is the case), these are the main elements:

  • Life time value: this is the total value of revenue expected from that customer, over the life time of that customer
  • Customer churn: this is what is used as a proxy of how long customers are staying
  • Cost of acquisition: what is the total cost of acquiring the customer, which will be a combination of sales and marketing costs
  • Cost of retention: an essential part of any business which is based on long trailing revenue streams, including brand building, account management and customer support
  • Cost of delivery: for tech based businesses this is minimal, as the platform does all the ‘heavy lifting’
  • Cost of running a business: this is the standard office rental, cost of executives or office-holders, investor relations, legal support and other compliance related costs.

This calculates a product yield which is a return on investment for the sunk costs of building the product.

In real estate property management businesses, the accepted valuation method is 3–4 times annual revenue. For tech companies, a multiple of revenue is also used but this has been higher than 10 times for some time.

Why the difference between 3 times and 10+ times? Firstly, the cost of delivery is genuinely minimal, hence the product yield is normally at least 50% of lifetime value. Second, the growth potential if the product is truly scalable, and the founder can find a way to reach the right customers, has no limits as there are no capacity constraints, as evidenced by the rapid global expansion of Uber.

So what’s the best way to approach investments in tech companies, and especially those which are pre-cashflow positive?

  • The most effective investors are those who are actively engaged in their portfolio
  • The external factors driving valuation are fickle and can change rapidly. There is a ‘herd mentality’ that goes with it. A second opinion is always a good idea
  • Remember the ‘inside’ tech investors don’t have a magic formula either to pick the winners – hence this part of your portfolio can only be considered speculative
  • Ask questions to get inside the business model. Does the founder know how they will reach their customers? Do they know how much this will cost? What is the likely customer retention and engagement cycle? How long will they take to find out if the idea works? Will the money last?

Tech has had some amazing success stories that grab the headlines, but you hear far less about the massive number of failures. There are 1.2 million apps in the Apple store, but we use only seven each on average. The majority go nowhere. It can be a scary ride that’s not the place for a big chunk of your retirement savings, but it’s also an exciting space to be in.


Rachel White is a partner at corporate advisory firm, Verde Group. This article is for general education purposes and does not address the personal circumstances of any individual.


Leave a Comment:



For sale: how to manipulate a company valuation

Have tech investors suckled for too long?

Platinum’s Kerr Neilson: it’s all about the price


Most viewed in recent weeks

How to enjoy your retirement

Amid thousands of comments, tips include developing interests to keep occupied, planning in advance to have enough money, staying connected with friends and communities ... should you defer retirement or just do it?

Results from our retirement experiences survey

Retirement is a good experience if you plan for it and manage your time, but freedom from money worries is key. Many retirees enjoy managing their money but SMSFs are not for everyone. Each retirement is different.

A tonic for turbulent times: my nine tips for investing

Investing is often portrayed as unapproachably complex. Can it be distilled into nine tips? An economist with 35 years of experience through numerous market cycles and events has given it a shot.

Rival standard for savings and incomes in retirement

A new standard argues the majority of Australians will never achieve the ASFA 'comfortable' level of retirement savings and it amounts to 'fearmongering' by vested interests. If comfortable is aspirational, so be it.

Dalio v Marks is common sense v uncommon sense

Billionaire fund manager standoff: Ray Dalio thinks investing is common sense and markets are simple, while Howard Marks says complex and convoluted 'second-level' thinking is needed for superior returns.

Fear is good if you are not part of the herd

If you feel fear when the market loses its head, you become part of the herd. Develop habits to embrace the fear. Identify the cause, decide if you need to take action and own the result without looking back. 

Latest Updates


The paradox of investment cycles

Now we're captivated by inflation and higher rates but only a year ago, investors were certain of the supremacy of US companies, the benign nature of inflation and the remoteness of tighter monetary policy.


Reporting Season will show cost control and pricing power

Companies have been slow to update guidance and we have yet to see the impact of inflation expectations in earnings and outlooks. Companies need to insulate costs from inflation while enjoying an uptick in revenue.


The early signals for August company earnings

Weaker share prices may have already discounted some bad news, but cost inflation is creating wide divergences inside and across sectors. Early results show some companies are strong enough to resist sector falls.


The compelling 20-year flight of SYD into private hands

In 2002, the share price of the company that became Sydney Airport (SYD) hit 80 cents from the $2 IPO price. After 20 years of astute investment driving revenue increases, it sold to private hands for $8.75 in 2022.

Investment strategies

Ethical investing responding to some short-term challenges

There are significant differences in the sector weightings of an ethical fund versus an index, and while this has caused some short-term headwinds recently, the tailwinds are expected to blow over the long term.

Investment strategies

If you are new to investing, avoid these 10 common mistakes

Many new investors make common mistakes while learning about markets. Losses are inevitable. Newbies should read more and develop a long-term focus while avoiding big mistakes and not aiming to be brilliant.

Investment strategies

RMBS today: rising rate-linked income with capital preservation

Lenders use Residential Mortgage-Backed Securities to finance mortgages and RMBS are available to retail investors through fund structures. They come with many layers of protection beyond movements in house prices. 



© 2022 Morningstar, Inc. All rights reserved.

The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.