What a P&L Doesn't Tell
I've written in previous posts about a possible tech bubble due to overvaluations and short-sighted deal flows moving young companies upstream, far too quickly. In this post, I'm offering a partial retraction, and hoping to open a question set around how we can value companies more accurately. We may touch on some economic theory, but, as always, this isn't meant for the bean counters. The primary method of tech valuations is revenue multiples, and it's been standard to see 6x-10x for firms with a solid run rate and recognizable logos. However, there is a lot of ground between a 6 and a 10, so what makes this up? Analysts may look at P/E, hard costs, debt obligations, category, and peer comparisons. Taken on the whole, this seems like enough data to have consistency and transparency as to why a firms present value is what it is.
There are some intangibles that also get measured, something dubbed Invisible Assets. I'd like to explore and expand that concept today. First, we might look at the founding and executive team. How deep is their rolodex? Do they have industry expertise that may be defensible from competitors? Do they have experience scaling companies to growth-stage or even IPO? Understandably, these are things that should be factored into a valuation; good captains sink less ships. We also might look slightly deeper than revenue at key logos. This, again, makes sense. Would you rather invest in a firm with $10m ARR and ambiguous logos, or a firm with $10m ARR who works with Google, Facebook, and other tech behemoths?
But, what about some of the things that can't be captured in a pitch deck or a P/L? For example, if you have an SDR team with deep expertise, and consistently hitting quota, that will be read as analysts as "CAC is lower than peers, lower G&A than peers". And, with CSMs that are consistency generating above-average NRR, we might point to the IP and say they have a technical advantage over the competition.
But is there anything deeper than this? For example, how do these things translate into customer relationships? Are these predictors of deeper long-tail growth than a P/L and traditional valuation methods capture? Inversely, would high employee turnover, even in a high-growth company, perhaps indicate risk long-term? My gut tells me yes, but, there are more foundational economic questions we must ask. Valuations are based on present-value, a point in time measurement. How can we better factor in short or long term risk or growth potential, if we're saying what an asset is worth now? Going a layer deeper, we might say that an investors relationship with a company is 1:1. Things like employee retention, and having a leadership team that builds leadership teams, are 1:Many, and lay the ground work for future success, both in-firm and out. While the invisible hand might be good at looking at 1:1, non-temporal valuations, it's a bit blinded by time-series, macro-economic performance.
Tech might hold some of the answers, as pricing for a round is often related on intangibles, and has to have some foresight into how a company will go from A-B, B-C, etc.
An interesting concept is how to build some sort of generalized. reciprocity into pricing structures. If, as we move toward a post-scarcity economy, we need to look at our economy as interconnect network flying through space-time, it makes sense that foundational firms should be valued beyond the value they create for shareholders.
The notion of indexing comes to mind, as it bets on system-level growth over time. A consideration for tech, is that indexing also requires active trading to provide liquidity and "price-checks", and early stage tech is only OTC on a few venture exchanges.
Last, thinking through a potential NFT solution to this problem, we'd need to go deep into company engagement data to provide enough transparency to price accurately, but also keep founders protected from short-sighted active traders looking at quarterly gains.
Food for thought.