The past year has seen tech valuations reach historic highs in a UK market that is becoming more global – and more crowded.
Some quick examples? Look at both the public markets – the IPO of Just Eat at a multiple of 104x EBITDA – and the private markets, with artificial intelligence start up DeepMind acquired for more than $400m without having launched a product. Whilst these prompt questions about the realism of such valuations, AO.com (priced at 72x EBITDA at its IPO), is demonstrating why such businesses can be valued so highly – even for this relatively mature business in a mature market (domestic appliances) revenue is expected to grow by around a third this year as it expands internationally.
These may be outliers, the pick of the bunch, and the valuations certainly don’t reach the heights seen in the larger US market, but there a growing UK trend towards higher valuations, and more frequent fundraisings.
A more Crowded Fundraising Marketplace
The UK market has seen a steady increase in the number of investors willing to commit capital to technology businesses, at earlier and earlier stages. This has been driven by the arrival of new investor types looking for ways into a market that has traditionally been dominated by the VCs:
- Large Private Equity groups are opening dedicated funds to target smaller investments in the tech space or forming partnerships with traditional VCs. CVC has recently been fundraising for a small tech focused fund and Accel KKR, a mid-market tech investor that has been expanding into Europe was formed from a partnership between venture capital firm Accel and KKR, one of the oldest and largest buyout firms;
- Secondly, large global technology companies are investing internationally in start-ups and early stage companies, increasingly in London. Google Ventures launching a $100m fund to invest in European Entrepreneurs in July and other US based funds from multinational giants such as Bloomberg are continuing to grow and employ more advanced techniques in finding new opportunities; and
- Alternative sources of funding have emerged in the form of crowd funding platforms. UK-based Funding Circle, which lends between £5k and £1m to businesses, has now lent just over £330m since founding in August 2010.
Speed of Adoption and Scalability
The online distribution of applications has led to rates of adoption that were previously impossible, such as WhatsApp, which at the end of 2013 was growing at around 1 million users a day. This benefit also extends to digital media and other technology platform businesses, offering huge scalability at little marginal cost.
What does this mean?
The combination of a crowded investor marketplace and the potential for the right technology company to scale up at a tremendous rate, results in rapid value appreciation.
This, in turn, provides the shareholders with opportunities to seek sequential investment rounds in short succession, whilst avoiding heavy dilution.
It also means that traditional valuation methodologies based on revenue and EBITDA are less and less relevant, as there may not be any of either. Adoption rates, user base, and other non-financial metrics are key in this context, with a robust estimate of the potential market critical to determining the potential value of the business.