The High Value of Technology Startups: What Is the Reason?

June 13, 2021 by Soject

Rather than a technology-driven startup, which company or organization can achieve 450 million active users per month and a value of $ 19 billion over five years with a team consisting of only 55 people? Isn’t it strange that Tesla value, which is only 15 years old, is more than any other American carmaker? Why is the value of Tesla, founded precisely 100 years after Ford, is almost doubled? Why is the value of Ford with 115 years of experience not so high? What is the reason for the extremely high value of technology startups?

The answer is one phrase: The scalability and the potential of easy and relatively cheap growth of tech-driven startups.

Before we get into the meaning of growth and scalability, as well as the reasons for the high valuation of technology-based startups, let’s take a look at the valuation meaning.

What Is Valuation? Let’s Learn More about the Exact Concept of Valuation.

Valuation is the process of determining the present value of an asset, company, or business. The current value of an asset or company can be equal to its intrinsic value or economic value, depending on the method used. In a word, valuation is to answer the question, “How much is an asset or a company worth?”

Valuation is one of the most important pillars of financial science, so there are many ways to value assets and tech-companies over time.

To value assets, one must look at the potential for revenue, the cost incurred, the market value, and the like. Valuation of companies is usually done based on criteria such as growth and expansion potential, duration of the activity, the capability of the management team, current, and future income, and so on.

The Concept of Valuation

Some concepts – such as time – may lose their true meaning due to every day and sometimes overuse. The term “valuation” – which startups often use – is of the same type. Before going into the details, we will get more familiar with its exact meaning.

In various sciences, there are many definitions for the concept of “value.” But when we talk about value in the financial and economic sciences, we mean the present value of an asset or business. The current value can describe intrinsic value, monetary value, fair value, or market value. Each of these terms has its own exact meaning in financial science:

The Exact Meaning of Value in Financial Science:

Intrinsic value means the actual value of a tech-company (or any other companies), taking into account all its tangible and intangible assets. fundamental analysis is the method to obtain it .
Economic value is the maximum value or price that buyers or investors place on an asset or company that they are willing to pay.
Fair value is sometimes used interchangeably with the market value. The two terms are very similar, but there are slight differences between them. Fair value is a reasonable price from the point of view of both parties. Fair value is agreed between the seller and the buyer, given that both parties are willing to trade.
Market value is a price determined in the market based on the amount of supply and demand.

When we talk about valuation, what exactly do we mean by value? The answer depends on many factors:

The type of asset or company we value
Available information
The method used for valuation
And similar cases.

For example, value-listed companies use current fundamental value analysis to calculate all of a company’s future cash flows to determine its intrinsic value finally.

However, the intrinsic value of a company may not be equal to its market value or fair value. The fair value of many financial assets, such as stocks, is determined by supply and demand.

But how do you get the fair value of a technology-based company or startup?

As there is no transparent market for companies to trade, their fair value must be calculated in other ways. This is where the concept of valuation comes into play as a way to find the fair value of a business.

For information on startup valuation methods, you can refer to this articles:

The Most Prevalent Startup Valuation Methods

Well, after understanding the concept of valuation, we will continue to discuss the meaning of growth and scalability. Finally, we will discuss the reasons that lead to the very high valuation of technology-based startups.

What Does Growth and Scalability Mean?

To illustrate the concept of growth potential and scalability of a tech startup, which can justify its high value, I will suffice with an example:

Consider the largest online retailer in the United States, Amazon. Jeff Bezos found the company in 1995 with the mission of selling books online. A year later (1996), its revenue increased from $ 511,000 to $ 16 million.

The average daily number of visits to the Amazon website increased from 2,200 in December 1995 to 80,000 in March 1997.

Of course, such growth has never been associated with profitability. The company was listed on the NASDAQ in 1997 and had its first quarterly profit of $ 5 million, five years after its initial public offering in 2002. In 2003, Amazon had an accumulated deficit of $ 3 billion.

But why did a loss-making company raise $ 54 million in its initial public offering of $ 438 million? Why did investors trust this valuation and buy the startup stock?

The answer is:

Extremely high growth potential and scalability!

In the case of Amazon products and services, we can no longer calculate the growth rate, but this tech-based startup growth trend can be summarized as follows:

Amazon started as an online bookselling website in 1995, but now:

It has one of the most valuable brands on a global scale.
It is the largest online retailer in the world, with a market value of $ 796 billion.
Millions of people use Amazon cloud services platform solutions and products to build apps.
Amazon Virtual Assistant currently has millions of users.
through learning the machine, it predicts the user’s behavior and accordingly suggests taking the necessary actions

Is This Rapid Growth and Scalability Possible for All Technology Startups?

Never!

The nature of technology-driven startups does not end with growth potential and scalability. On the contrary, this potential is along with very high uncertainty. On the other hand, according to the survivorship bias that also applies in the world of technology and startups; out of the large number of startups that are set up to restructure or transform any industry, only a minimal number succeed in capturing the market.

Very big success for a very small number of startups can be attributed to this factor: The transformation and reconstruction of industries are happening very fast.

Consider, for example, the digitization of services available in different industries. A small percentage of emerging startups benefit from the largest share in the transformation and reconstruction of any industry. However, after a while, natural or manufactured barriers emerged for competitors to enter. Therefore, the first and most successful startups with a minimal number will have a significant market share until the next generation of developments.

Hundreds of messenger startups emerged in 2009. Yet WhatsApp alone has achieved such great success with a value of $ 19 billion. Consider online retailers: Amazon has a significant market share, and the rest of the cast, which is not small in number, is vying for tiny territory.

So you can’t imagine a very high valuation of WhatsApp, Facebook, Uber, AirBoney, or any other successful startup as a bubble. Rather, the reason these tech companies are so highly valued is that they have captured a significant percentage of their potential market very quickly.

At the moment:

WhatsApp is the most prevalent messaging app in the world, with 1500 million daily users.
Facebook accounts for 42% of the total monthly visits to social networks in the world.
Uber makes 500 million daily trips to 65 countries.
Airbnb has a record rent of more than 3 million accommodations per day.

Bubbles in Ratings of Technology-Based Startups

Of course, we cannot say that valuations are always based on the growth potential and scalability of the startup. A clear example of the bubble in the valuation of technology-based startups dates back to the late 1990s in the United States, when the Internet’s commercialization had begun, and technology was advancing very rapidly. During this period, the stock market index of Internet startups increased from less than 1,000 units to more than 5,000 units.

However, In 2000, the income coefficient for valuation was 34 !!! And the number of companies that managed to initial public offering their shares on the stock exchange is 350 !!! . (In the meantime, some of the companies that submitted their shares not only did not generate revenue and profitability but also did not even have products to offer.)

So it may be that when technology experiences a sudden and dramatic leap and revolutionizes various industries, the valuation of technology-driven startups is bubbling. But as the years go by, it is usually not possible to imagine a bubble for the very high valuations of startups that have conquered the market in a short and very fast time and have a significant growth model.

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