Technology and capital: Still growing together in 2018?
INSIGHT ARTICLE |
Ample cash ready for deployment by private investors generated much discussion at two recent RSM Tech Connection events, held in the firm’s Boston and McLean, Virginia, offices. Steve Ingram, national technology practice leader at RSM, and Steven Pipp, CFA, research manager at Silicon Valley Bank and Tech Connection presenter, recap the discussion and share additional insights in the following Q&A.
What’s the current investment climate like for the technology industry?
Steve Ingram: We’re seeing a tremendous amount of available capital from both private equity (PE) and venture capital (VC) investors eager to land deals and invest in the hottest technology companies. In the last quarter of 2017, PE firms executed more than 1,300 technology transactions across North America and Europe, a new high in deal volume. Likewise, PEs and VCs have raised over $30 billion in 2016 and 2017 in capital commitment, a level that will likely continue in 2018.
Given the available dry powder, many technology companies are not eager to go public, instead raising funds from private investors. Delaying their initial public offering (IPO) also means avoiding the business, legal, regulatory requirements and accounting challenges an IPO launch might impose. In addition, staying private means they’ll remain unaffected by market volatility and disruptive regulations. A sparse 26 technology companies went public last year and 2018 will likely see the same number. Many companies are opting to delay their IPO because they’re comfortable where they’re at, and PEs and VCs are happy to oblige them with funding.
Steven Pipp: I’d agree with Steve here. The average age of technology companies at IPO has climbed by about two years during this bull run—equivalent to one, maybe two more rounds of private financing. While this has pushed out the transparency and scrutiny of the public markets, I’d also point out that many of those rounds were priced to perfection. By delaying their offerings, some of these companies may simply be waiting to grow into that last private valuation and avoid a down-round for their debut.
What technology sectors are hot with investors?
Ingram: Companies offering software in communication, entertainment, network management, e-commerce, enterprise and financial technology (fintech) are all heavily sought after by investors. Likewise, cybersecurity is of huge interest, given growing threats and demands for protected data privacy.
Pipp: In addition, the potential of self-driving vehicles, robotics, artificial intelligence (AI) and machine learning technologies are appealing to investors. AI is quickly becoming embedded in nearly every product imaginable, from consumer products to industrial manufacturing. The early patterns of investment resemble that of another ubiquitous platform—big data—which also continues to attract steady funding as the need for data integration and assessment multiplies.
What are investors looking for?
Ingram: Aside from popular sector areas mentioned previously, investors are looking for demonstrated strong organic growth in the company. In addition, business scalability and barrier-free business models not prone to suppressive regulations or public policy are important to investors. Likewise, investors are often intrigued by innovative or unique technologies and solutions that shake up business as usual, similar to Uber and how it disrupted the transportation industry.
Pipp: Adding to that, a strong executive team is always essential. There are probably hundreds of qualified startup founders or executives currently at pre-IPO companies with the golden handcuffs of illiquid stock options. As the backlog of unicorns works its way to the public markets, we could see a new generation of disruptive innovation companies.
Is there a technology industry talent shortage and if so, what are companies doing to address it?
Ingram: While investors may be influenced by concerns of talent and labor shortages in the technology industry, many also accept that talent can be found all over the globe. Technology companies are leveraging virtual working environments to hire the employees they need, from engineers and programmers to customer service reps. I know of a technology company of 95 employees and only 20 actually work in the office headquarters. The rest of the developers and programmers are sprinkled throughout the country. If investors see that a virtual workplace model is successful for a particular company and it’s not an impediment for growth, it’s a non-issue.
Pipp: While I’m excited by the distributed workplace model, I think there are limitations. Many companies are hiring teams of developers outside the United States, notably in Eastern Europe, but those offices and teams always need an experienced leader. That type of management talent is always at a premium, no matter where you are in the world. It may take some time before that quality of leadership is ready outside of major technology hubs. I think companies will increasingly tap nontraditional students who are learning at coding academies and online.
What are some ways a technology company can better position itself to attract investors?
Ingram: It depends on the type of investor you’d like to attract. For PEs, their investment strategy is finding companies to increase revenues and profits. They’re often looking for companies where they can financially engineer operations and cut costs. Companies that can demonstrate scalability and have financial metrics that show strong potential can be appealing to them. Conversely, for the VC investor, they’re all about growth and grabbing market share. Their investment horizon is longer than a PE and showing profits isn’t as important as seeing a strong growth trajectory within a company.
Pipp: Knowledge and demonstration of key metrics specific to your business model can help entice investors. Venture capitalists are looking for early indications that the business will scale efficiently, so things like high lifetime value to customer acquisition cost and attractive gross margins mean that their investment would fuel smart growth. Additionally, the Rule of 40 may be helpful in determining reasonable growth relative to spend. At the later stages, investors will likely look for a path to profitability and scrutinize the quality of cash flows. By then, establishing internal controls related to forecasting, systems and personnel can bolster investor confidence.
A panel of private equity deal experts discuss the trends behind the deal statistics of the last quarter of 2017.
Starting the working capital mechanism discussion at the onset of a transaction is more important than ever. Learn more here.