Posted March 5, 2016
1/ A few common fallacies about valuation of public and private technology companies:
2/ First, ask any MBA how to value tech companies, she’ll say “ discounted cash flow, just like any other company.”
3/ Problem: For new [and] rapidly growing tech [company’s], up to 100% of value is in terminal value 10+ years out, so DCF framework collapses.
4/ You can run as many DCF spreadsheets as you want and may get nothing that will help you make good tech investment decisions.
5/ Related to fact that tech [companies] don’t have stable products like soup or brick companies; future cash flows will come from future products.
6/ Instead, [a] smart tech investor thinks about:  future product roadmap [and opportunity],  bottoms-up market size [and] growth,  talent and skill of team.
7/ Essentially you are valuing things that have not yet happened, and the likelihood of the CEO and team being able to make them happen.
8/ Finance people find this appalling, but investors who do this well can make a lot of money, but spreadsheet investing is often disastrous.
9/ Doesn’t mean cash flow doesn’t matter, in fact opposite: this is the path to find tech companies that will generate tons of future cash.
10/ Corollary: For tech companies, current cash flow is usually useless for forecasting future cash flow [because current cash flow is a] lagging not leading indicator.
11/ This trips up value investors … all the time; tech companies with high cash flows [are] often about to fall off a cliff.
12/ Because current cash flows are based on past products not future products. And [in a startup] profitability often breeds complacence and bureaucracy.
13/ Always, always, always, the substance is what matters: WHO and WHAT. WHO [is] building the products, and WHAT products are they building.
14/ Brand will not save you, marketing will not save you, channels will not save you, account control will not save you. It’s the products.
15/ Which goes right back to the start: Who are the people, what are the products, and how big is the market. That’s the formula.
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