EquityZen's Guide to Investing in Pre-IPO Tech Companies
- What is Secondary Investing?
- Current Investors
One assumption about private tech companies is that there's no available financial information, especially revenue. That's not always the case: some digging through public news updates can often shed more light on the situation. The following private companies provide detailed updates on their finances:
- Cloudera ($100 million in revenue in 2014)
- Nutanix ($300 million in a bookings run rate)
- Kabam ($400 million in revenue in 2014)
- AppDynamics ($150 million in bookings in 2014)
The common metrics to track in the late-stage tech world are annual revenue and revenue growth. Annual revenue is simply the top-line cash coming to the company from its customers. It should not be confused with profit, which is the amount of cash that the company actually keeps from the revenue.
To compare a company's metrics against another, analysts compare what multiple of the trailing 12 months' (TTM) revenue the company is being valued at. As an example, Kabam was last valued at about $1.2 billion, and had $400 million in 2014 revenue. This corresponds to a 3.0x multiple of TTM Revenue. A lower multiple is desired, as you're "paying" less to invest in the corresponding revenues (similar to value investors seeking low P/E Ratios in the public markets)
Armed with this multiple, we can compare this to other competitors in the sector (gaming), especially private companies.
- Kabam: 3.0x
- Zynga: 3.1x
- King Digital (Makers of CandyCrush): 2.1x
Revenue growth looks at how annual revenue is increasing (or decreasing) year-over-year. The reason investors have been willing to invest in unprofitable tech companies is their ability to grow revenue to a point where the company can eventually generate cash flow. To be sure, there is no guarantee that these companies will grow their revenues or become profitable. Successful tech companies exhibit triple digit revenue growth in their early years, and it tends to decelerate (though still grow) in later, more established years. Tom Tunguz, a VC at RedPoint Ventures, has some excellent analysis on the correlation of market cap to revenue growth.
With all this being said, keep an eye out for a few things:
- Source of finance data: is it "rumored" in TechCrunch, or actually being announced by the company?
- The right competition: are you comparing metrics to competitors, or companies in a different sector that may trade at different multiples?
- Bookings vs Revenue: Bookings are when a company gets paid upfront for future services, whereas Revenue is realized when the company actually delivers the service. The difference is important, and you can learn more about it here from OpenView VC's blog post.
Available information about private, venture-backed tech companies can be limited when you're assessing a secondary investment. However, the company's roster current professional investors is usually well-known. EquityZen provides this information on our Trending page, and you can also check Crunchbase.
There are a few different types of professional investors to keep an eye out for. It's important to understand the difference as different investors have different motivations.
- Venture Capital: VC's are looking for outsized returns, and have non-permanent capital. That means that the money they have raised from their Limited Partners (LPs) needs to be paid back in a finite amount of time (10 to 12 years). Because of that, VCs are motivated by liquidity: they need their portfolio companies to eventually be acquired or go public, so that they can cash in and return $$ to their LPs. (Examples of VCs: Sequoia Capital, Andreessen Horowitz, Index Ventures)
- Strategic Investors: Strategic investors are usually large companies from a similar sector that are investing to establish a relationship with the private company. "Strategics", as they are known colloquially, do not have LPs and can typically be more patient with their investments. Additionally, the involvement of a Strategic can provide a private company with a natural acquirer down the road. (Examples of Strategics: Salesforce, Google, Facebook, Oracle)
- Institutional Funds: Institutional investors include Hedge Funds and Mutual Funds. These investors typically invest later in a company's lifecycle, once they've had visibility into a proven revenue and growth model. (Examples of Institutional Investors: Fidelity, Coatue Management, T Rowe Price)
Some researchers in the space have also published the most successful investors (Check out CB Insights' piece: "Which Venture Capital Firms are Best at Spotting Unicorns Early?").
Investors invest at various stages of a company’s lifecycle. For example, YCombinator acts as an accelerator and early-stage investor. Therefore, expect lower valuations and a longer time to eventual exit. Institutional Venture Partners, on the other hand, looks to invest in companies "with over $10 million in revenue". By knowing what stage the investors typically invest in, you can get a handle on when a company may be looking to go public or get acquired.