Valuation of technology companies

Research and development (R&D) can be capitalized in a company’s financial statements if it meets the criteria of a capitalized asset under current accounting standards.

Capitalization of R&D implies that R&D expenses are recorded as assets in the company’s financial statements rather than as immediate expenses. This means that R&D costs are spread over several years and amortized over the estimated life of the R&D assets. This capitalization can be justified if the company can demonstrate that the R&D costs are likely to generate future economic benefits and if the amount and duration of these benefits can be reliably estimated.

Capitalization of R&D can be a way for companies to enhance the value of their investment in innovation and to give a true picture of the value of their assets in the long term. However, it should be noted that the capitalization of R&D is often subject to strict criteria and requires careful evaluation by accountants and auditors to ensure compliance with applicable accounting standards.

Valuing technology companies can be more complex than valuing other types of businesses because the key assets of these companies are often intangible assets, such as patents, software, trademarks, or databases. Therefore, it is important to use specific valuation methods to value these assets.

The Venture Capital (VC) approach is a valuation method used by venture capitalists to value startups and early stage technology companies. This approach is based on the analysis of companies in terms of growth potential, risk and return on investment.

The Venture Capital approach focuses primarily on three key factors in evaluating a company:

The management team: Venture Capitalists evaluate the quality of the company’s management team, including their experience, expertise and ability to execute the company’s strategy.
Market: Venture capitalists evaluate the company’s market potential and the size of the business opportunity. They also look at the competition and market trends to assess the viability of the business.
Stage of business development: Venture capitalists evaluate the stage of business development, focusing on key indicators such as revenues, expenses, financial projections and milestones.
Using these three key factors, venture capitalists apply valuation methods such as the comparison method, the discounted cash flow (DCF) method, or the earnings multiple method to determine the value of a company.

The Venture Capital approach is commonly used by venture capitalists to value startups and early-stage companies, as it provides a more appropriate assessment of risk, growth potential, and expected returns than traditional financial valuation methods.

Other methods for valuing technology companies include:

• Comparable method : This method involves comparing the company with other similar technology companies to estimate its value. Comparison criteria may include measures such as revenue, earnings, market capitalization, or valuation ratios.
• Discounted Cash Flow (DCF) : This method is used to estimate the future value of the company based on its future cash flows. It takes into account growth projections, profit margins, capital expenditures, discount rate and other factors to determine the net present value of the business.
• Real options method : This method is used to assess the value of intangible assets, such as patents, software or brands. It takes into account development costs, future growth rates, abandonment costs and other factors to determine the value of the asset.
• Recent Transaction Multiples Method : This method is used to assess the value of a business based on multiples of similar transactions recently completed in the industry. Comparison criteria may include measures such as sales, earnings or market capitalization.

These methods are not exhaustive, and other factors, such as competition, technology risk, regulation, and market uncertainty may also be considered in valuing a technology company.

(For the valuation of intangible assets see also our Intangible Assets page…)

A Series Seed, A, B… refers to a funding stage in the life cycle of a start-up or early stage company.

Series A is the first major financing stage after the seed or pre-seed phase. It is usually done when the company has already achieved certain important goals, such as validating its product or service in the market, acquiring customers and building a strong team. In Series A, investors provide funds to help the company continue to develop and grow, in exchange for an equity stake in the company. The typical Series A funding amount is between $1 million and $10 million.

Series B is a later stage of financing, which comes after Series A, when the company has already achieved significant results and wishes to continue its growth. At this stage, the company has typically developed a strong customer base and has begun to generate revenue. Series B investors provide additional funding to help the company grow further, gain market share and strengthen its competitive position. The typical funding amount for Series B can vary widely, but is often between $10 million and $100 million.

In summary, Series A and Series B are important milestones in the life cycle of a start-up or early stage company, and often mark key milestones in the company’s development and growth.

Preferred stock is a common financial instrument used in serial fundraising. Preferred stock gives venture capitalists additional advantages over common stock, such as:

• A priority right to dividends : shareholders with preferred shares are paid first, before common shareholders, in the event of a dividend distribution.
• A priority right to assets in the event of liquidation : if the company is liquidated, shareholders with preferred shares are paid first, before ordinary shareholders, out of the proceeds of the liquidation.
• A conversion right : Preference shareholders can convert their shares into common stock at any time, usually in the event of a sale of the company or other transaction.
  

Preferred stock offers venture capitalists some security in terms of recovering their initial investment, as well as the potential for a higher return on their investment if the company is successful.

BSPCE (Bons de Souscription de Parts de Créateur d’Entreprise) and Stock Subscription Warrant(s) are two types of financial instruments commonly used in startups and growth companies to attract and reward employees and key team members.

BSPCEs are warrants that allow beneficiaries to purchase shares of the company at a preferential price set at the time the BSPCE is granted. BSPCEs are generally reserved for employees and members of the company’s management team. BSPCEs offer a tax advantage for the beneficiaries, as they are not subject to income tax at the time of their allocation, but only at the time of their exercise. They are also interesting because they are free.

Stock Subscription Warrant(s) are similar to BSPCEs in their operation except that they are subject to a charge at the time of their acquisition.

BSPCEs and Stock Subscription Warrant(s) are attractive financial instruments for employees and key team members, as they allow them to participate financially in the growth of the company and to benefit from a significant potential return on investment if the company succeeds. They are also a way for the company to attract and retain key talent by offering direct equity participation in the company.

When the company issues BSPCEs or Stock Subscription Warrant(s), it may apply a discount to the exercise price of the BSPCEs or Stock Subscription Warrant(s) compared to the Series A investment price. This discount is generally applied to compensate for the increased risk for the beneficiaries of the BSPCEs and Stock Subscription Warrant(s) compared to Series A investors because they will be entitled to acquire ordinary shares.

As seen above, the preference shares will often have priority over the ordinary shares. The price of the common stock will therefore be lower than the price of the preferred stock.

The discount can be variable and is notably function of :

• The advantages of the preferred shares (multiple at 1.5x, 2x…, precipitous dividend…)
• The structure of the capital (% of holding of the preference shares…)
• The number of options issued

To evaluate the discount of the common shares taking into account the preferences held by the A; B Shares… it will be necessary to retain an option approach and in particular based on Black & Scholes.