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Traditional business valuations are based on income, assets, cost approach and historical performance. Technology companies present a significant valuation challenge, since they typically have limited revenues, few fixed assets, and a history of losses – and a short history at that.

It is important to understand the many unique elements of valuing a technology company.

The factors typically present in a traditional valuation are either not present or provide very little insight in a technology company valuation.

Typical valuation methodology looks to assets and/or income for value and involves income, assets and cost approaches. Operating businesses are usually valued based on an expectation developed from their historical performance. On the contrary, technology companies typically have limited revenues, no history to speak of, and a track record of financial losses.

Often the technology company will represent the first of its kind of business. Therefore, it is difficult to find a peer group or competitors to benchmark performance. So, investors in technology companies usually look toward the future with an expectation of explosive growth.

Here are some other factors that impact the process of valuing a technology company vs. a traditional business:

Lack of Fixed Assets – Technology companies do not invest significant dollars into land, buildings, or other fixed assets and derive most of their value from intangible assets. Also, technology companies generally have no product or working prototype.

Projections are Key – The valuation of a technology company is based on the projected future stream of income of its intangible assets or intellectual property. Projections include assumptions regarding demand for the product, revenue growth, competition, alternative technologies, the economy and many other factors. However, such assumptions, if based on market research, known facts and sound logic can be a basis for value.

Capital – Another difficulty in the valuation of technology companies is determining the cost of capital. Many technology companies are dependent upon equity financing causing the cost of capital to approximate the cost of equity. Some technology companies issue hybrid securities, such as convertible bonds. Technology companies may have bank debt, making it hard to rate. In general, estimating the cost of capital from historical data is more difficult with technology companies that have short histories.

Management Strength – Investors often have their own methodologies for valuing technology companies. Some may evaluate certain factors and assign values to them. While a good idea may have value, without good management it may not be successful. Strong management may be worth more than any other characteristic. Industry contacts and relationships are important factors. Demand and an analysis of the marketplace must be evaluated. Finally, the feasibility of the product itself must be considered.

Intangible Assets – Aside from methodology and the many factors that contribute to value, one must be able to discretely identify individual intangible assets. Many characteristics can be indications of intangible assets. Such an asset may have a specific description or specific identification. It may be subject to legal ownership and protection such as a patent or copyright. Some intangible assets may have some form of tangible existence such as a license or contract. These are only some of the factors that may help to determine the existence of an intangible asset.

Intangible assets can be the largest component of a technology company. The value of these intangibles is what drives the investors’ expectations and ultimately the price. While generally accepted valuation methodology may be applied to intangibles, the specific factors that are considered and the individual valuation procedures may differ on an asset-by-asset basis.

Given these challenges, it is clear that the valuation of any technology company should be performed by an appraiser familiar with current trends, data sources, market transactions and market participants.

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