Investing in technology: it's not a bubble, but…

Ed Waldron, Jonny Bethell (Taylor Wessing)
19 February 2014

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Taylor Wessing's Ed Waldron and Jonny Bethell wonder whether the recent appetite for tech businesses is sustainable.

At a recent seminar, jointly hosted by Taylor Wessing and the British Venture Capital Association (BVCA), the association's director general Tim Hames described the recent upsurge in appetite for technology deals from institutional investors as "not a bubble, but..."

Hames's comment followed keynote speaker Raphael Grunschlag, head of European technology banking at William Blair, who said that the increased investor appetite in the space represented "a bull market with outsized rewards for perceived winners".

The panel, which also featured Scott Collins of Summit Partners, Ian Spence of megabuyte and Robert Fenner of Taylor Wessing, compared and contrasted today's market with that of the dotcom bubble of the early-2000s and found encouraging differences between the two. However, the old concerns regarding bloated valuations and the sheer pace of the industry need to be heeded, and most importantly require a high level of expertise.

Valuation & substance
Despite one or two recent eye-catching valuations, there is generally more substance behind most businesses seeking institutional investment as compared to the dotcom bubble of the early 2000s.

Target companies will typically have developed to a reasonable size prior to seeking substantial institutional investment, and the investors will be seeking returns based on largely proven technology trends. The market has not seen a return to investing in an idea rather than an underlying business.

High valuations for technology businesses are not necessarily an indicator of over-valuation – with technology behemoths such as Amazon and Google proving what value a market-changing tech company can achieve.

London – a centre of technology investment?
Due to the strength of the US in the technology sector, commentators have questioned whether there is sufficient expertise outside the US to guide both investors and tech companies through the investment process and, from the investors' perspective, conduct the requisite analysis of the investee business – particularly in respect of IPOs. It is correct that London has not seen many significant technology IPOs, but this is as much a result of the dearth of IPOs generally in recent years as it is a reflection of the expertise in the sector.

Tech in London is undeniably gaining strength – Tech City is a good example of this. Furthermore, more than £1bn was raised by technology companies on the London market in 2013, representing the highest amount since the start of the crisis.

Private equity and technology
It is not unfair to say that private equity has traditionally been reticent about technology investments, particularly in the mid-market and above. Houses such as Francisco Partners specialise in this area, but increasingly others such as Inflexion Private Equity and Lyceum Capital are deploying capital in the sector.

The point on a company's growth curve at which it turns from a cash-burning enterprise to a profitable one (built on a reasonably secure list of customers and an established offering) is the natural entry point for the asset class – they will generally be happy for their initial cash to fund the next stage of development, but are less inclined to go back to their LPs for follow on funds (outside of M&A activity).

It is tempting to assume that a more established business is a safer place for an investor's capital, but this relationship is not always a linear one. Due to the pace of change in the sector, what can be the most prevalent item of technology today can be historic tomorrow: notwithstanding Silver Lake Partners' recent buyout of Dell, some have questioned the future of the PC sector. Even where a business is in a preeminent position in a growth sector – BlackBerry's position in the mobile space five or so years ago being a good example – given the unique features of the tech market, a leading position can be lost in short order.

Expertise
The key to a successful investment in technology is already, and will increasingly be, expertise in the sector. Those investors who have the best expertise and the most experience at their disposal are likely to be those that achieve the highest returns. This applies to a sponsor's investment team, to the advisers and analysts they use, and to the management team they choose to back. The breadth of the technology industry dictates that expertise is often sub-sector specific: mobile, cloud, infrastructure, telecoms all have their own unique areas of risk and reward.

Informed investment decisions based on independent thought and made off the back of extensive analysis of a company's business are likely to be crucial to maintaining a healthy and sustainable market. The threat of a tech bubble increases exponentially when investment in the sector becomes normalised and the herd gathers pace.