This article by Bill Gurley from 2011 discusses the qualities that make some companies deserving of a high “valuation.”
Not surprising that there is extensive overlap with the principles followed by many investors on this board (e.g. Saul’s post #80039):
1)Competitive advantage (business model cannot be easily replicated by aspiring competitors)
2)Network Effects (your product has the rare quality that it becomes more attractive as customer numbers increase)
3)Predictable revenue. As Saul has pointed out many times, the subscription software model is FAR more predictable than relying on more people buying coats each year.
4)High Switching costs. Again, as Saul has pointed out, if a customer depends on your software to run his business, ripping it out and starting over with a competitor’s software is hugely disruptive.
5)Gross Margins. To quote Saul:
“If you have 85% gross margins, a million dollars in sales is worth $850,000 to you. If you have 42% gross margins (still quite acceptable), the same million dollars in sales only brings you $420,000. Now really think about that!”
6)Scalability. Higher sales=higher profit margins. Software excels in this area.
7)Customer Concentration. If you only have a small # of customers, they have negotiating power and your profits could suffer if they threaten to leave.
8)Partner dependency. If a business depends on interactions with partners, this takes some control of the business away from management and makes it less predictable.
9)Marketing costs. If you need to constantly advertise to attract customers your business is less valuable than a competitor whose products are so awesome that the business grows through word of mouth.
10)GROWTH. Super important contributor to valuation, but only if it is combined with solid profit margins.