Finance in the world of tech

What makes tech so important in the world of finance

S ince the availability of the internet in the 1990s, the tech industry has centered on the
transformation of the data revolution from the industrial manufacturing led revolution. Today, it
stands in the trillions of dollars and is the single largest addition to wealth in the last 20 years (over
45% of Total Market Cap in NASDAQ are tech companies in 2017). This information in the internet age has
been touted as the fourth industrial revolution (The Global Information Technology Report 2016, World
Economic Forum).

Tech is here to stay.

What makes Tech businesses so unique?

Now, while the finance in the tech industry seems simple, Revenue (Employee Cost + Facility Costs), the
complexity comes from the absence of physically tangible commodity which can be consumed over time
and a fundamental shift in the dynamics of the relationship.

Lets break this down into 3 fundamental aspects which set tech finance aside:

Value in use as compared Investment on intangibles

with value on sale + Longevity + first

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Value in use as compared with
value on sale
New models of receiving value
The emergence of consumption
tied directly to the providers
revenue (SaaS, pay-per-use,
freemium, pay-as-you-go, pay-
per-instance) open several
questions of when value is
being delivered and when
commensurate consumption of
effort occurs.
Example
A company (lets call it,
Healthinity) which I had
worked with, had built a unique
device in the field of healthcare
where the revenue model was
linked to a franchise and pay-
per-use structure. Healthinity
would receive revenue from the
product over the lifetime of the
product as the value of the
product would keep getting
enjoyed rather than on the sale
of the device.
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Longevity
New asset class
Compared with a tangible
product, the technology
industry requires consumption
of service over a period with an
implied promise of support
which may not be
commensurate with revenue
generated.
Example
A company (lets call it,
GilFrend) which I had worked with, had built a product after 4
with, had perfected a SaaS
based solution to ERPs. While
the service was priced based on
number of licenses used
monthly, there was an implicit
understanding that the
company needed to support the
data and integrity of the system
in perpetuity and an express
understanding for technical
support for the next 3 years.
Investment on intangibles first
New fundamentals
The fundamentals of technology
services imply a significant
investment of time, effort,
resources and capital initially.
Whether it is learning/ building
a domain expertise or
developing a product, the value
is being generated much before
the consumer fetches a service/
product.
Example
A company (lets call this one
Ensecore) which I worked
years of research and
development of over $5M. This
product had received adoption
with its first few clients jumping
on to the beta product which
was refined over time which
would do significantly different
functionality from the final
product. However, only the final
product would make revenue
when the circle would be
completed.
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 The new intricacies in finance

> Invoicing is not necessarily revenue

GilFrends was initially contemplating booking revenue as invoiced. Applying the simple principle of
Substance over Form, the revenue recognition is to be deferred till the time that the company has
an obligation to perform services though the collection of moneys may have happened much earlier.

> The role of estimations

Lets take an example of the popular collaboration software, Slack. Slack is free up to 20 users and up
to a volume of conversation threads. Slack begins collecting revenue when an organization has been
crossed the 20-user limit. Does this mean that the revenue was not earned the time that the product
was being used by under 20 employees? No. It was. The value was being delivered and the customer
engaged from the time that a company started using it and began engaging with the product.

> Recovery of cost

Ensecore, which had built the product over the years had booked losses against all the development
effort expended, which was not right. An assessment of the time expended showed that the endearing
value of the product would be over the next few years and there was a definite association of the
effort to the product being developed. Isnt the development efforts value going to reap benefit over
the next 5 years or more? Yes. Then the cost of the development effort was really an asset that human
effort was used to build.

How does this change things for you?

There is no one way. While GAAPs have guidelines for measurement and recognition, the business can
choose to differ on certain aspects simply because of the uniqueness of their business model. The real
decision of what is right needs to come from experience on the technical side as well as the business
side. This is what is making CFOs great CEO candidates off late.

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Original publish date: Sep 11, 2017
Author: Pradyumna Nag
Contact: nag[at]prequate.in

The author is a seasoned finance professional with equal parts experience in Finance, International
Business, Management & Strategy.

Disclaimer: This paper is a property and copyright of Prequate. No reader should act solely based on any
statement contained herein without seeking adequate professional advice. The authors and the company
expressly disclaim all and any liability to any person who has read this paper, or otherwise, in respect of
anything, and of consequences of anything done, or omitted to be done by any such person in reliance
merely upon the contents of this paper.

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