The 7 Decisive Investment Signals When Evaluating an Enterprise Tech Company

When evaluating a new tech company as a potential partner, there are seven essential signals you should watch to determine if they’re a safe bet.

👋 Hi and welcome to The DX Report — all about Digital Transformation, the Digital Experience, and the Digital Enterprise. I’m industry analyst, author, and speaker Charles Araujo, and I’m all about providing insights and analysis for enterprise IT leaders as you make the big bets about your organization’s future!

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Photo by Chris Liverani on Unsplash

✋ Note: This analysis is a follow-up to my analysis, How You Can Accelerate Innovation By Building a Digital Transformation Platform. While that piece lays out the reason you need to invest in the tech to build a Digital Transformation Platform, I realized that there is a lot that goes into making those sorts of decisions. This analysis helps you understand the signals that can help you do so.

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Enterprise IT leaders have traditionally selected technologies based on a set of technical requirements. They identified the technical, functional, and non-functional requirements of the technology they looked to acquire, then compared vendors against those criteria. While there was sometimes a reference to the stability of the company, etc., it was these requirements that drove most of the decision-making process.

While this approach may have worked fine when most technology purchases were of commodity technologies, this approach is now outdated when enterprise IT leaders must make bets on emerging technologies and companies.

Rather than focusing on requirements as the chief driver of selection, enterprise leaders should look at each new technology vendor as an investment. As any other investment, they should evaluate it based on several factors that will assess the overall fit, sustainability, and potential return of the investment, with requirements being only one of these factors.

While fulfilling requirements is essential, in most cases there will be several vendors that do so, likely including all major vendors. Therefore, an over-focus on requirements will lead enterprise leaders into the Distinction Bias trap.

Instead, enterprise leaders must go beyond looking solely at requirements and evaluate the investment based on the overall fit with the organization's "investment profile."

The Enterprise Tech Investment Profile

As a personal investor, you have an investment profile. Factors such as your age, your investment goals, personal values, and current investment portfolio will influence future investment decisions. This profile will establish your levels of risk tolerance and the type of companies you invest in.

Much like with traditional financial investments, every enterprise, likewise, has an enterprise tech investment profile. In this case, factors such as risk tolerance, overall technology budget, the level of innovation and transformation focus, and alignment to strategic plans will dictate your investment profile.

While there's no color-by-numbers formula for determining your investment profile, having a clear set of strategic objectives, a vision for the future you are trying to create, and a sense of how much risk (both in terms of how much you're willing to invest and the risk of new technologies or unproven companies not surviving) will help you create your investment profile.

With that profile in-hand, you will be able to more adequately assess potential investment opportunities when you are considering acquiring and deploying a new enterprise technology.

The 7 Investment Signals

When you are considering a new piece of enterprise technology, you should NOT focus on evaluating the solution or product. Instead, you should evaluate the company because that’s the real investment you’re making.

When you do, you should do so based on the following seven criteria, weighted based on your investment profile. While you can create a defined rubric, if you desire, the point is to simply be aware of each of these criteria as you evaluate your investment. Note that the criteria are listed in no particular order.

Requirements

The first criteria is the solution’s fit to your technical, functional, and non-functional requirements. As I mentioned previously, you should be wary of falling victim to distinction bias here. In fact, using a simple binary approach here may be useful — every solution either does or does not meet your requirements. Alternatively, you can assign some sort of percentage indicating the degree to which it meets your requirements.

The point is that the degree to which something meets every requirement is rarely decisive, so make sure that any investment you make will meet your requirements, but beyond doing so put little stock in minor improvements or capabilities that exceed them.

Investors, Investment Levels, and Valuations

The professional investment community takes a hard look at many of the same things (although not all) that should concern you as you assess the risk of investing in a technology company. As a result, looking at who has invested, the amounts invested, and whether or not valuations are rising through various rounds are all solid indicators of investment risk. A few critical notes on this criteria:

• Investors are looking for financial return so their criteria may not always align with yours, so be cautious. Look for a focus on fundamentals, market disruptiveness, and longevity.

• Not all investors are the same. Look for those that focus on enterprise tech or have a solid portfolio and track record of investing in enterprise tech, and which has success stories based on their portfolio’s impact on the enterprise tech market (rather than on just positive exits).

• Companies that have not taken on investors are not necessarily a bad investment, but proceed cautiously. While most founders will say that they have elected not to take outside investment so that they can retain control, that's typically a warning sign. Often, this is code for resistance to outside advice and involvement, or that they have been unable to acquire funding. Unfunded companies represent a risk to the enterprise buyer as they will likely have difficulty competing and sustaining growth in this hyper-competitive market.

• For publicly-held companies, you should evaluate them differently based on how recently they went public. If they went public within the last 12-18 months, you should look at them like a privately-held company and evaluate their investors, investment levels, and valuations primarily based on their pre-public information. The initial period after an IPO is often volatile as the market establishes their track record. After a company has been public for some time, you should look at the overall market analysis in terms of valuation and investment holdings for guidance.

Partners

Another key evaluation signal is the quality and depth of the company's industry partnerships.

To be clear, I'm not talking about an organization that identifies themselves as part of some larger firm’s partnership program. Instead, you're looking for deep, bi-directional partnerships represented by:

• Joint development programs

• Deep, native integrations

• Co-selling arrangements

• Financial investments, either bi-directionally or by the larger firm investing in the smaller firm you're evaluating

The idea here is similar to looking at an organization's investors. These sorts of deep partnerships typically come with significant levels of due diligence and are a strong indicator of sustainability.

Founders

One of the things that professional investors look at closely is the pedigree of a company's founders. You should do the same. In your case, however, you should be less interested in their ability to lead successful exits and more focused on some specific elements:

• Their expertise. Do they have specific expertise and experience that leads you to believe that they will have (a) created a truly innovative solution that will help you solve your business challenges and that (b) they will continue to innovate in a way that is in alignment with your goals.

• Their track record. You do want to look at their track record of company starts and exits, but mostly from the perspective of whether or not they ultimately created value for their clients and if they created companies that ultimately survived. Founders who create companies that get repeatedly consumed (i.e., the solutions do not survive in their original form) by larger competitors may not be a positive sign.

• Their origin story. It's also important to look at the founder's why. The light bulb moment that led them to start the company is a critical indicator to their authenticity and their genuine belief in the problem they are seeking to help you solve. If they are authentic in their origin, they are more likely to (a) continually create meaningful improvements that are aligned to your needs, and (b) ensure that any eventual acquisition or growth doesn't undermine the company's founding principles.

Vision

Linked closely to the founder's origin story, but just as important for more established or public organizations, a company's vision of the future and how it presents it is one of the most important signals of investment potential.

What you're looking for is a vision that is:

• Clear and well-articulated

• Aligned to your vision of the future and where you're taking your organization

• Focused on solving a specific problem that is meaningful to you

Overall, the company should be able to tell a compelling story about the future, how that future impacts you, and how they will help you respond to it. If they can't do so, the risk that they fall out of alignment with you and your goals increases substantially.

Growth Rate

Growth rates can be difficult to ascertain for non-public companies, but you should be asking for it from any potential partner. A private company that is not willing to share growth rates (at least a rate without hard revenue figures) is a warning sign as it likely indicates sub-par growth.

You're not necessarily looking for rocket-ship-growth. While that can, in some respects be positive, it can also be a warning sign. You are looking for healthy and sustainable growth. Rapid growth indicates market uptake, which is essential for the organization's staying power in the hyper-competitive enterprise tech market. At the same time, however, extremely high growth rates may spell trouble if they are outrunning their capital access. Extremely high burn rates are not good, especially in our current market state.

There's also an inverse relationship here. The larger a company gets (particularly if its public), the more impossible it becomes to sustain super high levels of growth. Still, the market will demand that growth to maintain its valuation, therefore, these large growth-driven companies will begin to make bad moves in an effort to goose their growth rates. In most cases, I see this as a warning sign. The good news is that when organizations get to this size, they are typically already part of your tech estate and not something you're necessarily needing to make investment bets around.

Revenue per Employee

Again, this may be a difficult number to get for non-public companies, but ask for it anyway. This ratio is less valuable for very small companies, but it is a fabulous indicator for companies once they break through the very early stages. Low-levels indicate either over-hiring or low revenue returns — or both.

For earlier stage companies, it may be important to look at this during several different periods of time. This is particularly true right after a capital round. Early stage companies will often use capital to acquire new staff, but revenue from that investment will lag, so you need to look at the number at various points.

Likewise, the signal quality of the number will rise as the organization grows (read Mostly Metrics article on this for more detail). While there's no magic number, looking for something in the range of $250k R/E is solid unless you're evaluating a very small company.

Placing Your Bets

As I discussed in my piece on Digital Transformation Platforms, you need to be placing bets on the innovative tech companies that will help you move your organization forward. But figuring out which bets are good — or not — is tough when everyone is in sales mode.

These seven signals will help you separate the good bets from the bad ones and, most importantly, help you align your investment choices to your needs and risk tolerance.

Happy investing!

So, that’s my take on how to make the right investments in enterprise technology, but what do you think? Agree? Think I’m completely off? Let me know!

And don’t keep this conversation to yourself. Invite your friends and associates to weigh in!