- Steve Sarracino, founder and partner at Activant Capital, told Business Insider that the theme of 2019 was non-tech businesses masquerading as tech companies.
- While almost any modern business will be tech-enabled or use technology in some way, high margins define whether a company is a tech business.
- Sarracino is not opposed to investing in non-tech companies, but highlighted the importance of defining whether a company is actually a tech company before investing.
- Read more BI Prime stories here.
2019 was the year of non-tech businesses presenting themselves as tech companies — but that’s all going to change next year, according to Steve Sarracino, founder and partner at Activant Capital.
“We’re going to see some pause in 2020 on these normal businesses masquerading as tech businesses and getting tech multiples,” Sarracino told Business Insider.
Activant, founded in 2012, has invested in a range of retail, fintech, and industrial technology companies, including payments processor Bolt, digital mortgage startup Better.com, and autonomous retail robot manufacturer Simbe.
Sarracino highlighted WeWork as the most obvious example of the normal-masquerading-as-tech phenomenon, but said that the problem runs much deeper.
“It’s getting harder as an investor to pull apart what is digital transformation and what’s an old-line business,” Sarracino said.
While almost any modern business will be tech-enabled or use technology in some way, there’s a difference between having a website and actually operating a tech business.
“The first thing we always look at for any of these businesses: what are their gross margins?” Sarracino said. “That tells you a lot about their business.”
Gross margins show how much revenue is left over after subtracting out the direct costs of providing a service.
If the margins are high, the business is more deserving of a lofty tech valuation. These sorts of businesses can be risky investments because of the upfront cost of creating the technology and proving it works, but will have low costs per sale once the technology is built.
“They have to build a company using their own product to prove it works,” Sarracino said.
WeWork’s since-withdrawn IPO filing used the word “platform” 170 times, and the word “technology” 93 times. It defined the company not as a tech-enabled real estate company, but as a space-as-a-service company. The terminology mirrors the software-as-a-service model of companies like Salesforce and Workday.
“WeWork obviously wasn’t a tech business,” Sarracino said.
Sarracino is not opposed to investing in non-tech companies, but he highlighted the importance of defining whether a company is actually a tech company before investing.
“It doesn’t mean you don’t invest in those businesses, it just means the pricing should be representative of the business model and financial profile,” he said.
Sarracino said investors have to have to be careful of companies that spend like tech companies, but don’t have nearly as high margins. While those kinds of businesses could be rapidly expanding, it doesn’t mean that the expansion is sustainable.
Sarracino highlighted newer tech-enabled models of home equity loans as another example of a business that is presented as tech, even if it may not be.
“People have been creating new financial products since the history of humans to to unlock value or equity and create credit out of it,” he said.
Join the conversation about this story »
NOW WATCH: WeWork went from a $47 billion valuation to a failed IPO. Here’s how the company makes money.