Fully-Remote Companies Means More than Working From Home
During the pandemic, we heard plenty of discussion about remote work, why employees love it, why companies are fighting it, and why we should expect to see hybrid in-office/at-home work styles. It may take some time to work out the bugs, but it is clear that remote work in some form will become a part of the work plan.
There was occasional mention of how businesses could lower their facilities and related overhead costs by moving to a remote model. However, commentators overlooked some aspects of the remote revolution.
First, there is a distinction between bricks-and-mortar (B&M) companies and virtual, or fully-remote companies. Many B&M businesses sent most of their employees home to work during the pandemic but considered employees working at home offices an unwelcome disruption.
By contrast, fully-remote companies have no physical office. Everyone works and communicates online from wherever they are. Out of sight and largely ignored, this new breed of company with a virtual work style was emerging.
The discussion covered the advantages and disadvantages of working from home. However, there was less examination of the differences in financial performance between B&M and fully-remote businesses. No one noticed that they were attracting higher exit valuations than B&M businesses and that the founders of these businesses created more wealth for themselves and their angel investors.
At Exits, we noticed the trend to virtual companies a few years ago. It was a surprise to us that we were able to sell them for more money than their conventional B&M tech counterparts. It seemed strange that a company with no physical presence would be worth more to an acquirer than a substantive B&M company with everyone in sight and readily available.
Watching and evaluating tech industry trends, particularly those that affect our business of mergers and acquisitions, allows us to identify research opportunities. With the topic of ‘why virtual companies were more valuable’ largely untouched, it seemed opportune for us to start the research.
Virtual Companies Sell for More Money.
We observed several features that made them more valuable.
Lower Expenses. With no physical offices, virtual businesses don’t pay for facilities, maintenance and overhead. They accumulate fewer fixed assets.
Being fully online, they can recruit talent from around the world to work virtually, usually for far less in compensation. These significantly lower expenses drop to the bottom line, increasing the profitability of the virtual company.
Greater Agility. With less overhead and talented remote employees, virtual companies can more easily pivot to take advantage of new opportunities without bogging down in corporate procedures. Agile businesses tend to be more profitable.
Easier To Scale. With lower expenses and less overhead, these businesses can scale more easily and with less investment. Because they are more profitable, they generate more internal cash and so need less financing to fund growth. It is a virtuous circle.
Lean and agile create a power advantage. Traditional bricks-and-mortar businesses typically need to trade off profitability and growth. They can reduce expenses to be more profitable, but that also means less investment in growth.
Conventional tech firms can reinvest all the cashflow and raise additional capital to finance faster growth. However, they cannot maximize profits and growth simultaneously.
Lower expenses and greater agility allow fully-remote companies to be both more profitable and faster growing. This is a rare and valuable attribute in the fast-growing tech industry. As a result, they command higher prices in an exit transaction than comparable bricks and mortar.
There are other intangible reasons that make virtual companies more attractive to acquirers:
No geographic restrictions. We noted that these businesses can employ workers anywhere in the world, often at less cost. There are other advantages in having no geographic restrictions. Entering new markets is easier because licensing and other regulations are obviated when there is no physical presence.
Fully-remote companies can domicile anywhere in the world and have the flexibility to locate in a tax-friendly jurisdiction.
Employees Love the Freedom of Working Virtually. The pandemic demonstrated that employees thrived in working from home. Recovering wasted commute time and the flexible work schedule around family activities rather than always prioritizing work first is a huge advantage. Companies hiring for remote jobs has a huge advantage in recruitment as a remote team is drawn to flexible jobs and the work life balance that the ability to work remotely brings. With cloud based computing, employees can work anywhere regardless of their time zone.
Team members have the option to work anywhere which makes these remote positions highly attractive to prospective employees.
Simpler exit transactions: In our experience, with greater operational efficiency, fully-remote businesses are easier to acquire, integrate and relocate.
For Founders, the advantages of being virtual continue to multiply:
Fully-remote companies can make their Founders richer.
As we continued our research into why they sell for more, we also observed that virtual companies were a better financial deal for the companies’ founders. With less need to raise financing, Founders avoid dilution, retaining a significantly larger portion of the equity.
Many of these companies can scale on internally generated funds, as noted above. If they do need to raise financing to grow, they can usually avoid venture capital investors with their costly liquidation preferences. The end result is a bigger pie with fewer slices cut out before the founders take theirs.
A Real Public Company Comparison.
We wanted to validate our findings by quantifying the fully-remote company financial advantage, particularly for founders. We organized a research collaboration with a remote work expert at the Harvard Business School, Dr. Prithwiraj Choudhury, an entrepreneurial finance professor at The University of British Columbia, Dr. Jan Bena, and me, a graduate of both schools.
We found a fully-remote real estate brokerage firm: eXp Realty, and a few bricks-and-mortar comparables, including RE/MAX and Redfin Corp. We co-authored a case study: “eXp Realty and the Virbela Platform”, Harvard Business School case#: N-621-068. The case illustrates the many advantages of a virtual company and compares the financial performance of eXp Realty, a virtual real estate brokerage, to its bricks and mortar competitors.
Coming out of the research for the case study, we compared the financial performance of eXp World Holdings and Redfin Corp shown in Figure 1.
|Annual Revenue 2020 ($M)||
|Annual Revenue 2015 ($M)||
|2015-2020 revenue growth||
|Profit before Tax ($M)||
|Valuation 5/23/2021 ($B)||
|Financing raised ($M)||
|Founders % Holdings 2020||
|Fig. 1: Select Financial Comparisons|
In the five years from 2015, eXp’s revenues exploded 78-fold from $23M to $1.8B, while Redfin grew at a more leisurely 5-fold from $187M to $886M. eXp became profitable in 2021, while over the 16-year history to 2020, Redfin has never reported a profit. Curiously, eXp’s valuation often trails that of Redfin. Part of the explanation may be that because so much of the stock is still retained by the founder’s family, the relative lack of liquidity dissuades many institutional investors from buying the stock.
eXp achieved this outstanding growth with almost no external financing, while Redfin raised more than $700 million in equity and debt financing, including a public offering, over 16 years.
Of particular note, the founder’s family still retains 57% of the equity of eXp whereas the Redfin founders are long gone.
This financial comparison between eXp and Redfin convinced us that virtual companies sell for more money and make their founders richer.
Founders’ Wealth Creation Formula
We took the financial analysis one step further. We developed the Founders’ Wealth Creation Formula to demonstrate mathematically why virtual companies sell for more money and why their founders keep more of the proceeds. Consider:
Founders’ Wealth Creation = (EBITDA * Multiple – LP) * F * (1-T) – EC
- Founders’ Wealth Creation is the quantum of money that the Founders retain from the gross proceeds earned on the sale of their company
- EBITDA is Earnings Before Interest, Taxes, Depreciation and Amortization and other non-cash charges to the Income Statement
- Multiple captures the qualitative and quantitative factors which the acquirers impute to adjust the value of the company
Note: EBITDA * Multiple calculates the value of the company and the gross proceeds that the acquirer is paying to buy the company
- LP is the Liquidation Preference paid to the Venture Capital investors
- F is the percentage of the equity retained by the Founders
- T is the percentage of their proceeds that the Founders pay in taxes
- EC is the Exit Cost that the Founders pay to their professional advisors
Our observations at Strategic Exits after selling several virtual companies indicated that they out-performed bricks-and-mortar businesses on every term in the Formula:
- EBITDA is higher because costs are lower
- The EBITDA Multiple is higher because virtual companies grow more quickly
- Virtual companies can scale without venture capital investment, eliminating Liquidation Preferences
- The Founders are less diluted, so F is higher
- Taxes can be lower if the company can domicile in a tax-friendly jurisdiction
- The M&A transactions are often simpler so the Exit Costs are less.
Not every virtual company scores better on all of these terms. However, the FWC formula demonstrates that, in general, fully-remote businesses sell for more money and the founders create more wealth for themselves and their investors than do conventional B&M businesses.
As these findings become more widely appreciated, we expect to see a greater proportion of businesses founded as virtual businesses from inception, especially post-pandemic. The economics are just too compelling. We noted that it is more difficult for established B&M businesses to convert to all-remote operations. We expect, therefore, to see many examples in the coming years of agile virtual companies disrupting many industries and established companies falling behind as they can’t pivot as quickly.
In the Alliance of Angels presentation, we explain these observations in greater detail.