Why Investors Should Prefer Companies with Remote Workstyle

The year was 2020, and businesses adapted to the virtual workstyle to continue their operations during a pandemic. While remote working was not necessarily a popular choice, it became an imposition due to the circumstances. From a business point of view, the result was significant cost savings on real estate and several other services that were considered mandatory. It became easier to turn a profit by simply adopting the remote workstyle. But things haven’t been the same since the pandemic was over.

As soon as working from the office was approved by governments, organizations mandated their employees to work from their premises. Almost 90% of companies are planning to implement return-to-office policies by the end of 2024, primarily due to productivity, company culture, and employee retention purposes. However, professionals comfortable with working from home did not want to change their working style again. The result was increased attrition, coffee badging, impact on employee well-being, hybrid working model, etc.

Now, in 2024, when we have a good mix of work-from-home and work-from-office companies, which one of them offers more value to investors, and why? We answer these questions with David W. Rowat ’s insights on the advantages of remote companies and use his formula to determine their valuation.

The Rise of Virtual Companies: A Pandemic-Accelerated Trend

The concept of virtual companies isn't new, but the COVID-19 pandemic has undoubtedly accelerated their growth and prominence. Even before the global health crisis, there was a trend towards virtual companies selling for higher prices and exiting earlier. This intriguing pattern prompted further research, and the pandemic provided an unprecedented opportunity to witness virtual entrepreneurship unfold on a massive scale.

The shift to remote work brought virtual companies into the spotlight, revealing both the first-order and second-order effects of virtualization. First-order effects are well-documented: virtual companies operate without physical offices, leases, or fixed assets, resulting in lower overhead costs and increased profitability. However, the second-order effects are equally significant and less explored.

Employees have discovered the benefits of working from home, including flexible hours, improved work-life balance, and zero commute time. This new way of working has led to happier, less stressed staff who can prioritize various aspects of their lives alongside their careers.

Interestingly, the pandemic exposed a divide between adaptable organizations and those struggling to transition to remote work. Many office-centric companies found it challenging to unlearn deeply embedded office protocols and embrace virtual operations. This struggle highlighted the persistence of outdated management styles focused on command and control rather than empowering employees and managing by objectives.

Now that the pandemic is over, there is a visible tension between management teams eager for office returns and employees who prefer remote work. This conflict is particularly evident in the tech sector, with companies like Google and Apple engaging in public debates about their future work models. A hybrid approach seems to be emerging as a compromise, with staff coming to the office a few days a week.

Fully remote companies have avoided this conflict entirely by embracing virtual work from the start. Millennial workers who grew up communicating wirelessly are naturally drawn to this model. Working virtually isn't just a necessity for them – it's a passion and part of their identity.

The pandemic has served as a catalyst for the virtual company trend, pushing businesses to adapt and innovate. As we move forward, it's clear that the landscape of work has been permanently altered, with virtual and hybrid models becoming increasingly prevalent across industries.

The Hidden Power of Virtual Companies: Unveiling Second-Order Effects

While much has been written about the first-order effects of remote work, such as managing the shift to hybrid systems and office cost reductions, there is a compelling story that's not getting enough attention: the second-order effects that make virtual companies more valuable and profitable for founders and investors alike.

Tapping into Global Talent

One of the most significant second-order effects of virtual companies is their ability to hire and manage talents in foreign countries. Without geographic restrictions, these companies can attract the best employees from around the globe, often at a fraction of the cost. For instance, a Filipino engineer might cost one-third of what you'd pay in Silicon Valley, while a Bangladeshi engineer could be as little as one-tenth. This reduces costs and brings in highly motivated employees excited to work for an international, fully remote company alongside other top-tier professionals.

Capital Efficiency and Reduced Dilution

Virtual companies are inherently more capital-efficient due to their lower expense burden. This leads to two crucial advantages:

1.????? Founders spend less time fundraising and more time focusing on the business.

2.????? There's less dilution for founders and early investors, as the company doesn't need to raise as much money along the way.

Profitability and Growth

When you sum up these second-order effects, virtual companies emerge as cost-effective, agile, and easier to scale. As a result, they tend to be more profitable and grow faster than their traditional counterparts. This increased profitability and growth potential is why fully remote companies are often valued higher in the market.

Maximizing Returns for Founders and Angels

Because virtual companies are capital efficient and often avoid venture capital financing with its associated control changes and liquidation preferences, founders and angel investors typically suffer less dilution. This means that the early stakeholders earn a larger share of the proceeds in the event of an exit.

While there are potential third-order effects related to international tax strategies and regulatory arbitrage, these are generally not applicable to U.S.-based companies due to citizenship-based taxation. However, the second-order effects alone make a compelling case for the advantages of virtual companies.

The Founder's Wealth Creation Formula: Quantifying Virtual Advantages

David developed the Founder's Wealth Creation Formula to illustrate virtual companies' financial benefits. This formula aims to predict the amount of money entrepreneurs and angel investors will receive at exit time, highlighting the advantages of virtual operations across multiple factors.

The Founder's Wealth Creation Formula is as follows:

(EBITDA × Multiple - Liquidation Preferences) × Founder's Equity % × (1 - Tax Rate) - Exit Costs

Let's break down each component and how virtual companies outperform their brick-and-mortar counterparts:

EBITDA: Virtual companies typically have higher EBITDA due to lower global compensation costs, no facilities costs, and lower administration expenses. They are also more agile, generating higher revenue per unit output.

Multiple: The EBITDA multiple is often higher for virtual companies because they grow faster, attract top talent, and are easier to acquire and integrate. Buyers are willing to pay more for these advantages.

Liquidation Preferences: Virtual companies can often avoid venture capital financing, eliminating liquidation preferences altogether.

Founder's Equity: With less need for external financing, virtual company founders typically retain a higher percentage of equity than their brick-and-mortar counterparts.

Tax Rate: While this may not apply to U.S.-based companies, international virtual companies may benefit from lower tax rates.

Exit Costs: Virtual companies often have lower exit costs due to simpler transaction processes.

To illustrate the stark difference between virtual and brick-and-mortar companies, let's consider a hypothetical example:

EBITDA: The brick-and-mortar company earns $15 million, but the virtual company pulls in 50% more, with $22.5 million.

Multiples: The brick-and-mortar business has a 5x multiple, while the virtual company enjoys a 40% higher multiple at 7x.

Gross Proceeds: This leads to $75 million for the brick-and-mortar company versus a massive $157.5 million for the virtual one.

Liquidation Preferences: The brick-and-mortar company faces $3 million in preferences, while the virtual company has none.

Founder’s Equity: Brick-and-mortar founders hold 20%, but in the virtual business, founders retain 50%.

Tax Rate: The brick-and-mortar company is taxed at 25%, while the virtual company benefits from a 0% tax rate in an international scenario.

Exit Costs: Brick-and-mortar exit costs are $1 million, whereas the virtual company only incurs $0.5 million.

Founder’s Exit: In the end, the brick-and-mortar founder walks away with $10 million, while the virtual company’s founder exits with a staggering $78 million.

While these numbers may be somewhat aggressive, David’s experience suggests that virtual companies typically achieve exit prices 50-150% higher than brick-and-mortar counterparts, with founders taking home 100-300% more.

This analysis demonstrates that founders can potentially earn about eight times as much by operating a virtual company versus a traditional brick-and-mortar business. Even with more conservative estimates, the financial advantages of virtual companies are significant.

As we move forward, we'll likely see a surge in fully remote startups, not just due to the pandemic but also because of the substantial financial benefits they offer founders and investors. The paradigm shift towards remote work and virtual companies is here to stay, driven by their compelling financial advantages.

About the Speaker

David W. Rowat is an expert in mergers and acquisitions, having facilitated nine successful exits and more than a dozen pivotal financings. He has served various roles throughout his illustrious career, including corporate development, strategic planning, and C-level positions. David is currently a Partner at Strategic Exits Partners, using his deep knowledge to review the client companies’ business operations, financials, R&D, sales, and marketing to solve challenges and create opportunities.

Watch his full keynote at Keiretsu Forum here .

Reference:

https://www.cnbc.com/2023/09/11/90percent-of-companies-say-theyll-return-to-the-office-by-the-end-of-2024.html

https://www.cbsnews.com/news/return-to-work-in-office-2025/