- Tech Companies
- A look within Tech Companies
- Making Money
- Paid software
- Software as a Service (SaaS)
- Mobile Apps
- Marketplace Platforms
- Open source
- A quick look at Unit Economics
- Raising capital: Angels, accelerators, VCs & more
- Next Steps
If your goal is to get a career in tech then it’s important to know what your future work environment is going to look like, so we’re going to spend some time exploring how tech companies and startups operate.
Let’s start by defining some basic terms.
Tech company is simply the shorthand for “technology company”, a broad category of companies that could include everything from Rovio, the makers of the popular “Angry Birds” mobile games, to WeWork, the coworking company, through to SpaceX, the Elon Musk-led rocket company. It really comes down to how we are using the word technology.
Since virtually all companies make use of some form of technology (law firms using software like Microsoft’s Office 365, sales people using smartphones in the field etc), we don’t generally consider a company that simply uses technology in the day-to-day running of their business to be a “tech company”.
So what is a tech company?
I like the definition found on Wikipedia:
“A technology company (or tech company) is an electronics-based technology company, including, for example, business relating to digital electronics, software, and internet-related services, such as e-commerce services”
Within the tech industry there are people who would prefer to use a stricter definition, breaking down companies into technology companies, technology-enabled companies etc. But for the purposes of this course, and more importantly, your career, I think it makes sense for us to take a more expansive view. After all, I would be surprised to hear that someone who was looking to move into a tech career would turn down an offer from Uber saying “No thanks, you are merely a tech-enabled company, not a true technology company”.
Will this definition make everyone happy? No, but that’s fine. For the sake of simplicity throughout this guide I’ll be using the term tech company to refer to the wider world of tech companies, tech-enabled companies and startups, and the examples I use will tend to come from software, internet-related services, or ecommerce companies.
Startups, Unicorns, FAANG, The Valley
Wikipedia’s page on startup companies says “While entrepreneurship refers to all new businesses, including self-employment and businesses that never intend to become registered, startups refer to new businesses that intend to grow large beyond the solo founder”
“A startup is a company designed to grow fast. Being newly founded does not in itself make a company a startup. Nor is it necessary for a startup to work on technology, or take venture funding, or have some sort of “exit.” The only essential thing is growth. Everything else we associate with startups follows from growth.”
The common factor in both definitions is the strong emphasis on growth. These definitions also show how startups can exist as a subset of technology companies (a startup can be a high growth-focused technology company), but that doesn’t mean that all technology companies are startups by default – to qualify they need to be fully focused on growth.
This growth-focus doesn’t mean that a startup is inherently better than a tech company (or any other type of company), it just has a different goal and focus. Facebook famously had a motto of “move fast and break things” while they were in their early hyper-growth startup phase and this culture undoubtedly helped them reach their extreme level of success. But a “growth at all costs” style doesn’t translate so well to companies in fields that are less tolerant of mistakes, like medicine, law or accounting.
Unicorns do exist
A unicorn is an informal name given to a privately-owned startup that’s valued at one billion dollars ($1B) or higher. It’s commonly attributed to venture capitalist Aileen Lee who popularized it in 2013. At the time there was only a small group of companies that fit the criteria so it made some sense to give them a nickname based on a mythical being. But with the huge growth the tech industry has seen in recent years the number of unicorns has exploded from 39 to hundreds. We now have a new term we use to describe even larger privately owned companies like Stripe or SpaceX that have a value of $10 billion or higher: the Decacorn.
FAANG and Big Tech
FAANG is an acronym that refers to large, high-performing tech companies: Facebook (now Meta), Amazon, Apple, Netflix and Google (now Alphabet). While it’s still commonly used it’s not an entirely accurate representation of the current largest or most powerful technology companies. Based on current market valuations you would expect Netflix, and possibly Meta, to be replaced with companies like Microsoft and Nvidia.
The name Big Tech usually refers to the group of large tech companies that are seen to hold powerful or politically sensitive positions in the market, like Apple, Alphabet (Google), Amazon, Meta or Microsoft. You’ll commonly see it used in relation to ideas around monopoly power, antitrust, and “breaking up big tech”, where the market valuation of a company is less important than their perceived impact on society (for example Tesla currently has a larger market capitalization than Meta/Facebook, but Facebook is much more likely to be referred to as “big tech”).
The Valley and beyond
It’s hard to spend much time discussing the tech world without mentioning Silicon Valley. Considered by many as the home of technology, Silicon Valley is located between San Francisco and San Jose in California and is the headquarters of tech giants like Apple, Google and Meta (Facebook). The transistor was invented in SV, as were the first companies to successfully commercialize the technology, like Fairchild Semiconductor and Intel. That’s where the “silicon” in Silicon Valley comes from, as silicon is one of the key materials in the manufacturing of modern semiconductors used in all our electronic devices.
But tech exists far beyond the valley. There are large tech communities in New York City, Seattle, Austin and more recently, Miami. Outside of the United States you’ll find thriving communities in London, Berlin, Stockholm, and more further afield in cities like Tel Aviv. And the vast majority of technology manufacturing is based in Asia, with China, Taiwan, and South Korea having particularly strong technology economies.
With the huge increase in work from home / remote working throughout the pandemic there is a strong argument to be made that the value of being in the more “traditional” tech locations has decreased. As someone who has worked remotely for many years, I think this point of view has merit, but there are also some real benefits of meeting and working in-person.
It’s quite likely that we will see more tech companies being founded in smaller cities and also moving to a hybrid of “remote days” and “office days”. As a future tech employee, you’ll have a range of options and will not need to be restricted to the location you happen to live in.
A look within Tech Companies
We’re learning about tech companies, not tech charities, so we know they exist to make money. Using our fairly broad definition of “tech company” we can see there are a range of products and services they bring to the market:
In many ways these were the original tech companies. Digital electronics companies build the physical electronic devices you use throughout your day, including the device you’re using to view this lesson right now. Because modern digital electronics manufacturing is so complex most companies don’t actually build components or devices themselves, they contract out the production to specialized manufacturers in Asia. These companies are huge in their own right, like Foxconn, who make devices like Apple’s iPhone and Amazon’s Kindle, and TSMC, who make the processors for companies like Apple, Intel, AMD and Nvidia.
While digital electronics companies may have been the OGs of the tech world, when most people hear the words “tech” or “startup” they are probably thinking of software companies. Surprisingly enough, software companies build and sell software products. This includes the applications we use at work, like Microsoft’s Office products, entertainment focused apps like TikTok or Netflix, or search engines like Google. How each of these software companies actually makes money varies quite dramatically, so we’ll explore their revenue models in more detail a little later.
Internet-related (tech-enabled) services
These companies make heavy-use of technology to power the services they offer to their customers. An example would be Doordash, who have built software systems to manage the complex logistics involved in their food delivery business. This includes offering customers a wide range of food choices via their app, supplying the customer’s order to the restaurant, receiving payments from customers, managing payouts to restaurants, finding available workers to deliver food, providing them with efficient routes to the customer’s address, and handling fraud issues and customer disputes when something inevitably goes wrong. This is far more complex than the old days of “phone the pizza shop then pay the delivery driver in cash”.
Electronic commerce (or Ecommerce) is the name given to companies that sell products over the internet. Amazon was an early pioneer in e-commerce, originally founded in 1995 by Jeff Bezos as an online book store and now offering millions of products to people in markets across the world.
More recently, platforms like Shopify have made it significantly easier for people to start selling products online, helping fuel huge growth in the ecommerce industry. Many ecommerce companies also benefited during the early days of Covid, as people around the world made the switch from buying goods in stores to ordering online and getting them delivered at home.
E) All of the above
Of course, we also have the tech companies that are so large and wide ranging in their product offerings that they effectively offer products within each of these categories. A great example is Apple: they sell electronic devices (iPhones, MacBooks, Apple Watches), software (the operating systems used on each device, like iOS, but also professional software like the video editing suite Final Cut Pro), internet related services (Apple Music subscriptions or iCloud storage), and ecommerce (you can buy their products in their Apple.com website). This all-round product strength is a good reason why they are one of the most valuable publicly-traded companies in the entire world.
As mentioned earlier, for the purposes of simplicity we will continue to focus our learning on the software, internet-related services and ecommerce areas of tech.
Choosing the right revenue model can be the difference between a company that thrives and a company that dies. Let’s take a look into some of the common ways tech companies bring in revenue.
(Note: the isn’t an exhaustive list – there are almost as many ways to make money as there are tech companies)
One of the oldest forms of tech revenue is also one of the simplest – selling software in a one-off transaction for a fixed price. This is the model that powered the rise of Microsoft’s Windows operating system and early video game console games like the Super Nintendo, where customers make a one-off purchase in return for an ongoing license to use the software.
This revenue model is often popular with customers who like paying one time for a product, but it has fallen out of favor for software companies as product expectations have changed. Software has moved from being sold in a “completed” state (like an encyclopedia application sold as a CD-ROM in a retail store), to the world today where products are sold digitally and customers expect ongoing development to ensure the software they use is bug-free and available to use on their latest device. This ongoing development can be extremely expensive (teams of programmers aren’t cheap!) so many companies have shifted to subscription-based revenue models to try and fund the ongoing activity.
Software as a Service (SaaS)
The huge growth of the internet in the late nineties led to a revenue model that allows for software to be sold in an ongoing, subscription-based model, known as SaaS. Rather than downloading and running software on a local computer, SaaS products are hosted centrally (in the “cloud”) on remote servers, and accessed via the customer’s web browser. As long as you have a web browser and a decent internet connection, you should be able to use a SaaS app.
Customers can continue to use a SaaS product for as long as they need by paying an ongoing monthly or annual fee (the subscription). Part of the subscription fee will go towards the ongoing development and support of the product, which should help the software to offer continual value to the customer. As the customer is accessing the app from their browser, not a downloaded app, they are always using the most up to date version of the software. If a customer does decide to cancel their subscription then they’ll simply lose access to the app.
SaaS is very popular in B2B (“Business to Business” – when a company sells products or services to another company) as it simplifies some otherwise complicated IT processes, like managing the installation and support of applications across staff computers, and keeping track of user licensing and costs. The software developer also has the advantage of only needing to support one version of the software that they are selling, letting them avoid the kind of situations where they’ll have a large customer who won’t upgrade beyond a 10 year old version of an application that they will then have to continue supporting.
But SaaS is not all rainbows and unicorns, there are some potential downsides as well. Since you’re accessing an app from a centralized “cloud”, if you lose your internet connection or if the host goes offline then you’ll be unable to use the application. Some people would also prefer to simply pay once for a product or service and do not like the idea of being tied into the kind of long term arrangement that is a fundamental part of SaaS.
Millions of small, independent software developers can thank the explosion of smartphone apps in the past ten years for providing them with a new way to make a living. As you are surely aware, mobile apps are available from marketplaces like Apple’s App Store and Google’s Play Store. These markets are often “walled gardens”, where the operator maintains strict controls over the apps, content or media they allow to be hosted and sold on their platform.
In the early days apps were limited to being given away for free, sold in one-off transactions or funded through in-app advertising. Later, the marketplaces allowed for additional in-app purchases to be allowed, helping to ruin the days of thousands of parents who now have to explain to their children “No, we aren’t going to spend $20 on a mystery loot box”.
There were some other issues with the one-off model. The non-business customers that make up the majority of the app store’s users are notoriously price-sensitive, and most are unwilling to pay more than a couple of dollars for an app, if they are willing to pay anything at all. And when customers do make a purchase, the app stores themselves take a large cut of the purchase price, often up to 30%. Some of the largest apps like Netflix and Spotify have refused to allow people to sign up within their product’s apps at all, saying the “tax” or revenue split they’d have to share with Apple and Google was simply too high to work.
The one-off purchase model also runs into another issue we’ve previously discussed – it doesn’t allow for the ongoing costs to developers to continue to build and support their apps. If someone pays $1 once for an app then they will expect the app to continue to work on future versions of iOS or Android, but it might not be in the developers best interest to continue working on the product over the course of years if it’s not continuing to bring in significant revenue. In an effort to counter this, Apple and Google eventually allowed mobile apps to be sold using recurring subscriptions as well (while taking their cut of the ongoing revenue as well, of course).
We’ll talk about advertising as a revenue model in more detail below but it’s worth mentioning that it’s an important source of revenue for many developers, especially those with apps targeting markets that do not like (or are not able or old enough) to spend money to purchase apps, like mobile gamers.
Marketplaces earn revenue by taking a percentage or fee in return for matching buyers with sellers of products and services.
One of the most well known examples of an online marketplace is ebay, which was launched by Pierre Omidyar in 1995 as a digital auction site. Ebay provides sellers with a place to offer physical products to its millions of users, and in return for each sale Ebay takes a service fee. While the individual fees are quite low, in aggregate they are enough to turn Ebay into a multi-billion dollar business.
A more recent marketplace example, this time focused on providing services, is AirBNB, which allows people to list spare rooms through to entire houses for short term rental. Like Ebay, AirBNB’s primary source of revenue are the fees it charges on the listings that are made on it’s platform. Uber operates on a similar model, helping to match “riders” with drivers as an alternative to using a Taxis.
Marketplace platforms can be very tough to launch as both sides of the market (buyers and sellers) need to be in place before people are able to find any value – sellers wouldn’t list on ebay if it didn’t have customers waiting to buy, and AirBNB would struggle to find customers if it didn’t have any short term rentals available. Solving these chicken and egg type problems takes real skill, and is a top priority for early employees in product and growth roles within marketplace startups.
Advertising may not have a lot of fans, but when executed well as a revenue model it has been able to provide the bulk of revenue to some of the most successful tech companies of all time.
We can split tech companies who earn revenue with advertising into those who provide the advertising (the platforms), and those who receive money from platforms in return for running their ads in front of their own customers.
You could make a strong argument that Google is the king of all advertising platforms – more than 80% of Alphabet’s (Google’s parent company) revenue comes from Google ads, for a total of $147 billion in 2020. Why is their advertising so strong? Intent. When you type in a Google Search you are specifically telling Google what you intend to look at, and Google’s customers (the advertisers) are willing to pay a lot of money to get their ads for relevant products or services in front of you.
Meta (and the companies it owns, like Facebook, Instagram and Whatsapp) are another giant advertising platform but their ads operate in a different way, targeting users based on their profiles and interests rather than on the specific searches they are making (as people using these services tend to be scrolling through their social feeds). While Google is able to show me an ad that matches what I am currently looking for (a search for “Paddle Boards” will give me a list of brands selling paddle boards), Facebook’s ads are interrupting me while I’m performing another activity, so while they may also show me an ad for a paddle board, if I’m not currently looking for a paddle board then I’m less likely to click through and, ultimately, purchase the board.
Advertising is not only a source of revenue for the major social platforms, it’s also a key element for many content providers, including online news providers like the New York Times and CNN, blogs, podcasts and video games. Many of these companies would struggle to sustain their businesses by selling their products or services directly to consumers, so they choose to run ads (usually via one of the large platforms) on their sites or apps in return for a split of the revenue.
In the freemium model a basic version of a product is offered free of charge, and the user can choose to “upgrade” and pay for additional features. Freemium is a fairly popular model in software, especially with consumer-focused products like smartphone apps.
One of the key advantages of this model is that it “lowers the friction” in getting new users – if there is no cost to use a product, it is generally much easier to get someone to try it. But this swings both ways – a large user base will normally have larger support costs, but the vast majority of these users will not actually be contributing to the company’s revenue in any way. There are also some issues of customer psychology to consider, for example if your users get used to using a product for free (they are “price anchored” to no cost), they may be unwilling to pay for extra features even if they would genuinely receive a lot of additional value from them.
Open source software is software that has been licensed in a way that lets anyone use, change or distribute the software and its source code, for any purpose. That might seem like a strange foundation to build a company around, but it can work! A popular method of monetizing open-source is through selling consulting, implementation and/or ongoing support services to people who are either unable or unwilling to do the work themselves.
An example is WordPress, the incredibly popular open source Content Management System (CMS) tool that powers hundreds of thousands of websites across the world. WordPress is made by a company called Automattic, who lead the development of the free open source versions of the software. But Automattic also sells services to people and companies who do not want to manage the installation and upkeep of a WordPress site by themselves. As the literal creators of WordPress, they are so well positioned as experts that even companies that specialize in building software, like Facebook and Salesforce, choose to pay to use them for their services rather than managing WordPress themselves.
A quick look at Unit Economics
Unit economics refers to the relationship between revenue and cost that each additional customer brings to a business. I know that’s pretty dry but try not to fall asleep here as this is important, and not really too difficult. A company has “positive unit economics” if it makes money for each additional customer or user that it adds, a sign the company has a strong business model.
It is common for software companies to have strong unit economics as the cost of an additional user is often very small compared to the revenue they can bring in. Think of Instagram, where each new user probably costs Meta (Instagram’s parent company) a couple of cents in storage and bandwidth to host their photos or videos, while in return Meta gets a valuable new target for their advertising customers.
Not all tech companies have positive unit economics. For much of its life, Uber’s ride sharing service was an example of negative unit economics – each additional ride that was completed on their platform contributed to an overall loss to the company. Much of this was down to a strategic choice by Uber to focus on user growth over almost every other metric, and they funded the financial losses by selling additional shares of their company to investors who believed in their long-term success.
Raising capital: Angels, accelerators, VCs & more
Companies need money to survive. And yet, when Instagram was acquired by Facebook for close to $1B in 2012 they famously had no revenue. How did they fund their growth and ongoing operations? They raised money (capital) from investors.
What’s in it for the investors? Beyond any potential bragging rights, they receive equity, or a share of ownership, in the companies they invest in. If the company is successful and “exits” like Instagram did then they should make a positive return on their investment.
A company that self-funds its growth (the founders use their own money until the company is able to pay for itself) is said to be bootstrapped. Self-funding allows the founders to maintain full ownership and control of their company, but unless they also have very deep pockets, there is going to be a limit to how much they can afford to spend and this can lower the speed the company can grow.
If a company’s primary goal is to grow quickly or they have high startup capital costs then they will usually turn to outside investors. The first group are the so-called “Angel” investors, individuals with money who are looking to make relatively small personal investments into startup companies. Angels may also have industry experience or a network that can be useful to the startup. Angel investors are usually investing at the “pre-seed” or “seed” stage of the company’s lifecycle, where the product or service to be offered may only be an idea.
Early-stage startups may also apply to join startup accelerators, organizations that provide a structured period of guidance, mentorship and (usually) money in return for a small percentage of company equity. The most famous accelerator is Ycombinator, which was founded in 2005 and has helped companies like AirBNB, DoorDash and Coinbase that now have a combined value of more than $400B. The top accelerators like Ycombinator are very popular and therefore very selective in the startups they agree to take on, with current acceptance rates at less than 5% of all who apply.
Growth-focused startups will usually try to raise money from venture capitalists, or “VC”s. Venture capital is a type of private equity that raises money from limited partners or LPs, and then invests the money into high-risk startups. Many VCs will specialize in investing in specific industries or sectors where they feel they have an advantage, like marketplaces or SaaS.
Many VC firms will focus their investing on specific stages within a company life cycle, so early-stage VCs might look for seed and Series A level companies (companies that are still trying to find product/market fit), while later-stage funds will invest in the growth rounds, series B, C, D etc.
Startups will “pitch” (give a presentation explaining their product) to VCs, who will decide whether they want to make an investment. If they are interested they will offer the startup a term sheet, a non-binding agreement outlining the terms and conditions for the investment, like the amount of money to be invested and the equity to be given in return. After agreeing to terms there will usually be a short period of time to work out the administrative details and then the money will be transferred.
As a VC-backed company grows it will normally reach the point where it needs another round of funding before it runs out of runway (the amount of time before they run out of money). With each round of funding the startup will receive more money but in return they will give up more equity, so by the time a startup has raised multiple rounds of funding it is common for the founders to have less than 50% equity (and control) of the company.
In return for investing their LPs money, VCs will usually take “2 and 20” – a 2% annual management fee and 20% “carried interest”, their share of any of the eventual profits from the investment. And where do these profits come from? An exit or liquidation event, a transaction where the shareholders of the startup can realize the value of their investment. The most common exits are:
- Acquisition, where the startup is bought by another company
- Acqui-hire (a combination of “acquisition” and “hiring”), where the startup is acquired mainly as a way to recruit the existing employees into the acquiring company
- Merger, where two companies combine into a separate new legal entity
- Initial Public Offering (IPO), where the company “goes public”, is listed on the stock market and can sell shares to public investors
As the vast majority of startups will either fail completely or fail to make a large financial return, VCs will try to create a portfolio of investments in companies with high risk / high return potential. An early-stage VC will be placing a lot of small bets on companies that have a very high probability of failure, with the hope that a small number will pay off with extremely high (100x or more) returns that are enough to “return the fund”. A growth stage VC on the other hand is investing in companies that are further along in the startup lifecycle, so their investments have less risk (in theory at least) as the company should have a strong product, revenue etc, but this will result in lower returns on their investment.
Why should you care?
You might be asking why any of this matters if you have no intention of working in the investing side of the industry, and that is a fair question!
How a company chooses to fund its growth will have a huge impact on their day-to-day operations, but also on their long-term goals and the expectations that they will need to meet. If you’re interested in working in a startup then their choice of funding can have a large impact on the next few years of your work life.
If you choose to work with a bootstrapped company they will probably not have as much money to spend as a venture backed startup, which could play out in the form of lower salaries and fewer benefits or perks. Bootstrapped companies are less likely to reach sky-high valuations and exits that you’ll read about on Techcrunch, so if you do receive equity or options in the company then they are not likely to be worth much. But it’s not all negative – once a bootstrapped company has reached breakeven point and can support itself financially, they will have the freedom to grow at a rate they feel is comfortable. This can result in more relaxed working environments and a good work / life balance.
On the flip side, venture-backed startups have the money and resources to fuel growth, but that’s what they have to do – GROW. The money they get from VCs isn’t supposed to sit in their bank accounts, it needs to be spent on costly expenses like recruiting staff and paid advertising.
And the VCs are not interested in companies that are simply “good enough”, they need the 100x outliers that will give them the returns they need to please their LPs and raise their next fund. This can place a huge amount of stress on a startup’s founders and employees – the company may be growing revenue or user count at a steady state (along with their expenses) but if they aren’t hitting their monthly growth targets they may struggle to raise the next round of funding, which can result in an otherwise promising company running out of cash and dying.
This growth at all costs pressure can lead to higher stress and longer work hours, but the rewards can be equally high, both in terms of potential for career growth and large financial payoffs (the startup lottery may have low odds, but people do win!).
By this stage you might be tempted to skip startups and try to work at an established technology company instead, but they have their own potential drawbacks. It’s a little out of scope for our current topic so make sure to check out my guide to working in startups vs established technology companies to learn more.
Now that we’ve covered how tech companies can make money, it’s a great time to look at one of the main ways they spend it – on their people. Check out my guide to popular tech job roles to learn about the key roles in technology companies, and hopefully, you can find one that interests you.