Investment: Chasing Returns
People invest in expectation of positive returns in the future, be it tangible (such as monetary), or intangible (such as social benefits and convenience). It would be irrational for someone to willingly walk into an investment knowing fully well that it would generate losses with 100% certainty.
Yet with so many different types of investment opportunities on the market, with different historical returns and risk profiles, why are some of the top angel investors, venture capitalists and institutional investors investing in startups and private equities of SMEs (small and medium enterprises)?
Investing in Startups and SMEs for Growth
When we speak of startups (especially in the tech space), we often think of the early days of Facebook, Amazon, Netflix, and Google – the much-vaunted FANG stocks on Wall Street. We have a tendency to view startups as nimble, and fast-moving – able to quickly pivot their business to suit market sentiments. This is in contrast to the common perceptions of the slow moving behemoths in traditional multi-national corporations (MNCs).
A Harvard Business Review article provides a key reason for such differences:
“While existing companies execute a business model, start-ups look for one. This distinction is at the heart of the lean start-up approach. It shapes the lean definition of a start-up: a temporary organisation designed to search for a repeatable and scalable business model.”
It is precisely such repeatable and scalable business models that allowed the FANGs to grow fast and eventually transform into the large public companies that we know them as today via IPOs. What enables startups and smaller companies to excel and prime themselves for future growth is their organisational agility. In fact, this is what the global management consulting firm McKinsey & Company has to conclude regarding agile companies:
“Part of what makes agile companies special is their ability to balance fast action and rapid change, on the one hand, with organisational clarity, stability, and structure, on the other … research consistently showed a strong relationship between organisational health and the creation of value: the healthiest companies far outpace those with moderate or low health in long-term total returns to shareholders. Our new analyses suggest that speed and stability are significant catalysts for organisational health and performance.“
Even Yale University’s endowment allocated 31.0% of its portfolio for exposure to startups (via VCs) and private equity in 2013, generating 29.9% annualised returns since 1973. The rationale given by the endowment in their 2013 Annual Report was that the “traditional 60 percent equity/40 percent bond portfolios are not diversified, not equity-oriented, and not appropriate for long-term investors“. The endowment further substantiated this view in 2016 by stating that “the heavy allocation to nontraditional asset classes stems from their return potential and diversifying power … providing an opportunity to exploit market inefficiencies through active management”. This observation is also in tune with what Deutsche Asset & Wealth Management has put forth regarding how adding alternative assets (such as startups and private equity) to a portfolio of stocks and bonds can reduce volatility and increase the overall portfolio efficiency.
However, not all startups will eventually grow fast and long enough in order to succeed like the FANGs, and might even fail totally. In fact, as the Monetary Authority of Singapore noted in their consultation paper on securities-based crowdfunding:
“Based on data compiled by the Department of Statistics Singapore, only about 50% of startups
survive to their 5th year. The UK Office of National Statistics, Business Demography
2011, 13 December 2012, indicated that around 50% to 70% of business start-ups fail
completely over five years. According to the US Bureau of Labour Statistics, 65% of new
business establishments fail completely over ten years.“
Invest in startups & SMEs via Catapult. On Blockchain.
In lieu of such risks when investing in early stage startups and private equity, at Catapult we believe that by providing a vibrant secondary market for such assets and the means by which efficient portfolio diversification can be achieved, we can open up such alternative investments as viable options to investors, such as via equity crowdfunding or peer-to-peer lending.
Stay tuned to our future articles in the series as we explore the risk-reward trade-off in startup and private equity investments, portfolio diversification for risk management, and how Catapult plans to help in making such alternative investment accessible to all.