I am often being asked by people about the ‘attractiveness’ of investing in start-up companies given the world is in recession. I say tough times are actually the best time to invest in start-ups.
Regardless of the ‘time’, we should be maximising our return but in manner that we are comfortable with given the risks associated with the investing. Most of us are not multi-millionaires.
Good practice for investing says you should have portfolio of investments, from your superannuation, family home, stocks, cash, property and in some cases private investments in companies and investment funds.
The return expectation from each of these will be commensurate with the risk associated.
If you want exposure to the start-up investment market, then you should not be allocating more than 10 percent of your ‘at risk’ portfolio, and then with these funds you should be looking to build portfolio of investments to diversify the risk away from having all of your eggs in one basket.
If, for example, you have $100,000 to invest we would advise building up portfolio of five investments over three years. Or, if you had $200,000 you might look to double the investments to 10. For larger sums of money, 10 to 15 is an ideal portfolio number.
Why so many investments and not one or two? Start-ups are high risk as the failure rate is extremely high; some might say even as high as 60 percent will fail within three years of getting going. For that reason, you want to maximise the return opportunity from each and every investment in your portfolio, because it is likely good percentage of your investment in start-ups will lose your money.
However, one or two out of 10 may actually give you something like 10 times your money back, or even greater and up to 30 times your money. So in portfolio of 10, it’s the one or two deals that make you the portfolio return.
I can see the savvy among you saying – it is about selection, make sure you choose the ones that are going to make it big and put all of your portfolio into those and you will make that return across your portfolio. Oh to be Nostradamus!
Picking winners is so hard that unless you are an accurate star picker, I would suggest building up portfolio. The expectation of return from this portfolio is that you should make well above the sharemarket return for portfolio and possibly in the area of 25 percent, if you are lucky and good!
There is another factor; most of us who do invest in start-ups do it because we love the space, we like contributing to young entrepreneurs, we are nation building and while we are hopeful that we might actually get return, it is not the only driver of our activity.
Over the past 20 years in America, and more recently in Europe, Asia and Australasia, investment in start-ups has been growing asset class.
This is because we have seen the stories of $70,000 investments in Trade Me being turned into many millions and also because there has been lot of wealth created for entrepreneurs and corporate people who now have no need to work. They are managing their portfolios, they have time and they like to stay connected to the go-go world of technology and entrepreneurship.
Which gets me to the starting point – is it good time to invest in start-ups? Actually, it is the best time right now because asset values are low, entrepreneurs are hungry for cash and assistance, and the world needs innovation. America particularly has been stuck in time-warp, almost paralysed with its own issues. Creativity has been destroyed, so now is the time to get our great inventions and companies into that market. It is also acknowledged that ‘recession investments’ provide top quartile returns for investors.
If you are interested in investing in start-ups, touch base with your local Angel Network. There are now 16 organisations across New Zealand involved in this type of investing. They share leads, they conduct due diligence together, they make investments and they assist each other to get returns from their investments. The risks are huge and the traditional forms of funding like banks are just not appropriate.
It is great collaboration which is lot of fun and very rewarding because we are, after all, nation building the next crop of entrepreneurs who will be the new Gary Paykels, Sam Morgans, Stephen Tindalls and Jan Camerons.
Andy Hamilton is chair of the Angel Association of New Zealand. www.angelassociation.co.nz and
[email protected]
