Most people have their own story about “that missed” investment opportunity. “I could have backed this… or I should have got into that!” We’ve all heard slightly wistful, hard luck stories along these lines. However, actually taking the brave step and backing these early-stage companies with your hard-earned cash, is easier said than done.
Anyone can regret with hindsight their missed opportunity to back Google, when the founders, Larry and Sergey, where toiling away in their garage. And to be fair, if it was me who missed out, I’d be too embarrassed to have the conversation in the first place.
But how do we find the courage to get involved in these risky opportunities? Because, if you can afford to take the risk (remember, early-stage equity investments are not for everyone), there can be some life-changing returns if you choose the right businesses.
Unlisted companies are currently one of the main driving forces behind the UK economy. They are achieving unprecedented levels of survival and success. The opportunity for wily investors to achieve tax-efficient, risk related returns that aren’t subject to the short-term sentiment driving the main financial markets, is exceptional.
Not every business will realise its potential and any capital invested is at risk, but the possibility of achieving superior returns from being an early participant in the ones that succeed is real.
So, what should you be looking for as you try to pick the right business to invest in? There are a few key things that immediately spring to mind.
Firstly, is the opportunity solving a genuine problem? In other words, is there a true need for the product or service and can it really be commercialised?
This is a simple question to answer, because you just need to put yourself in the shoes of the potential customer. Ask yourself if you would pay for the product or service, then extrapolate your answer to see if it has mainstream, or even significant niche, appeal.
Related to this is whether the company in question owns and can protect the Intellectual Property.
Licence agreements can be torn up on a whim and disagreements abound in the world of distribution. You only want to be investing into a company that owns and has protected the IP, not a company that has a right to distribute it.
Is it disruptive and scalable? A lot of people talk about disruption, but true disruption is not only something that changes the way we do things; it must be scalable as well. It must be something that appeals to many people or serves a unique niche in a market with very few competitors.
Disruption is all around us right now. We are effectively in a Technology Revolution, which will be documented in the history books of the future. From Crypto-Currencies to Artificial Intelligence and deep machine learning, disruption is happening every day in most sectors.
Think ahead 30 years, to a time when it has been widely predicted our children’s vocations are going to be very different to our own. We’re being told by futurists that there will be no lawyers or doctors in the future, our kids won’t need to drive cars etc. What does all this mean? It means Opportunity! There is so much disruption happening right now and the opportunity to get involved is very real.
Disruption aside, does the business offer recurring revenue streams? It’s easy to get carried away with disruption, but it’s also important to get back to basics, and recurring revenue is a sign of a solid business model.
Subscription or SaaS (Software as a Service) businesses are ideal as they provide a constant flow of regular revenue, which enables cashflows to be managed efficiently. Companies with lumpy revenue models often struggle with cashflows, as fortunes ebb and flow.
Look for companies that have a steady recurring revenue stream, as well as the potential for a large upside. Recurring revenue is a company’s bread and butter and keeps the lights on. It provides businesses with the opportunity to stay in the game, to play for the big wins.
Lastly and most importantly, is there a quality team involved? This is, in fact, the first thing you should look at. You could probably disregard one of the above “musts”, so long as the team is strong and has an excellent track-record.
Have the people in the team been successful in this sector before? Have they successfully exited businesses previously? Most importantly, have they grown businesses and provided investors with timely returns?
Even if the team is inexperienced, the proposition should not be ruled out immediately. To make up for their lack of experience, does the team have one or two seasoned and successful advisors behind it? If it does, then the combination of youthful enthusiasm, technical know-how, and quality business experience could be an absolute winner.
Picking prospects which are scalable, have a strong management team and operate in sectors where they have competitive advantage and the ability to disrupt, is not easy. But focusing on these factors will certainly help you identify them and, at the very least, save you a lot of time on extra due diligence, as you quickly rule out propositions that don’t have any of these attributes.
So next time you’re peeking into a garage and you see a couple of super-enthusiastic and slightly crazy entrepreneurs working away, don’t just turn around and ignore them. Consider the above, ask them the right questions… and if their names are Larry and Sergey, think twice before you walk away!
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