Following the recent economic announcements Worth Capital’s Matthew Cushen reflects on when to take a risk, just as it feels risky..
WHEN IT’S RISKY, TAKE RISK.
The UK already faced some recessionary pressures and a frothy equities market. Then we faced a virus that disrupts global supply chains and always looked like it would unleash economic chaos greater than the human cost (if that is a comparison that can morally be made). So, we’ve seen financial market panic, with continued volatility, and now interest rates that have been cut back to the bone. As we see our equity portfolios suffer double digit declines, no wonder there is a temptation for us all to retrench.
However, there is an asset class that has little exposure to wider economic volatility and might even benefit.
Investing in start-ups is inherently high risk/high return. Which is why the Government has been offering attractive tax reliefs since 1995 through the Enterprise Investment Scheme (EIS), then an extension in 2012 with the Seed Enterprise Investment Scheme (SEIS). Both were called out in the Tory manifesto as schemes to even further strengthen. But they weren’t mentioned in today’s budget. With other priorities the Chancellor must have decided to put them in the ‘working well, no need to tinker with right now’ pile. The tax reliefs have been maintained – 50% of an SEIS investment coming back off your income tax bill and 30% of an EIS investment (along with various other tax reliefs).
There is a reason for these generous reliefs. Many start-ups have unproven ideas, immature business models and are often even pre-revenue. But these are reasons why they are relatively immune to economic shocks to the economy. They have little revenue to lose. Cash flow is not driven by revenue, it’s driven by spend and these are the periods in which resources may actually be cheaper. Start-up businesses are well versed in the need and ways to be agile, nimble and able to flex their resourcing and operations. So recessionary or other short-term shocks hit mature businesses (small, medium and large) harder and often the largest businesses, with complex supply chains and more revenue dependencies the hardest.
So the fundamentals and risks around ‘mainstream’ investments have changed – and sadly we have to brace ourselves for fall out amongst small, medium and very large businesses across many sectors. But the fundamentals of seed investing have either stayed the same or become more attractive. Hence the logic that these perceived higher risk asset class is relatively more attractive.
There are the pre-requisites of effective seed investing. Including casting a net wide to trawl truly innovative propositions with the potential to build distinctive brands. Finding strong teams who are smart, organised, energetic and tenacious. And building a portfolio of diversified seed investments – as you can expect some failures, with portfolio returns being driven from outsized returns from a low number of successes.
Then, as a long-term seed investor, I’ve learnt there are some watch-outs that are always important but never more so than in a sensitive macro-economic environment. Founders need to be laser focused on their cash flow, completely buttoned operationally, able to think quickly to mitigate problems and to act quickly to take advantage of opportunities. The businesses need to be adequately funded with decent cash runway, and ideally with investors able to follow on fund so avoiding the need to pitch to new investors in a difficult macro funding climate.