To stay put or to fade away

Conventional wisdom often tells upstart investors in the stock markets to invest thro mutual funds if they are not sure of their own stock picking talent. The logic – mutual funds engage expert fund managers to do the investment on behalf of investors in return for a fund management fee. The fund managers are specialists that watch every day market movements closely, track the businesses of companies they invest in, market momentum, liquidity situation in the economy etc., on the basis of which they pick up early trends. Yet, seasoned investors have often observed that markets surprise everyone on the upside as well as the downside. No one is spared from its vagaries. The question then crops up in the mind of every investor – if the fund manager who is an expert is also equally vulnerable as I, why would I trust him with my savings and why would I pay him to make mistakes? Had I taken a direct exposure and made money, both the fortune and accompanying thrill is mine. And if I had lost, I am richer by experience (of the bitter lesson) which I would never repeat.

I take a parallel and am thinking about professional investors like Angels, VCs and Private Equity veterans. I am much used to the refrain from these folks over the lack of fundable ideas, extreme valuation expectations of entrepreneurs / managements. Why wouldn’t these moneybags stop bemoaning and start an enterprise of their choice and invest in it? Why expect others to dream up an idea that has all the elements of (what they think as) a good investment in it?

The fact of the matter is, some investors do turn entrepreneurs. But turning an entrepreneur is a different ballgame because founding a business is not as easy as much simpler capital allocation that investors are wont to do. When you are an investor, you need to study an existing business, analyze its history, evaluate its management, compare its market standing with its peers and track its growth momentum. But if you were to found a business, then you have to start from the scratch – dream up an idea, find the right team with the right talent, assess the market potential, do the paperwork for compliances, lay down systems and processes, develop the prototype, have it tested by potential customers, fine tune it before you get it going. Then is the big question of how much to invest in or whom to partner with.

Of both the above choices, the former is relatively easier, only relatively because you are investing in an existing, well founded going concern. In the latter, you spray and pray. But the returns from investing early in a (seemingly) successful startup is huge in comparison with investing in a going concern. You get to buy a slice of a startup business at dirt cheap prices because startup founders need the money badly (not many would like to take seed stage risks) and they can’t haggle on valuations beyond a point. Existing businesses, will have many suitors and so you have to pay the top dollar to win the bidding war and own a stake. This is a critical difference why we still find venture investors amongst us despite the significantly greater risk involved in a seed stage enterprise.

Yet the most important temptation to invest in a startup is because besides the financial fortune, you get a lot of personal satisfaction of being involved in the venture (probably a domain of your choice, in which you have some knowledge) right from the word go, guiding the founders along the right path and learning from them as well. Bright young upstart entrepreneurs brimming with new ideas do not hesitate to tread the unbeaten track, adopt the most unconventional ways to meet an end blissfully unconcerned about the cost of numerous trials involved. They are fired by the endless energy of their dreams, of achieving the feature they imagined, to unleash the power of their idea. They put their most creative, often disruptive imagination to work, and work from effect to cause to deliver solutions that erect very high entry barriers for the also ran. That earth shaking disruption, could drive fears in the minds of existing players that could tempt them to adapt fast and review their own businesses. Those that are able to adapt quickly will survive, others will be in a hurry to buy the startup out, in case if they are willing. The name of the game is survival, at any cost. That’s the startup founders’ biggest dilemma as well – to build it to last or to flip !

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