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 !

Creative conundrum

I concede.  Having known some, it’s way too difficult to explain why creative individuals are the way they are.  Not that they are weird or something. On occasions when they don’t conform to conventions and follow their hearts, it seems they are kind of warped.  Scratch deeper and we get at some stark rationale – in that quite little quirks and twists go into the making of an individual.  To suppress them all and follow the clock and calendar and creed until the individual is lost in the neutral gray of the host is to be less than true to their inheritance.  Life never compels one to follow another man’s rules.  It’s true that we have the same hunger and same thirsts, but that is for different things in different ways at different seasons. Lay down your own day, follow it to its noon, your own noon or you’ll sit in an outer hall listening to the chimes but never reaching high enough to strike your own.  

Their appetite for novelty is inexhaustible.  For them, life is one long process of trying risk laden new things, getting tired before starting all over again.  The levels of creative energy sets them apart from other mortals.  They’ve long since realized opportunity is often difficult to recognize;  something we usually expect to beckon us with beepers and billboards.  Like the CNBC analyst that cautions investors to wait till markets stabilize for investing in a relatively inexpensive stock, by when the stock is in every one’s radar, the arbitrage vanishes and valuations shoot through the roof.

So if you are a lesser mortal but raring to set your own rules and go,  remember.  Before you dunk in the creative seas,  always use the rule #1 in the old life guard rule book – Seize the opportunity by the beard,  for it is bald behind !!!

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The middle class watch

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In recessionary times like this, one can never figure the ways of the middle class consumer right, except that (s)he is extremely value conscious and so on.  Yet for most businesses that harp on “high volume, low margin” model, it is the principle catchment category given the sheer size.

Neither rich nor poor, it stands out by its sheer variety in terms of background, profession and income levels.  With that change their aspirations and lifestyles.  This is precisely what lures foreign investors (both portfolio and strategic) and businesses such as high street retail to capitalize from emerging markets like India and China.  Here’s the Economist version.

In essence, the middle class mind works like a radar, picking up on signals from near and far, tending more towards free market and democracy.  They are not entirely risk averse and they are not afraid of breaching barriers to entry.  Closer home we have Narayana Murthy of Infosys and Kishor Biyani of Future Group to lean on. These value-for-money attitudes transform countries and economies. With its aspirations and capacity for delayed gratification, the middle class is more likely to invest in education and other sources of human capital, which are vital to prosperity. For years, policymakers have tied economic success to the rich (“trickle-down economics”) and to the poor (“inclusive growth”). But it is the middle class that is the real motor of economic growth.

Now the middle class is at risk as globalization goes into reverse they may well be hit harder than the rich or poor. They’ve learned to borrow and enjoy life and so are hurt by the credit crunch. They have houses and shares, so their wealth is diminished by falling asset prices. That’s roughly 2.5 billion sharing that plight and one never knows how their minds will work when their hopes are dashed.

May be, they could survive a downturn in the short term. But a prolonged crash might well undo much of the progress the developing world has lately made towards democracy and political stability. It is hard to imagine the stakes being higher.

It pays to track the direction of the middle class thought process.  If you are an entrepreneur, that’s a critical segment you can’t afford to ignore.  That’s where you should focus your business intelligence resources now that you’ve pretty much nothing else to do as people walk more on the road than into your store 😉

The famous Japanese enterprise

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In Japan, the Railway rules. Every working day a vast ganglia of 45 bullet, main and suburban-overground lines, with another 13 underground, channels 4.1m swipe card-carrying commuters into Tokyo’s central wards alone, with clean and exceptional precision. Shinjuku station alone disgorges 900,000 passengers each morning, sucking them in again in the evening, some of the men (and they are mostly men) by now inebriated, before dumping them in their distant bedroom towns.

Every year 2,000-plus train Chikan, or perverts, are arrested for groping women and schoolgirls—the vast majority during the morning rush hour, causing minor delays. For years, females just put up with the indignity of groping, either out of embarrassment or out of fear that their claim would not be taken seriously. But habits are now changing, and women will hold up the offender’s hand and shout “Chikan!”. Several lines also have women-only carriages for peak hours. A few men’s lives have been broken because of false accusations.

The only thing that can be said with confidence is that Japan has found original ways to make money out of people’s sexual predilections. Little more than a stone’s throw from the huge Shibuya station is the “Shibuya Pink Girl’s Club”, which on its varied menu offers a Chikan densha, or pervert train.

The “groper’s course” starts at ¥12,000 ($130), where the connoisseur picks out from the menu the girl of his choice, dressed either as a schoolgirl or office receptionist. This girl then beckons him through the window of a mock-up train carriage, which not only broadcasts station announcements, but even shakes and rattles. For the next 45 minutes the connoisseur is under no risk of arrest as he gropes to gay abandon—before joining the slumberers on one of the last real trains home.

This is it. The Japanese creativity never misses an opportunity 🙂

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“So if you can’t take a company public, how do you get out?”

Asks Fred Wilson.  Fred contends that the IPO market has been languid since 2000 and to sustain the current pace of innovation financing, VCs need a new route to exit their investments. M&A have lost momentum. The acquisitions by Google (YouTube, Feedburner), Microsoft (Facebook), AOL (Takoda) and Yahoo (Del.icio.us, Flickr) have flailed post acquisition.  Soon this window too will be shut.

So Fred suggests a new path to liquidity.  I quote –

“This topic came up in the comments to my Decline of the Firm post and one thing that was mentioned is Goldman Sachs’s GS True market. As my friend Roger Ehrenberg (author of the awesome Information Arbitrage blog) explains on Seeking Alpha:

But now there is a new game in town, and it relates to IPOs: Goldman Sachs’ (GS) GSTrUE (“GS Tradable Unregistered Equity OTC Market”) program.

It turns out that there is another private liquidity market under development called Opus-5.

The idea behind both of these new emerging (and currently illiquid) markets is to provide a place for private equity investors to trade securities with each other. The companies remain private, do not have to file with the SEC, and do not trade daily like public stocks do. When an entrepreneur or investor wants liquidity on a position they own, they come to these private markets, offer their position or part of their position for sale, and a trade is made.”  (Hat Tip : Narain)

Huh, is that so simple?  I see some basic flaws in such private exchanges.

a) Signals despair : Private exchanges have no market makers; and hence no two way quotes. The very fact that a VC investor is putting up his stake for sale declares (a) the investment has turned bad; or (b) the investor is in a hurry to exit. There is only an `ask’ and without a counter `bid’, VC has bared all her cards. Out goes her bargaining power.

b) Disillusions founders: Founders look up to VCs to provide them strategic support, connections and mentoring. If VC stakes change many hands, the founders lose orientation and may even stray. They feel they’ve been taken for granted.

c) Tax treatment of Income : Trading thro private exchanges meant for a special category of investors like VCs will make them ineligible for concessional tax treatments (capital gains / business income) available to traders in public markets. Proceeds from such divestments may get treated as windfall / speculative income – that could suffer far higher rate of tax.

d) Cartel plays : It is possible for a group of high networth investors to get together and indulge in price manipulation or badger a VC into submission. All they need to do is quote their bids in unison with a time stamp. Take it or leave it.

A better way I think, is [to let VCs like Fred not have post-selloff remorse] is “stock warehousing”. VCs can found a platform with high networth investors and build a fund that offers liquidity in lieu of stock placements, with a promise to take them back at a later date at a pre-determined price. Just have a neutral body for valuations. VCs get liquidity, they don’t forego control and the business is run as usual.

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