Investors in venture capital trusts have very specific and very particular reasons to consider techn...
Investors in venture capital trusts have very specific and very particular reasons to consider technology stocks as part of their VCT portfolio of investments. But before considering the specifics of VCT investment, let us analyse the technology market.
A year ago, the FTSE techMARK 100 index was on the brink of rising and attracting lots of investors into technology investments, before collapsing as summer 2000 progressed.
Launched in November 1999, the index measures the performance of companies committed to leading-edge technology and quoted on the London Stock Exchange. Oddly, compared with the FTSE 100, the techMARK 100 index excludes the top 100 technology companies there is also a techMARK All-Share index that includes these.
TechMARK was not just launched as a means of tracking technology companies but as a specific sub-sector of the main market that innovative growth companies could join, even if they lacked the three years' minimum trading history generally required for the full list.
The techMARK 100 index began life on 4 November 1999 with a value of 2,000. By 6 March 2000, it had peaked at 5,743 and by early January this year it had toppled all the way back to less than 2,400.
Some of the individual stocks have had extraordinary performances: Online auction website QXL, for example, rose to £7.78 per share before tumbling to a minimum of 6.5p. The best-known B2C company, Lastminute.com, was floated at £3.80 per share, rose to £5.50, and is currently about 85p. Even established FTSE 100 companies were not immune from these wild swings. Sage, the accounting company with a long growth record, peaked at £9.75 before falling to a minimum of £2.65, and even the mighty Marconi peaked at £12.76, well ahead of the recent low of £6.20. Those who invested in early 2000 in techMARK companies are clearly nursing large losses. But does this mean the technology world is about to come to an end? To answer the question we need to look at what lies behind the headlines.
The modern world is experiencing rapid technological change. You only have to look at the dramatic growth in the use of mobiles phones, which have become smaller, cheaper and more powerful.
Ten years ago very few people owned one,whereas now more than 50% of adults in the UK are mobile owners. The PC is now commonplace in the home, as well as the office, and the advent of interactive TV is opening new fast growth markets for those who want to sell to the consumer. Importantly, we have seen the phenomenal growth of the internet, arguably the most important technological development of the late 20th century.
These are fundamental movements, which can lead to rapidly growing markets and tremendous growth for some companies in these areas. Contrast this with pubs and restaurants while there is growth in this market, it cannot compete with the growth rates in the technology markets because the eating and drinking sector is already mature.
What happened over the past two years was that entrepreneurs spotted the huge opportunities that the growth of the internet would create. Investors worldwide caught this fever (akin to the gold rushes of the late 19th century) and invested at ever rising prices.
Other technology stocks were carried along by this wave of enthusiasm. Unfortunately, markets tend to overreact to news, both good and bad, and a change in sentiment was inevitable.
Getting over the shock
Because the earlier enthusiasm had been so overwhelming, when investors began to realise that some of the new companies did not have sustainable business models and share valuations were too high, even for those with established records, the downturn was savage. All of a sudden, instead of everyone wanting to invest in technology, nobody did. This reaction is probably as silly as the earlier over enthusiasm.
In time we shall see a return to the recognition that technology companies as a class have fundamental and sustainable growth associated with them and, at the right price, represent the best long-term investment opportunities. This will probably take some months yet while the shock of the extreme volatility wears off, though there are some signs at the time of writing that the worst may be over. For long-term investors, prices are crucial. If they rise to levels that assume significant growth has already taken place before it has, all that is left for the investor is the risk of failure. There is no upside if achievements are actually made as the current price already assumes this.
Now, let us turn to the venture capital manager who invests in technology. Fundamentally, managers seek companies in which to invest where they believe there is scope for considerable growth. The risks of investing in early stage technology companies are very high. Some will undoubtedly fail, some will survive but not succeed, and a few will go on to become stellar performers. The manager will be looking for opportunities where he believes there is a possibility of at least increasing his investment tenfold.
A venture capitalist investing in unquoted companies has the advantage of being able to learn a great deal about the company, its products and markets much of which may be commercially sensitive and would not be released by a public company. This is a privileged position, but one that, unfortunately, comes at the price of illiquidity.
Unlike the investor in the stock market who can sell their shares (in theory, at least) at any time, the investor in unquoted companies is stuck until the company is sold, goes public or bust.
For these reasons, the venture capital investor wants to invest at the lowest price possible. The insane market of early last year led to entrepreneurs getting huge prices for their companies' shares before they
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