Many people may well read the headline and be thinking ‘what on earth is he talking about?’ Admits Jack Rose, as he argues why young venture capital trusts may be a good option for clients at the moment
We are currently facing one of the biggest socio-economic challenges in a generation, if not a lifetime. The cost in both human and economic terms is not only tragic but enormous.
This virus has, is, and will continue to cause immense disruption changing many elements of our way of life forever. So how could someone suggest now is a good time to consider investing in a young VCT? Well, hear me out…
Innovation and opportunity
"Innovation is the ability to see change as an opportunity - not a threat" - Steve Jobs
This crisis, like those before it, will alter society. It will rip up the fabric of normality and reshape it. In that disruption, as the fabric frays, there will be moments of opportunity for innovation, which, in turn, will lead to impactful change.
Writing recently for Harvard Business Publishing, Larry Clarke suggested there are four key shifts that occur in a crisis that provide the unique conditions needed for entrepreneurs to innovate.
Firstly, you see a huge uptick in the output of energy and ideas from a team rallying around a common purpose - in moments of adversity human nature pulls us closer together. Secondly a crisis provides a different perspective to our systems, structures, and operational procedures - we are forced to examine things in a new light.
Thirdly, it breaks down structure that, during normal times, is in place to create efficiency - this allows for more dynamism and flexibility. Lastly, it creates a conscious bias towards action, the pace of decision-making increases, businesses are forced to experiment to test thinking, to learn, to adapt and move forward - in short to innovate. It is Darwinism at work.
Moments such as these offer an opportunity for entrepreneurs. The financial crisis of 2007-2009 is a great illustration of this. Many hugely successful disruptive tech businesses were formed over this period, examples include: WhatsApp, Pinterest, Uber, and Airbnb to name but a few.
In fact, this period has been described by many people as a golden era for tech investing, something we believe is going to be the case again over the next 12-24 months as companies innovate and adapt.
Getting more for less
A further hidden opportunity for companies is the imbalance in the employment market. Current forecasts suggest unemployment could significantly increase in the coming months.
Recognising the anxiety and hardship that it will cause to many, paradoxically it can be good news for smaller companies, offering better access to skilled human talent that they need, at a lower cost. Further cost pressures such as marketing are likely to decrease too, meaning that well-funded start-ups will therefore be able to do more with less.
This brings me onto how a newer VCT offers investors the opportunity to make the most of this.
The benefit of a fresh start
Under usual circumstances, when selecting a VCT many investors, among many considerations, place particular emphasis on the size and maturity of a VCT's portfolio and its dividend track record. Larger more mature portfolios have historically been favoured as they offer a good level of diversification with more established investee companies to help support the dividend income.
However, faced with the current situation many existing VCTs with mature portfolios could find them acting as a millstone around their necks - with potentially higher cost bases and more significant levels of debt.
This is where a newer VCT can potentially hold two key advantages for new investors; they have a younger portfolio and, a higher percentage of cash. This is important for a number of reasons:
- Investments made in a new VCT will have all been completed subsequent to the patient capital rule changes. These rules have typically focused funding away from ‘traditional' businesses towards industries and companies that are often led by technology. These businesses often have narrower cost bases that can operate more effectively with remote or home working and often have less of a dependence on the physical presence of staff. This should allow them to be more dynamic and adaptable to the current situation. In contrast many mature VCTs still have significant portfolios of companies from before the patient capital rule changes came into effect.
- As companies mature and grow, they are more likely to take on debt funding to help their growth ambitions. When revenues contract debt can often be a key driver for a company's difficulties. Newer, smaller businesses under VCT rules are usually equity, not debt driven investments. They are not at a stage to need significant debt and therefore largely shielded from this potential pitfall.
- A younger portfolio also means that investee companies will have recently received funding. This should mean that they have healthy cash runways to navigate this difficult period. This importantly should be able to leave the VCT manager to use cash in the portfolio to fund new opportunities rather than needing to support existing portfolio businesses, exploiting new value for shareholders.
This brings me onto the last point, younger VCTs are likely to have a greater percentage of cash in their portfolio as they are still in the deployment phase. Not only will the higher cash weighting have protected the NAV recently, but it should also allow them to take advantage of attractive opportunities as they arise in the coming months.
In terms of opportunities, the fundraising market for the last few years has been particularly buoyant, especially in the angel investing market. This is likely to significantly slow in the coming months, which in turn will make it harder for early stage businesses to raise capital.
At the same time, there are likely to be more companies looking for fresh funds in the next three months than would otherwise have been the case, creating a demand/supply imbalance. This should make company valuations more attractive. Those VCTs sitting on high levels of cash will be able to exploit this opportunity.
An eye on the long term
As with any investment, investing into a VCT will not be right for everyone and especially at this moment in time. For those seeking the predictability of income that has become the hallmark of VCT investing the above arguments carry less weight.
It will, perhaps, resonate more with the younger VCT investors that, thanks to pension's restrictions have turned to VCTs, are less interested in the income for the here and now, but with an eye on the future and the opportunity it brings.
Jack Rose is strategic sales director at Triple Point
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What next for UK financial services?
Benefit of a fresh start