Venture vs Growth: Should You Invest in a Start-up?

When you talk to people about start-up investing it is not unusual to learn they harbour a secret fantasy of being an early or angel investor in the next Apple or Amazon, then cashing out by age 40 to buy a private island or live on a superyacht. But stories of financial returns on this scale from a single investment are extraordinarily rare, and their recounting usually fails to acknowledge the risk taken by those early investors.

Very different weighting applies to investing in a trending idea or attention-grabbing start-up versus a less exciting but lower-risk, long-term, diversified portfolio. A start-up or venture capital is far from a guaranteed growth strategy, so if return on investment (sooner or later) is an absolute must for every dollar you invest, you need to look at a lower-risk option.

Solely investing in start-ups is not a substitute for an investment strategy. For those who want to know how to dedicate some funds to start-ups, here is what I have learned:

1.    Putting money into a start-up is not inherently an investment. There are steps you need to take to build any investment portfolio, which has a time horizon. Putting money into a start-up, whether one or several, should be a small part of the portfolio which can be weighted towards higher-risk activity, because the hit rate with start-ups can be low. According to Figure.NZ, only 40% of businesses set up in 2017, and 28% of those set up in 2013, have survived to 2023. If you are going to dedicate funds to that sector, you must know that not only might there never be a return, you might not see that money again.

2.    Take emotion out of it. Your investment decisions should not be driven by nostalgia, or empathy, or even hopefulness. They should be deeply rational and informed by research and evidence. People in business, and particularly founders, like to support other entrepreneurs: their feeling is, “Hey, I've gone through that hard journey too,” and they want to support others that are going through it.

That worries me, as someone who invests right across the market. It’s a laudable aim, to show compassion and extend the ladder for others to climb, but it might not be an actual investment. Many people say to me, “Gosh, I’ve made all these investments and made no return whatsoever.” That is because ‘investing’ based on an emotional response can be likened to gambling; in an investment sense, it’s like walking into a casino, finding the roulette table, and putting it all on red.

3.    The built-in risk is actually disproportionate. This is because of the entrepreneur factor – so many New Zealanders are self-employed / SME owners who have already bet on themselves and perhaps put the family home on the line. To be in that position and then put money into a start-up, where you have no operational input or control, is going to be unwise for a lot of people.

It’s a position of exaggerated risk, not educated risk. For instance, when I asked a friend why they had invested in a particular fund, they told me, “Because they’re supporting some great ideas which sound like good investments.” That is high-risk, non-strategic thinking.

4.    If you must make direct company investments, proportion is critical. Full disclosure: I am invested in selected start-up businesses. But I’m an investment professional, and I am reluctant to tell anybody who comes to me for investment ideas to look at that area. It's simply far too high-risk.

Instead, I would steer people towards term deposits, bonds, domestic shares, international shares – all listed, all liquid. Then you should have your direct company investments, which are unlisted. That total bucket of direct investments for most people shouldn't be more than 10% of your entire wealth. In New Zealand, we tend to overweight property and business investments and in turn we skip financial assets such as shares and bonds in building long-term portfolios.

In light of the change of government, there is some important extra context that I suggest is relevant to the new Minister of Finance. New Zealand is not a nation of savers, which is a problem and possibly an issue of scale. In the United Kingdom in the late 1990s, I used to advertise our managed funds in the newspaper, and 20% of funds flow were direct online. However, for New Zealand to get the legal changes in place to accept online applications for managed funds took another 20 years.

That is an example of people who had experience of saving and knew they needed to save and that it was tax-beneficial for them to do so. Some used advisors, others did their own research, all were confident enough to invest directly.

At this point, we need more incentives to save for the future. KiwiSaver is terrific and important, but in its current form it is not enough on its own to get all Kiwis gathering what they need for retirement. To develop policy which strengthens our collective position it would be worth referring to the UK model where, for people able to do so, at the end of the financial year they can put excess money earned during the year into ISAs (individual savings accounts) and avoid paying punitive tax. This grows tax-free but is accessible for emergencies or house/rental deposits, not locked in like KiwiSaver.

Alternatively, people can top up their pension (KiwiSaver) for the same tax benefit. That is all part of the UK’s national habit and people’s conditioning towards long-term saving. If we were to adopt comparable policy in New Zealand, we would start to dilute the concentration risk of disproportionate investment in property, influence mindsets towards habitual saving, and expand the savings base of Kiwis for the benefit of generations to come.