Getting to "yes" in a world of "no"…


I think there’s something fundamentally wrong with the way we in the UK tend to talk about investment. And it’s all to do with what I call “the colour of money”: but no, that’s not the 1986 sequel to “The Hustler” with Paul Newman and Tom Cruise. It’s about the relative risk profile of individual investments relative to a market – or in economics terms, the beta.

You see, beta is (according to its Wikipedia page) “the volatility of an asset in relation to the volatility of the benchmark that said asset is being compared to“. Whatever form capital is held in, its owner holds it there relative to an external market benchmark – and if it fails to meet the expectations of that benchmark, its owner is likely to find a way to convert it into something more suitable.

Ultimately, each asset class (bonds, shares, property, gold, wines, commodities, tech startups, etc) has its own risk/reward profile – generally speaking, the greater the class’s beta (i.e. the greater the volatility of the class relative to, say, UK government bonds), the less predictable the outcome of holding it would be, and hence the higher the level of overall return an investor in that class would expect to receive in order to compensate it for the risk of holding its money in that particular form.

The absolute volatility of a given asset is called its sigma: what’s important here is that beta is a measure of relative volatility, which is a way of saying that your rational view of any given asset is strongly coloured by whatever benchmark you’re using to reckon it against.

Yet it’s rare (in my experience) for investors to radically change the asset class they invest in – that is, to change the colour of their money – because that also means radically changing the benchmark they measure success or failure against. And in some cases (e.g. pension funds) there are indeed rules that explicitly prevent them making riskier investments.

Hence the first big problem I’m flagging here is that we don’t really have anything like a credible benchmark for investing in startups. Which means that we can’t practically apply high-level rational investment strategies (such as beta) to investing in startups – pretty much everything you’ve learnt about investing in stocks is of only marginal value in the startup world. There are plenty of things wrong with beta (e.g. upside gains and downside risk are only ever equally accountable in academics’ graphs – everyone else has to worry about cashflow), but not having any kind of access to it makes startup investing practically problematic.

Moreover, the second big problem is that without any kind of benchmark, people can’t rationally move sideways from a different benchmark. This, I believe, is why we now have so many “latent angels” – people who like the idea of investing in startups and who would dearly like to, but whose cheque-writing hand remains somehow paralyzed by fear. No matter how many angel group meetings these latent angels attend, I suspect that the lack of credible industry benchmarks is a major factor in keeping their level of investment at zero.

The third big problem is that investment in startups isn’t even remotely scientific – it’s wide-boy, sharky territory (and here I’m specifically talking about the many cut-throat dealmakers masquerading as angels out there). Sure, angel gatekeepers and academics like to talk startup valuation up as a rationally priced deal based on opportunity and negotiation: but you need at least two bidders to make a market, and in practice I suspect few UK startups ever get more than a single offer on the table, particularly at seed stage.

For the tech entrepreneur, then, the UK (particularly London!) is a place where you’re surrounded by the wrong colour money. How likely is it that a self-described “business angel” who has made significant money out of some kind of financial services scam play will look to invest in a startup unless that startup closely matches his/her pre-existing money colour? Not likely at all, I think.

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