The two most significant economic downturns of the past 25 years, being the Dotcom bust and the GFC, produced the greatest concentration of wealth creation in history. Some of the most successful companies in history like Amazon, Microsoft and Google all solidified their market power in the shadow of the dotcom bust. Whilst the post-GFC era saw Facebook rise, and Uber, Instagram and WhatsApp all build customer bases in the hundreds of millions within a few short years of the bottom of the market.
I’ve been around tech companies and investment for almost two decades. What I love about technology is that it unlocks creative force and entrepreneurial horsepower en masse.
It’s easy to get into tech investing when times are good, but in the good times most of the ‘obvious’ opportunity has already been extracted. In these heady times we see the emergence of analogues like Uber-of-X and Slack-for-Y - ironically these analogues are rarely of less well-known companies where early stage value is still being created. In these times, if it doesn’t work out, there are plenty of jobs for the easy-come founders to go back to after their ‘get money first, make it work later’ approach has failed. The problem with this ‘risk-free’ approach to only starting a company in the ‘good times’ is that when you’re at the top of the ramp, there isn’t anywhere to go.
However, when times are tough the tourists leave the space, and it’s only the most committed and visionary founders who will leave their job or comfortable programming gig in the face of an economic collapse because they truly have faith that their idea can change the world. These companies that emerge in these periods are forged in the fire of an economic downturn. We are seeing these types of gritty founders standing out right now.
Incidentally this also goes for anyone with the foresight to also start investing in these difficult periods. For instance, it’s particularly exciting to be a part of the Wade Institute’s VC Catalyst program for aspiring VC investors. Every single person in that program has made a decision to not allow the difficulties of our times to stand between them and transformation.
So what is a world-changing idea? Often, it’s not what you think. When we’re weighing up a prospective investment, we might plot a company on a simple 2x2 quadrant to assess its likelihood of building something with competitive durability. The y-axis of this quadrant has the difficulty level of delivering the desired product and gaining customer traction. The x-axis is how “sexy” or exciting the product is, a proxy for how many people with applicable skills are attracted to solving problems in this area?
In the bottom-left corner of “boring and easy”, nobody makes any money, and nobody loses too much either because these companies rarely warrant investment relative to the other three quadrants. That’s usually the domain of nice ‘utility’ companies ticking along at a steady pace, or tech that proved to be much easier to build in markets much too small to be valuable.
Exciting and easy on the bottom right of the quadrant is typically where the majority of tech companies are concentrated. They are attracted to solving relatively obvious problems that have already been brought to attention by global companies, and their analogue approaches usually fail the durability test. In this quadrant competition is everywhere and market share becomes more expensive to acquire. These relatively low value ‘follower’ ideas are at an inherent disadvantage because ‘Uber’ didn’t have to grab market share from Uber to succeed. This is also where investors lose most of their money not knowing the difference between once easy to build product and another.
‘Exciting and hard’ on the top right is where all the most expensive technologists go. Big, intractable problems attract ambitious problem-solvers who are competing as much for glory as for material gain, and this makes these fields incredibly tough to back winners. If your VC fund wants to cure cancer or solve climate change, you’d better have a serious team behind you and a spectacular product, because the people you’re competing with sure as hell do.
However, over time ‘boring and hard’ is where the most money is consistently made. Zoom is the perfect example. If you said to people eight years ago, “Let’s do video conferencing software”, the reaction would be muted, to put it politely and in the frame of “that technical capability already exists”, boring isn’t blowing anyone’s mind in a hurry. But Skype didn’t work that well, Google Hangouts was poorly executed, and olde-world companies thought they had a monopoly - there was a real opportunity there. Sure, the pandemic accelerated growth, but Zoom had traction and scale long before it became a verb.
Software that’s used in specialised occupations or fields that most people don’t even know about, that also doesn’t attract the attention of talented technical generalists, qualifies as boring for our purposes. Boring doesn’t mean incremental or derivative - founders of these companies are full of ambition. Increasingly, these niche opportunities become really valuable where a niche can expand exponentially.
Framing investments in this way - looking at not just the size and attraction of the opportunity, but the likelihood of competition and the probable field of competitors - is a clever approach for aspiring technology investors. And particularly for those looking to capture the returns promised by the post-COVID recovery.
Another important approach is to make small allocations, early and often - especially when you’re first starting out. The extended Australian investment ecosystem has far too many people wanting growth stage risk with seed funding returns - there is no such thing. It is far more advisable to spread risk across a portfolio, rather than mitigate it by waiting on the sidelines for the company to succeed before piling-in. If you lean into your inherent curiosity and balance it with a sound investment thesis, you can assess and pursue every opportunity on its own merits and still generate early stage returns.
There are some incredibly investable companies in fields where Australia excels right now that are crying out for seed and early stage investment. Australia has incredible expertise in B2B software, AI, machine learning, robotics, chemistry and synthetic biology that has a long-dated opportunity for commercialisation.
You will lose money on some investments - that is the nature of venture capital - but the risk is absolute, you can only lose 1x your money in any given company. Notionally the same is not always true of leveraged equities or property, noting in practice the chance of a highly-rated stock or land holding plunging to zero is rare.
A portfolio approach where you invest early during tough economic times in companies solving difficult, boring problems is ideal. While a relatively small number of those companies will succeed, the compounding effect is such that early stage investors in these high-growth companies can see their money returned 100 times over or more. It’s this exponential growth and return that can pay for the less successful investments many times over.
Alister Coleman, founder, Tempus Partners