Alan kohler shares an expensive lesson
Last month Vivid Technology, in which my super fund invested about $50,000, pulled the plug and went into voluntary administration. (I need to have a stern talk to my fund manager!).
For me, and perhaps other shareholders, it is an expensive lesson in a very important aspect of investing in start-ups – the Valley of Death. Vivid didn’t make through the valley.
Vivid is (was?) a listed start-up, even though the corporate structure has been around a long time. It used to be called Greenearth Energy, and had a geothermal business in Victoria as well as a share in Israeli technology that turned carbon dioxide into diesel fuel.
A few years ago it abandoned the geothermal stuff and focused on a new smart lighting technology that reduced energy bills for owners of warehouses and shopping centres.
The chairman Charles Macek, is a friend (he’s in my book club) and I knew CEO Sam Marks. The technology looked a no-brainer and they were starting to sign up customers like Coca Cola Amatil. The share price was such that you were paying for the lighting start-up and getting a free option on the Israeli CO2 conversion thing, which also looked a winner.
All up, a good long-term prospect for my old age, and perhaps if institutions woke up to it, a medium-term 10-bagger as well. I was counting the money.
Death Valley is the period between when a start-up gets its initial funding and when it reaches operational break-even. The critical, and most heart-breaking period is after it achieves success as a product, but before it achieves success as a business.
It looks like this:
After getting its seed funding, the management starts putting on costs – renting offices, hiring staff, ramping up the R&D.
Usually they haven’t raised enough money in the first round to get all the way to break-even, which is where rounds B and C generally come in, and while some businesses look so compelling that there is no problem raising more cash along the way (Uber and Xero spring to mind) for most businesses the deepening losses put investors off.
That’s especially true for listed companies. They can be in a kind of twilight zone, not in the world of venture capital but not yet a proper listed company, attracting retail and institutional investors.
That’s what happened to Vivid. The board requested a trading halt on March 20 while they looked for cash and/or a sale of all or part of the business, but as time dragged on, the less likely it was that someone was going to pay a price that shareholders would agree to. They might as well wait and buy it from the receivers.
As Sam Marks said in a message to me: “there was too much uncertainty for the board, with major investors non-committal and M&A activity taking too long. When it came to the crunch, the tech, the people customer base and opportunity was amazing, we just couldn’t get through Death Valley in one piece.”
That’s why, when I interview the founders of listed start-ups for InvestSMART, I usually kick-off with questions about cash. From now on, I always will, and I’ll go hard.
Time in the market
On a separate note Andrew Mitchell and Steven Ng, the co-founders of Ophir Investment Management, tell the story of a retired couple who invested with them after a period of good performance, but managed to pick a cyclical top and there was promptly a big correction. As markets kept falling, their emails and calls became more frequent until, in frustration, they took their money out again, wearing a 10% loss.
If they had stayed invested for two more years, they would have made 50%.
Peter Lynch, the legendary investment manager, famously made 29% annualised return during his time running Fidelity’s Magellan fund, but he calculated that the average investor in the fund only made 7% p.a. because of the habit of taking money out when returns fell and buying back in after they rose.
The point is that most corrections are just that: 10-15% drops that result in buying opportunities. Sometimes they turn into crashes (30%) or grizzly bears that go on for years, but not very often, and usually these are pretty obvious – prices are clearly over-stretched or a recession is looming.
Corrections like last year’s two (7% in Feb-April and 15% in Oct-Dec) are a normal part of the market and both the tops and bottoms are virtually impossible to predict with any certainty.
The bottom line is that volatility is an inherent part decent capital growth. No volatility means (almost) no return, especially now with interest rates where they are.
But patience and courage - time in the market rather than timing the market – is the way to achieve capital growth.