Investing in Tech: Fortune Favors the Informed
The array of investment opportunities in the tech sector can present a daunting challenge for even the savviest investors. Words of wisdom from investment veterans on how to identify the next tech winner.
Developing an effective investment strategy can seem like an inexact science at the best of times; investing in the technology sector, ironically, more inexact than most other sectors. Fluid and kinetic, the sector is defined by the effervescence of its entrepreneurial ethos. But this effervescence can be as much froth and bubble as the vitality and innovation of market leaders such as Apple, Facebook and Waze. Even so, the tech sector is a compelling draw for investors, given the impressive returns that the most successful investments can offer. But herein lies a dilemma. The aspiration for all investors, naturally, is to find and back the next "unicorn"; but as the logic of business considerations and financial reporting testify, relatively few companies will reach the desired objectives of sector dominance, IPO, or strategic sale. The question for investors, neophyte and experienced alike, is the same: what considerations should be taken into account when seeking to invest in the tech sector?
The Over-Arching Influence of Tech
Philippe Cerf, Co-head of Telecoms, Media and Technology for Europe, Middle East and Africa within the investment banking department at Credit Suisse, observes that whilst caution can be an underrated quality in the investment arena, talk of the tech sector's buoyancy turning into a speculative bubble is wide of the mark. "We are seeing some correction in the market, but this is across the board," he says. "There's volatility due to uncertainties in the global economic outlook – China slowing down, Brazil on the verge of a recession." This wider picture, he argues, does not fully reflect the specifics – and the investment potential – of the tech sector. "The holy grail for investors is finding growth," he notes. "There is a lot of innovation in tech: software as a service, cyber security, data mining, connected objects to name a few trends that are transforming the way we carry out business. These are going to have a significant impact on all business sectors and represent a huge investment opportunity."
Gigi Levy Weiss, a Tel Aviv-based angel investor with ties to a range of Israeli startups, agrees. "The reality is when you start to look at the last few years, you see that everything is correlated to tech," he observes. Affable and knowledgeable, Levy runs through a range of business areas – from taxi services and the diamond trade – where innovation prompted by technological development has created increased efficiency and business transparency. Rather than classing tech as a discrete sector of the traditional economy, Levy argues it should be thought of in terms of the overarching influence it has over economic activity in general. "Tech used to be a kind of closed area, that didn't touch the traditional economy in any meaningful way," he recalls. But the combination of innovation and disruption potential, has opened up a range of opportunities for investment, growth and healthy returns. "In virtually every field right now…suddenly the best way to invest in it would be through technology."
A Good Bet? A Network-Enabled Approach to Due Diligence
This is some way off suggesting that the tech sector promises riches and prizes for all. The oft- repeated statistic suggests that as many as nine out of ten startups fail. A recent industry survey by venture capital database CB Insights suggests that on average, companies fail around 20 months after their last funding round. There is a positive to be drawn from this: the tech sector, it seems, is largely self-regulatory, and not in the grip of what was once described (in a slightly different context) as the "irrational exuberance of the marketplace". Still, it must be noted that tech startups more often than not prioritize market share over profit. What metrics, then, can be employed by prospective investors to gauge whether a company will fulfil its investment potential?
"It's important to remember that all these companies are losing money in order to generate growth," notes Greg Grimaldi, who co-manages a Credit Suisse fund focusing on identifying growth-oriented fintech firms. "The investment is in sales and marketing, to spur growth." But within this lies a conundrum: the very nature of the tech sector means that many of the ideas, and the talent developing these ideas, are untested prospects. What due diligence can investors undertake to weed out unviable prospects? Sound analytical insight is an obvious first step. "You want to know that there is a sustainable business model," Grimaldi says. The standard metric is weighing growth prospects against valuations – the desired outcome being that the projected return will outstrip the original investment.
Network Effects And the Value of the Crowd
Investment opportunities in the tech sector need not be the preserve of the larger players. Crowdfunding, an investment platform that provides individual investors the opportunity to pool their resources and participate in funding rounds on equal terms have begun to develop traction. Tel Aviv-based iAngels is an investment platform that trades on its knowledge of Israeli startups to give individual investors the opportunity to invest in a curated portfolio, on similar terms to angel investors and at a scale that more closely matches individual resources. Co-founder Shelly Hod Moyal underlines the democratic potential that her platform presents for investors. "Our goal is to open up the Israeli early stage market to a global community of private investors," she says.
Access to investment markets is one thing; being able to pick a winner from the crowded marketplace of startups is another, even with the guidance of curated investment platforms such as iAngels. Concentrating on a field or fields in the tech sector is an approach that has worked for investors in the past, and no doubt will continue to do so. Gigi Levy Weiss, the angel investor, admits to being excited by a number of areas himself. But beyond this, he also speaks about evaluating what he describes as a company's defensible competitive advantage as a guide. One such advantage which shapes much of his investment thinking at the present time is Network Effects, where the benefits of existing nodes are passed on to new nodes, adding value to the network as a whole. He uses the telephone as an example of the value that nodes add to the network. "The first person to have a phone couldn't call anyone until other people joined the network," he observes. Its utility was limited until the network expanded. And as it did, so did the network's value. Buyer/Seller marketplaces, such as eBay and Air BnB are a live example of value generating firms employing network effects to their advantage. "The first seller on eBay had no one to sell to, the first buyer no one to buy from. But as the numbers added up, they created very quickly this network effect, of people basically enjoying the benefits of working together."
Network effects exist in other contexts too. Cerf, of Credit Suisse, points out that the bank's extensive network, spanning both investment banking and private wealth management, creates a community – a network, if you will – that pools talent, ability, knowledge and investment opportunities for all the participants. "It's a chance to compare notes: what are interesting areas to invest in, what are the challenges faced by startups. And how to solve these challenges with a perspective that stretches across the globe."