The Lean Investment Model is targeted at ensuring Club members get the best returns, whilst minimising risks, already high, from investment in startups. We explain below how we do this.
It is a well-known fact that most startups fail; 3 out of every 4 according to an article in The Wall Street Journal. However, the concept of failure for a Venture Capital investor has a much broader meaning, for them failure means:
- Firstly, and most obviously, that the company closes down;
- but it may also be that the company is sold for less than the amount invested.
- Or that the company cannot be sold but continues to exist, a very common occurrence that many investors call a “living dead company”.
Clearly, the success rate of a portfolio of startups will depend on many factors, such as the resources, market and support that investors give to the company. However, if an average investor invests in 100 startups, statistically, after a few years, it is possible to obtain the following results:
- 10 companies sold
- 40 companies closed down
- 50 companies still exist but it is incredibly difficult to make money from the sale of them, or they are completely unsaleable.
In view of these numbers, even as experienced investors we are lucky to achieve a 10% success rate, which begs the question-why invest in startups?
We do not propose an alternative method to direct investment, widely known as Venture Debt.
Venture Debt is a type of funding in invested companies through Venture Capital; it is a loan but under different conditions to those demanded by banks. Venture Debt companies combine their loans with guarantees or rights to buy shares to offset the higher risk of default but do not ask for sureties, like many banks do. For more details on the mechanisms we recommend our blog post on the subject.
Now we are playing with maths and practical reality, by leaving money available to the company and delaying our investment over time we reduce the risk of mistakes and are paid interest income.
Clearly we lose the investment for the 40% of companies that close down; however for the 50% of companies that remain in existence we will have many opportunities to continue collecting interests and the capital is returned to us in this way.
On the other hand, with Venture Debt we can always hold onto our cards and convert a loan into shares through the option to buy. This mechanism allows us to observe the evolution of the company and invest if positive trends materialise that would result in a sale with a decent return. Generally speaking, we reduce the risk of failed investments.
To summarise, there are three main advantages of an investment such as Venture Debt:
- Reduced risk profile as companies that do not close down generally repay all the capital and interests.
- The minimum return on investment in the portfolio can be calculated, albeit with a certain margin of error.
- It provides the option to invest in companies that have demonstrated a good growth profile and are likely to sell.
For these reasons Lean Investment Club turns to Venture Debt for investment in startup companies as we believe that our Club members benefit from the differential advantages it has to offer.