Turning a good idea into an investment

Turning a good idea into an investment

29 Oct 2014

This is the transcript of a speech I made this week at the smartfuturelondon conference

How to turn a good idea into an investment

What makes a good idea?  If everyone agrees that change is inevitable and ‘it’s only a matter of time’, it always seems to take a very long time. Having heard yesterday’s presentation on smart energy – hands up if anyone thinks that’s a bad idea – I suspect that a common drag on the development of really good ideas is that everyone wants a piece.

I was watching The Man With The Golden Gun on TV the other day. It was made in 1974 when the world was suffering the first OPEC oil shock. So in the tradition of the James Bond series to be topical, they shoved in a sub-plot in which the Golden Gun Guy steals the Solex Agitator, a device that turns the sun’s rays into energy.  What a great idea. Someone should try that.

When mobile payments were agreed to be a good idea in 1997, there were more than 100 companies represented in the first mobile forum. That year, Coca Cola built a vending machine that accepted payment from a Nokia phone. Around 2005 I attended a presentation about mobile payment at which someone said that there was a Coca Cola vending machine in Helsinki. Everybody was trying to get a piece of mobile payments – and it was all taking a very long time.

Sometimes, great ideas are just too early. Twenty years ago, Larry Ellison of Oracle thought that the PC was an absurd device, being limited by its own processing power and memory. “Put it on the internet” he said. So Oracle launched what we would now call the first netbook. Unfortunately, the internet was too slow at the time. The Oracle NC failed. But one of Ellison’s managers thought it was a great idea. He was Marc Benioff and he left to found Salesforce.com in 1999. It is now the reference business cloud computing company and has a market cap of $37 billion or 7x forecast revenues.

The best and most valuable ideas seem to come from nowhere and often evolve in unexpected ways.

Text messaging was originally (mid 1990s) thought of as a business app – now there are 10 trillion texts sent per year – that’s 4 a day for every person alive

Facebook was founded in Feb 2004 from Facemash which was a way of checking out the best-looking girls at Harvard. Its market capitalisation is now just shy of $200 billion.

YouTube was originally conceived as a dating site. In my view, it is the biggest technology story of the 21st century. It has become the medium of choice for corporations, politicians and terrorists. It was launched less than nine years ago, in November 2005.

A few rather rude words about disruptive technology.

Although it’s the coolest thing on the planet, it might be better not to shout about it too much. There are two potential barriers to disruptive technology. One is that some people don’t want it. The atomic bomb and genetically modified food are a couple of obvious opinion splitters. Even the contraceptive pill, in the view of some people the cause of the biggest positive social revolution of the 20th century, was treated with hostility by many. Although to many people it epitomises the swinging 60s, it took until 1999 until it was approved for use in Japan. And there’s the thing. Controversial disruptive technology tends to be very heavily regulated and subsidised or taxed according to taste.

The other barrier is incumbents. Incumbents usually have deep pockets. In the 1830s and 1840s, canal owners lobbied aggressively against the railways. The bought up land to obstruct the laying of railway lines.

Disruptive technology works best when no one sees it coming.

And now here are some things that investors like to see in early stage companies.

  • Recurring revenues and repeat customers.

 Investors love to see customers that stick around and preferably sign up as regular subscribers. In many ways, the ultimate business model is that of the utility. The opposite is a business that effectively has to sell itself every day.

  • Business models that can scale without commensurate capex.

But of course the downside with actual utility companies is that their enviable cash flow supports a continuous capex programme. The reason why software companies are sometimes so highly rated is that incremental units of their product cost them nothing.

  • Enthusiastic but realistic managers

One of Warren Buffet’s 50 best known quotes is that we should try to invest in businesses that could be run by any idiot because one day they probably will be. Great advice, but these companies are very hard to find. Over the years I have been surprised by the extent to which the personality of senior executives, most often the CEO, dominates the culture of a company. And here is the most dangerous character – a bully. Bullies are invariably surrounded by people who don’t dare tell them the truth. And that is an unexploded bomb with a great big red flag waving over it. Look at the CEOs of the banks who blew up the world’s financial system. When they appear in front of toothless committees of investigation, are you more struck by their ignorance or their arrogance? Tough call. These were boardrooms staffed by men who kissed upwards and kicked downwards. And yes, they were invariably men.

Investors like managers who are enthusiastic rather than optimistic and realistic but not pessimistic.

  • Plausible short/medium-term milestones

Milestones should be plausible and realistic. We should feel that a start-up company knows what it hopes to do next week, next month, next quarter. If someone tries to interest me in a business that has invented a device that makes perfect poached eggs, I don’t want to be shown a graph of estimated global egg consumption up till 2020. I want to be shown a poached egg.

  • A vision of where the business will be in 3-5 years.

That’s why we are in the room.

  • Two ideas for ways in which investors could exit.

This is asking for the moon and we are getting way ahead of ourselves here. But it is worth asking: is there any reason why this company could not have an IPO? Are there any known obstacles to a trade sale?

  • Accountants like profits, investors like cash flow.

Finally, profits can be seen through the eye of the beholder. The tax man wants them to be as large as possible. It is not usually the job of the accountants to please HMRC. So you will generally see two profits in publicly listed companies – consolidated according to prevailing accounting standards and adjusted or (weasel word alert) underlying, generally higher. Underlying profits often correspond to profit definitions that feature in targets connected with executive pay incentives. In RBS in 2008, there was a minimal underlying profit of £80 million. Clearly a tough year. Especially if you looked at the consolidated net result attributed to shareholders – that was minus £24 billion.

Cash flow almost never lies. Lack of cash flow can make a profitable company go bust. Always think about cash flow.

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