A new way to invest in modern businesses

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Photo by kazuend on Unsplash

Debt Investment

Before the advent of Venture Capital a new business would likely take a loan in order to be able to bootstrap and grow to profitability. Since 20% of new businesses in the US fail during the first two years of being open, 45% during the first five years, 65% during the first 10 years, and 75% during the first 15, a loan can only be made to relatively non risky businesses, which are either predictable and not particularly innovative or given at a later stage once a business is somewhat established and therefore de-risked. And since a loan is capped and doesn’t pay out more if a business ends up being really successful, a lender cannot effectively use a portfolio to pool the risk and subsidize its losses with its winners.

Equity Investment

Venture Capital solved this problem for new companies by taking equity, a percentage of the company itself, which meant that, in theory, ‘skin in the game’ through both more downside and more upside potential, aligned interests between business founders and investors.

Venture Capital and its Rise Because of the Internet

Because the Internet is a fundamentally new type of communication network it creates very different market dynamics, where there are potential network effects (the value for each user is more, the more users there are) and potential viral distribution. These dynamics lead to natural monopolies for those companies that capture these effects (Google, Facebook etc.).

Debt or Equity Financing Aren’t Working for Most New Companies

The Venture Capital model is not a good match, however, for most companies, since most companies don’t have the potential to be worth enough regardless of how likely they are to be worth something. This is because if there is an opportunity to be worth something and the Internet plays a role, a winner will possibly grab it all from you. It also isn’t a good fit for people who want to build a company that is sustainable indefinitely, without being acquired or going public, as Venture Capital requires an exit such as this, to be able to sell the equity and return cash to investors.

We are Damaging the Business Environment

Overall, this is creating an ecosystem that favors large monopolistic platforms and disadvantages small, evergreen businesses. Our business environment, like our natural one is becoming imbalanced at both the individual and overall ecosystem level, just as our natural environment is with damaged ecosystems and mass extinctions. This isn’t healthy or sustainable in the long term. If you just have apex predators like Amazon Inc., you don’t have a healthy ecosystem like the Amazon rainforest.

The Pandemic has Made Things Worse

Against all this is the backdrop of a global pandemic that is doing two things to make the situation worse: (1) unlike in 2008 where the economic system froze from the top down via large financial services institutions, this time, it is mostly small businesses (shops, restaurants or bars, B&Bs) or individuals (freelancers) that have been impacted most immediately and severely (2) the pandemic is accelerating changes that are shifting the business environment as a whole to the Internet era with its accompanying business models that require new types of funding (e.g. ecommerce has grown while offline retail has shrunk).

A New Business Model For Small Businesses

While the Internet has created natural monopolies in many areas, including those that used to be served by lots of smaller businesses (such as Uber vs minicabs, in London) there is also some early evidence that for some types of products it may do the opposite.

A New Sustainable Investment Model

These new types of business aren’t limited to artisanal products but anything where, given the right tools to market and distribute a product, a level playing field can be created relative to the large brands. You could imagine that the Fast Moving Consumer Goods model of Procter & Gamble or Unilever, where multiple global brands are marketed and distributed under one umbrella, could be completely replaced by one where many more small businesses’ products were marketed via a newly emergent marketing platform, with distribution being handled by companies like Shopify. Given the right investment model, a healthy balance could be returned to the business ecosystem by being able to support almost any type of small business.

Written by

Architect: I used to design buildings, now I design companies. http://davidgalbraith.org

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