Is Investing in Small Companies Bold or Foolhardy?
Businesses around the world are collectively sitting on an unprecedentedly large pool of cash; much of this capital could be strategically invested in transformation, mergers, acquisitions and equity stakes. No one wants to risk shareholder cash, but there is a strong case for taking a chance on innovation.
According to a report published by the Institute of Chartered Accountancy for England and Wales, British companies had deposits of around £900 billion in 2020 while across the Atlantic, their U.S. counterparts were sitting on about $2.4 trillion.
By all accounts, there is a record volume of cash waiting to be unlocked and a huge opportunity for businesses to enhance their own value whilst contributing to jobs and GDP growth in the wider economy through targeted, strategic investment.
Many businesses are already investing in their own internal digital transformation programs, something that is widely agreed to be essential. Equally though, there are opportunities for acquisitions and joint ventures with strategic partners, including early-stage businesses. The start-up revolution that has swept the world by storm has created a whole new set of options. By taking equity stakes, undertaking joint ventures, or simply acquiring small innovative companies, larger businesses have the opportunity to rejuvenate themselves by tapping into new technologies and business models.
A Risky Business?
There are choices to be made. An investment in a well-established business is arguably less risky. Although historic performance is no guarantee of what will happen in the future, a business that has been trading for several years will be able to demonstrate revenues, profits, and a customer service record. A startup or early-stage company is – almost by definition – much more of an unknown quantity. It may have great technology but not many (nor indeed any) customers. It may be disruptive of the market it is addressing but not yet proven. On the upside, however, an investment in an innovative business might deliver much bigger returns than an apparently safer investment in a more established company.
You can apply the same logic to internal investments. Intrapreneurship is very much a part of modern business, with companies establishing essentially standalone startups within their structures. The question is, how much resource do you allocate to the internal venture? Would it be better to focus investment on the mainstream business?
What do the Stakeholders Say
This is a question not only for boards, but also for company owners – which may be a concentrated group of shareholders, or in the case of listed companies, a much wider community of investors ranging from individuals with a few shares to the big pension funds.
Investors don’t necessarily have a view on how the companies they own should spend their money, but they are very clear about the desired outcomes.
For instance, a survey by Boston Consulting Group carried out in 2020 found that while investors – at the time – had relatively low expectations for total shareholder returns, they wanted to see boards adopting strategies that built resilience in the short-term against expected economic and geopolitical headwinds whilst looking further ahead to long-term value creation.
Collaboration
What leads to long-term value creation? Innovation.
Very often the innovation is not being driven by the boards of major corporations but by young businesses who look at their chosen markets and set out to answer the question: “how do we do this better?” And what we’ve been seeing over the past decade is a rise in corporate venturing activity, with businesses either buying, investing in, or entering into joint venture agreements with startup companies.
This is not necessarily easy for either party. Global, well-established organisations work on different timeframes to small local businesses. Decision-making takes longer in the bigger organisations and – especially if listed – they have to constantly consider their shareholders. They may also be highly regulated. Startups, on the other hand, tend to be agile and expect answers and decisions to be made quickly. The two parties can find it difficult to talk to each other.
But not impossible. Over the last few years, companies as diverse as airline group IAG, Jaguar and John Lewis have sponsored corporate accelerators to connect with startups working in their sectors. This provides a chance to forge relationships, assess business models and in some cases invest or make acquisitions. Similarly, innovation hubs such as London’s Plexal deliberately bring major companies and startups together in one space to foster collaboration.
The advantage is that investment in a small company can be modest but ultimately deliver a big return; either because it is resold at a later date or as a result of boosting innovation within the organisation of the investor or buyer. The risks of failure may be high, but the potential returns are enormous. Therefore, companies such as Google and Qualcomm and Microsoft are active in corporate venturing.
The financial benefits may not be immediate. For instance, the acquisition of U.K. artificial intelligence pioneer Deepmind supercharged Google’s AI capability but at the expense of an ongoing investment. In 2021, however, Deepmind became profitable.
Each potential investment will have its own logic and drivers but while strategic investment in a small company might seem risky – it can deliver an enormous long-term payoff in terms of revenues or expertise. Often it pays to be bold.
