Investment management is all about prediction, and prediction is all about estimating the likelihood of relatively important events.
Therefore, before making an investment the first decision is to determine the events that matter most and also to rank the difficulty in making such decisions.
In the case of choosing which early stage companies from which to buy a royalty, the decision regarding scope of market, assuming the primary product can be delivered, seems paramount. Investing in early stage companies is a risk filled activity and the wins have to be significant, if the inevitable portfolio losses are to be offset.
Therefore, there has to be a positive view as to the magnitude and sustainability of market demand for the product, if deliverable and protectable from price competition. The decision regarding likely market demand for the product is easier for those knowledgeable about the industry to make than assuredness that the product can be created.
Predicted product pricing is an element of the decision-making which is frequently inadequately focused on. The product pricing is usually dictated by the cost of development and production, not the need of the customer, which impacts predictions regarding market demand. Also, product pricing has a lot to do with likely product competition. The failure to correctly predict the cost of necessary marketing is a recurring problem.
The likely success in creating the product envisioned by an early stage company can be more accurately assessed by those having experience in the field than by the investor and even by the developers of the product. Betting on technological success is high risk and should only be done if the investor is comfortable re the market demand and intellectual property protection.
My license plate holder proclaiming “Venture – Been There Done That” presumes experience leading to simple rules of engagement in dealing with the unknowable. The first positive, which must be present, is scope of the vision. The next is an assessment, by relevantly knowledgeable observers, of the key players, in both the creation and marketing of the product. Finally, a determination of the significance to me, as the investor, if all invested is lost. “All or none” plays can be great if they workout but are more difficult to make if; 1) investing other people’s money or 2) the considered investment is more than a single holding in a portfolio of opportunities.
The statement “Been There Done That”, indicating an abundance of experience, is even more significant when investing in established companies, as there is so much more data to consider. Judging the effectiveness of the management team by reviewing financials is the first step. One should want to invest in an expansion of that which has been successful and which will likely continue the success with more assets under management achieved by growing their business.
Also, in considering investment in established companies, even though revenue sharing investment is so much easier than future profit dependent investing, a study of the royalty issuing company’s competitors is extremely necessary and easily accomplished. If the company is already satisfying customers it is very likely that with additional facilities or services they will be able to continue doing so. Therefore, buying a percentage of the company’s revenues on reasonable terms is a prudent approach to obtaining increasing income disproportionate to the risk of capital loss. The investor’s use of leverage is also a consideration in established company royalty investing.
The greatest risk in investing in the expansion of established companies is over expansion relative to market demand for that being offered. The success of an enterprise in one location may be due to the personality of the management or the particular need of the community. Therefore, investing in personality dependent businesses is not a good idea and the investor should be comfortable with the need in additional markets for the products or services being offered.
In the end, if the patterns of success are present in a company and more than the current customer base can be projected, there is reason to finance expansion by investing in the revenue growth of that company.
Arthur Lipper, Chairman British Far East Holdings Ltd.
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