Technology is having a disruptive effect on many sectors and providing a lot of opportunity for change and growth. So, by failing to embrace technology, investors might find themselves on the wrong side, warns Dave McClure, founder of 500 Startups, a US-based start-up investor/accelerator. “We are seeing a lot more family offices jump into the market due to a growing fascination across the board for technology, particularly where that area of technology or innovation intersects with the family business’ area of expertise,” he says.
When investing in start-ups, family offices have an opportunity to look at industries they are already involved in and familiar with and target areas where technology and innovation can help accelerate or improve the overall performance of some of those sectors. “Interest is evident from the younger generation in family offices, who may be tired of doing the same old thing and looking for ways to direct some of the family business into innovation opportunities,” says McClure.
“Investing might be more relevant for those who have a family business in retail, finance or an area where technology is having a positive impact, such as payments or logistics,” he adds, noting that more than 15 family offices located in China, United States, Europe, Russia and Latin America have put money to work through 500 Startups.
Global tech
Consumption of technology is no longer just the domain of nerds, he says, with pretty much all walks of life across the world, even people who are not extremely well off, now owning mobile phones. One notable development is a greater number of people buying smartphones, for example roughly 100 million units were sold in India last year alone, which has led to the rise in mobile tech.
The omnipresence of technology in modern life is reflected in the rising stock prices of Apple, Amazon, Facebook and Google, he says, adding that similar trends could perhaps even be envisaged with Alibaba, Baidu and 10 Cent. “There are a lot of growing middle class markets in many emerging countries that are presenting opportunities not just in the US or Europe,” he says. “Probably close to one half of the planet has internet access and the other half will probably have it in the next five to ten years.”
McClure is keen to emphasise that many of the current start-up opportunities would not have been possible five or ten years ago. The market has opened up due to very dramatic shifts in the cost of building software businesses and the number of people who are operating and purchasing online. He estimates that a decade ago, costs would have been ten times greater and the number online would have been one-tenth of the number now.
“Many start-ups only really started to be possible just recently and it would not have been that much of a global story either, as most of the technology was coming out of the US, whereas now it is originating in other countries and going to other countries,” says McClure. “Now you see firms like Rocket Internet and Tiger Global going after e-commerce opportunities globally. A lot of those stories are echoes of similar stories in the US and Europe that have played out five years earlier.”
Capital efficient
As operating costs have fallen dramatically over the past 10 to 20 years, building up early-stage companies during their first two years can be very cost effective and require less than $1 million of investment. 500 Startups tends to focus on capital-efficient businesses in the software, internet and mobile businesses, and occasionally in the hardware or physical product sectors.
Investing in start-ups can be risky as there are very high fail rates of embryonic companies. Instead of approaching the market through one or two investments, McClure advocates taking a portfolio approach, either through investing in a fund structure or setting up a portfolio of 20 to 50 investments or more.
“In our case, it is more like 500 investments across our funds,” he adds. “We try to incorporate the basic ideas behind modern portfolio theory that Wall Street has introduced in the past 30 to 40 years to the technology investment industry. For instance, diversifying risk by having a large portfolio, an index or mutual fund and quantitative approach.”
Success stories
Despite high fail rates, investing in start-ups can nevertheless also result in very high success rates. McClure estimates that between 50% and 80% of investments may drop to zero, roughly 10-20% of companies would attain some level of success, while 5% achieve a fairly substantial level of success and can generate ten to 20 times or better returns.
“The larger the portfolio, the more smooth the diversification of risk will become,” he says. “Given we have invested in a total of 1,000 companies to date over the past five years, we start to see a fairly predictable series of trends and returns. If you are only investing in 20 companies or fewer, then you might see a very unpredictable and widely variant set of results.”
500 Startups has had six exits north of $100 million and McClure says that the firm has investments in probably another 20 companies that are still under private control and that are valued at above $100 million. Success stories include Makerbot, a 3D printing company that was acquired by Stratasys for $400 million in 2013 and Wildfire, a social media marketing software developer, which Google purchased for $350 million in 2012.
Additionally, 500 Startups is invested in Credit Karma that undertakes credit score monitoring and education, and though still privately held, it is currently valued at over $1 billion. “There are a bunch of other stories that are looking like they are working. Admittedly, we are awash in deal flow and cannot keep up with everything,” he says.
Global reach
500 Startups has an international outlook in sourcing seed-stage funding opportunities. Roughly half of the firm’s investments are within the Silicon Valley, about one quarter across the rest of the United States and the remaining quarter is split across 50 different countries around the world.
“Globally there are easily 50 to 100 markets which we think are interesting places to be. We have a huge interest and focus on the large language blocks, obviously Mandarin and English, but Spanish and Arabic are the two we think the rest of the world overlooks and which we think will be very substantial global languages in the long run.”
