Even though Institutional Investors (these include private equity funds, venture capital funds, pension funds, insurance companies and asset management companies) have money at hand, they do not usually make returns higher than 7% – 15% p.a. over long run because they do not get to take more risks.
There are no investment options available which allow taking risk higher than that of investing in businesses which are already showing signs of success/established but lesser risk than that involved in starting new ventures. Appropriately higher returns can be expected for taking higher risk but no such funds or businesses are available which could enable creation of such funds. Also, no liquid entrepreneurial funds are available which take the highest possible risk of starting new businesses and generate correspondingly high returns. With new regulations of listing AIFs, this is now possible.
We repeat the same examples mentioned in Businesses section to explain the concept of various risk-return payoffs. So you can skip them if you have already understood them well and move to the text after the examples.
It can be reasonably expected that actual returns observed over a large number of different businesses following the practices mentioned in the examples below can expect to show results in line with theory.
Assumptions: Let us suppose Proactibutors supplies ready made business plans and leadership teams to companies in the following examples. On average, let us assume an average amount X is invested as initial capital in starting a new business venture proposed by Proactibutors. It is important to remember that funding is easily available for small businesses to grow using the amended BSE SME rules here. However, we should also expect that some business may not show as much as success as expected and some business may need to liquidated if they are not successful and residual funds diverted to start other new businesses. Private Equity and the BSE main board can also be other relevant options suitable to certain businesses to raise funding after they show signs of success. There are no stringent requirements of getting listed on the BSE main board too except the size of the business. Click here for BSE main board listing criteria.
In the below examples Risk and Expected Percentage Return of Example 1 < Risk and Expected Percentage Return of Example 2 < Risk and Expected Percentage Return of Example 3 < Risk and Expected Percentage Return of Example 4.
Example 1: A profitable company valued at 100X, with annual profits of 5X invests 2X to start 2 new ventures. Starting a new business is risky compared to investing in current business. Since only 2% of company’s value is used to initiate a new business, there is not much risk for shareholders.
Example 2: A mature profitable company valued at 75X is planning to raise 25X for its core business. It can raise an extra 5X at post funding valuation of 105X (75+25+5) and invests the extra 5X in 5 new entrepreneurial ventures as subsidiaries of parent company. (5X is the investment required to start 5 different ventures. The parent company enters at face value and owns 100% of the subsidiary at outset.). Even though there is more dilution, value of original shareholder stake remains same in both cases at 60X. This enables each of the 5 ventures to raise equity and debt funding of their own after they initial signs of success. With relaxed rules of BSE SME, even the smallest profitable businesses worth a few lakhs can raise capital and get listed (click here to see rules). Also, innovative businesses categorized as Startups can get listed without being profitable provided they have 1 crore of pre-issued share capital. The return on investment for investors can be better compared to entire 30X invested in the original business especially if the new businesses have a good business plan and a good team. There is slightly higher risk (approximately 5% of value of original business is invested in new areas) in this and investors can expect correspondingly higher returns than option 1 for taking higher risk.
Example 3: A fairly new company valued at 7X is raising equity funding. It can raise 3X at post funding valuation of 10X to invest in its core business. However, it can raise another 5X at post funding valuation of 15X and invest 5X in same 5 entrepreneurial ventures as described in above example as subsidiaries. (Even though there is more dilution, original value of shareholder stake and share price remains same in both cases). Here 50% of the original company’s value is invested in new businesses and hence investors are taking higher risk and can expect higher returns.
Example 4: An investor invests 5X and starts 5 different ventures. Here, 100% is invested in new ventures. There is high risk involved and investors can expect correspondingly higher returns.
We can directly help you invest in such opportunities which help you take higher risk to generate higher returns or you can do the same using the help of Private Equity and Venture Capital firms who in turn, collaborate with us. Now, with the possibility of Alternative Investment Funds to get listed on stock exchange (see here), executing this option has become all the more easier as a listed fund enables liquidity. PE and VC firms can create funds with each fund targeting a different quantum of risk and hence expect returns in line with risk. E.g. Special funds can be created which target risk like in example 3 or example 4. Creating such unique investment options can mean easier fundraising from Limited Partners for creation of such funds and hence more fund management income for General Partners.