Small growth companies are a fascinating area of investment. The ideas behind them are often fresh, often related to technological innovations, and the entrepreneurs are passionate about what they do. In growth company teams, the company culture is straightforward and things are done with heart and soul.
Even though enthusiasm is contagious, return-oriented investors must force themselves to come back down to earth when considering the investee’s return prospects in relation to business risks. The investor’s task often involves optimising the risk–return ratio of the portfolio, which essentially means finding a delicate balance between return potential and failure. Small growth companies cannot substantiate their returns based on past performance, hence they must create forward-looking scenarios of their potential development paths.
Since early-stage companies often lack traction, we at Ilmarinen, mostly rely on qualitative analyses. A key factor is knowing the competitive environment. A lot is happening in the world at a very fast pace and, quite often, several contenders view for the same market segments and nearly identical solutions. History contains many examples of solutions that were technically the best, but did not experience a market breakthrough – the winners proved to be solutions that could integrate well with a broader whole or which adapted best to their ecosystem. To take one example, the Betamax video format initially had better picture quality than VHS, but the VHS format became the market leader due to its lower price, better availability and longer recording times.
In the 1950s and ‘60s, many future scenarios and dreams were built on conquering the cosmos and interstellar travel. The superpowers of the day focussed greatly on the cosmos, and succeeded in sending a few people into space. It was a costly venture. The development of IT also began to pick up, with the vision of serving a few large institutions with computers. Nowadays telephones are also computers, and nearly everyone in the Western world has one. The market for it existed; all that was needed was a functioning gadget, a wide range of applications, and billions of users – all, of course, at a reasonable unit price.
When an investor seeks a promising growth company and cannot rely on realised historical data for an analysis, the investor’s attention will at least turn to how thoroughly background work has been carried out in the analyses of other products and services in the same segment. Diligent background work is useful in planning the company’s operations and in targeting scarce resources. Another key factor is scalability: Can my product be sold to billions of people like the computers did?
It is a positive thing that new funds enabling investments across various sectors and in a company’s various stages have also emerged in Finland. Ilmarinen wants to be part of this development, and the company is, for example, the largest private-sector investor in the KRR fund-of-funds managed by Tesi.