Yesterday I shared my thoughts on ways entrepreneurs can derisk without selling their entire company. A friend reached out after reading the post and we had a conversation about private companies as an asset class to invest in. He isn’t involved in tech or start-ups, so I enjoyed hearing his perspective.
My friend views high-growth private companies (i.e., start-ups) as a truly unique asset class. He thinks a start-up is an amazing investment opportunity when it’s generating profits (not breaking even or losing money). The ability to generate more cash than the company needs to maintain a high growth rate is what makes it an attractive investment. He sees a supply-versus-demand imbalance that these companies can benefit from. Historically low interest rates have investors seeking higher returns. More investors are seeking this type of investment opportunity than there are companies that meet these criteria. As valuations for these companies rise, the return on invested capital goes down, but if the company is growing at a high rate and generating surplus cash, the return is probably far better than the return on holding cash in a bank account—a great investment.
My buddy makes some good points. If you can build a profitable company that’s growing quickly, it’s unique and hard to replicate. The higher the growth rate and the higher the profit margin, the more unusual the opportunity. If the entrepreneur can receive meaningful distributions without affecting the growth rate, the entrepreneur can derisk without selling ownership in the company and while the company quickly appreciates in value. That’s an amazing position to be in as an entrepreneur.
I think my friend makes a strong case for why entrepreneurs should maintain ownership of profitable high-growth companies. Having been an entrepreneur and having close friends who are founders, though, I can definitively say that everyone’s situation is different. Every entrepreneur must decide for himself or herself whether that advice works for their circumstances.