No scale? No investment.

Professional investors in early stage companies will talk about scale and scalability as much as, if not more than, other important considerations such as management and valuation. Lack of scalability is a deal breaker and you will often hear these businesses described as “life style” companies as if that is a bad thing.

It might not be to the investor’s tastes but so called “life style” companies are the bread and butter of our economy. Whilst they idly dream of finding the next Google or Facebook, the rest of us get on with our lives and focus on earning a living and then achieving a standard of living which goes beyond our basic needs.

In the process we pay taxes, employ people, educate and empower future entrepreneurs and build profitable companies that stabilise – and in the process don’t really give a damn that a professional investor on a fat salary and a bonus sneers at our “little” companies that will never become global empires.

We should be making great efforts to support these companies, not just because they represent future growth and stability, but because these more modestly ambitious companies take fewer risks, grow more steadily (and slowly) and will generate modest returns on investment. A basket (portfolio) of these companies will be less risky and yet provide much better returns on capital collectively than a comparable basket of so-called scalable companies.

There are some really good funds & fund managers, but you have to say that the claimed track record of a good number of funds – which are based on a “fair value” of their net assets – are modest to poor. As an investor you will pay dearly for their “success” – whether through initial fees for investing, management fees, carry or poor performance. And good performance is not about paper based value gains – it is about profitable exits.

You also have to ask why such bright sparks are incapable of picking winners. How many potentially successful companies do they turn down for the wrong reasons – scalability being one of them.

In a world where early stage companies basically write their business plans to suit the expectations of investors and still struggle to get funded, maybe there is a role for a group of investors to question the emphasis on scalability, and to start looking for reasonable returns from reasonable opportunities?

Just a thought.

Permanent link to this article: http://www.concap.cc/2012/02/no-scale-no-investment/