24 March 2021

Post-Covid recovery depends on picking winners – here’s how to do it

By Rupert Gather

55 Days, 19 hours, 29  minutes and 37 seconds……

So says my Time Until Pubs Open in England app as I write. By the time you read this that blessed relief will be even closer. We can now see a vaccinated, confused but certain path to our old lives, and to help us along the way the Government is focusing on recovery and ‘Building Back Better’.

But what does that actually mean?

There has been much talk about infrastructure spending as a the solution. Politicians love these grand projects: they are a physical embodiment of ‘doing something’, and its true they do have a stimulating effect, even if that is inflationary. Economic theory has moved on since the 1970s so we can hope for a more nuanced approach, but it doesn’t take away from the problem that big infrastructure projects are generally a waste of money. Said Business School has studied over 3,000 ‘Megaprojects’ and discovered that 27% were on budget or better, 2.8% were on budget and on time, while only 0.2% of projects were on budget, on time and proving beneficial. In other words the typical project is significantly more costly than promised, delivering significantly less benefit and at a much later date than scheduled. Be afraid about HS2, be very afraid.

The real answer lies with innovators. There are 5.6 million such entrepreneurial businesses in the UK that employ 16 million people and make up 47% of private sector GDP. It’s not just about the value to GDP and job creation, it’s the contribution to the growth of innovation and the spur to competition that generates new ways of doing business.  Pandemic lockdown, for example, has seen a record rise in start-ups and innovation as companies reinvent their business models and the power of the online world levels the playing field for new entrants.

The problem with innovative businesses is that they are by definition very risky. You don’t need to be a devotee of Schumpeterian creative destruction to note that more than 50% of companies fail in the first three years, even in normal times. So the sad truth is that if you are in the business of predicting success you are as likely to miss the great opportunity as you are to back a failure.

Conventionally this is why investors have stuck with portfolios and invest in say ten companies in the certain knowledge that three will go bust, four will flatline and three will be super heroes. The trouble with this strategy is that it becomes a self-fulfilling prophesy because backers have to put their money in highly risky propositions offering a huge return of 40%+ annual internal rate of return [IRR] to end up with say 15% when they have taken into account the duds.

I have spent a lot of time trying to spot winners because in my day job at InvestUK, our clients typically just invest in a single business and need to get it right. As far as we can track it we have a failure rate of about 10%, much better than the market, although as you would expect our average IRR is correspondingly lower at 8%. Our methodology generally follows ground rules set out by the Home Office for international entrepreneurs wanting to establish enterprises in the UK under the Innovator Visa. These are standardised tests of innovation, viability and scalability. Whilst it is necessary to abide by these metrics, as Field Marshal Helmuth von Moltke observed “no battle plan ever survives the first encounter with the enemy”. Well the same could be said about business plans so personally I prefer the three ‘P’s. Important as pubs are – and they are – it is not that ‘P’ that I had in mind, but rather a simple way of looking at what makes a backable proposition.

The first P is the ‘Past’, the founder’s history – and I don’t just mean standard business metrics like profit, loss and cash generation, I mean looking at their successes and failures in all parts of their life.

The second P is the ‘Plan’ which is where the entrepreneur lays out the future of their company. We have missed many brilliant opportunities but as we know from Dragon’s Den, it is notoriously hard picking winners. Everyone knows the story of Trunki, the ubiquitous pull along children’s’ suitcase that was killed as a proposition when the handle broke live on the show. Duncan Bannatyne stated with compete certainty that Tangle Teezer looked like a horse brush and wouldn’t make any money – but is now a £200m company. My favourite is the wonderfully named Wobble Wizzard which is literally a small rubber wedge that stops a table wobbling. One Dragon said that “it was the most ridiculous idea I’ve ever heard of, what’s wrong with a folded beermat”… but that was before the entrepreneur received a £1m order for steadying university exam tables.

The final ‘P’ – and to me the most important – is ‘People’.

Now this doesn’t necessarily mean the management, although whether they are likeable certainly helps. A property investor friend of mine in Hong Kong relies on his Feng Shui Consultant who guides him on the Chi, or flow of energy in a building project. He claimed the opinion of this Master was more reliable than the accountants he used for his due diligence. He was rather like Napoleon Bonaparte who preferred lucky generals to goods ones.

For all the soaring success and risk of failure innovators are the precarious rock upon which we must build our post-Covid success. They can make a heap of their winnings, risk it on one turn of pitch-and-toss, and never breathe a word about their loss. They drive innovation and build viable and scalable businesses. And they make for great company in the pub…

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Rupert Gather is founder and Executive Chairman of InvestUK.

Columns are the author's own opinion and do not necessarily reflect the views of CapX.