Should You Hunt Down a Tech Unicorn, or Back a Thoroughbred?

David von Dadelszen, director and head of operations at UK Bond Network

A unicorn: a mythical creature or a tech company valued at over $1billion. Whilst finding either is challenging, it’s unsurprising that investors are clamouring to invest their money seeking the latter. But to get the best returns, hunting the next big thing might not necessarily be the best option.

The UK is becoming a breeding ground for unicorns, with London being ranked the number one city in Europe for supporting both tech start-ups and scale-ups. Investing in one of these companies at an early stage can provide huge rewards, with average returns of 54 times the capital invested. Peter Thiel, Facebook’s first big investor, is proof of how lucrative unicorn catching can be, turning a $500,000 investment into more than $1billion.

While the UK boasts more tech unicorns than its next three closest European rivals combined, the odds of finding one are still not good. Some 80% of start-ups survive past their first year, but only half remain in business by the end of their fifth.

Assuming the start-up you’ve backed has managed to survive, the chances of it turning into a unicorn are still small. Of around 40,000 tech businesses in the UK, less than 20 have grown to become unicorns. Your 0.0005% chance of finding a unicorn is further reduced by the majority of potential unicorns being snapped up by bigger players before reaching the magic $1 billion milestone.

The competition to invest in the fastest growing companies is fierce, and is dominated by large or specialist private equity houses, making access a challenge for retail investors. However, this does not mean that strong returns are unachievable by investing in early stage tech companies. Investing at a $2 million valuation, and the company being bought out at $50 million valuation is still a 25x return – not something most investors would turn their nose up at.

Another way to get exposure to the ever-growing sector is to put your money behind a tech thoroughbred, investing in the likes of Alphabet, Amazon or Facebook. These big players show a continuing drive to innovate and evolve their businesses themselves in a similar way to far earlier stage companies.

Although you are unlikely to see an investment in Amazon increase by 54 times in the next decade, these companies have a huge competitive advantage through the proportion of possible users which are signed up to receive the existing services they offer, making cross-selling new services incredibly easy. Their users click one button to start a free trial, and after 30 days they start generating recurring revenue (and most likely already have the user’s bank details). The Amazon Prime Video service is a case in point; the speed with which they were able to deploy a competitive challenge to company hailed as the future of television – Netflix – was startling.

Technology is the fourth industrial revolution, and it is a revolution that isn’t going anywhere. Investing in both established players, and a diversified mix of new entrants with the ability to deliver standout returns will help smooth portfolio returns.

Investors still need to keep a sector diversified portfolio, but seeking out companies that have a bias towards leveraging technology in their sector, be that healthcare (3D organ printing), financial services (payments and marketplace lending), insurance (insurtech) or any other in time will pay, quite literally, dividends.

Author: Dylan Jones

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