When relatively large companies come to the stock market, perhaps a new technology companies such as Snapchat, we often hear about seed investors making hundreds of millions of dollars. Time and time again the headlines suggest that seed investors have made a massive return on their initial outlays. This gives the impression that seed investment is the easiest way to make big money but is it? Are the headlines perhaps a little skewed? Can it really be that simple to make big money?
What is seed investment?
In simple terms seed investment is early stage investment in a new company before it lists on the stock market or other similar entity (although not all companies do float on the stock market). The whole concept of seed investment is based on the idea of feeding a “seed of an idea” and making it grow. Many companies have made significant returns on early-stage investments but you don’t always hear about the ones which have crashed and burned costing investors hundreds of millions of dollars.
Why such big returns?
By far and away the vast majority of seed investments will disappoint on growth expectations, or crash and burn, with investors losing money. The earlier you invest in a new concept the greater the risk and the more chance of losing your money. Therefore, the risk/return ratio needs to be in favour of investors, offering a potentially large return for a potentially large risk. Once a company has floated on the stock market, having made use of seed investment in the early days, it is seen to be more established and in theory less risky.
Seed investment failures
We only need to look at the social media industry to see the likes of MySpace.com which literally crashed and burned costing investors hundreds of millions of dollars. In the end the company and the website was effectively “given away” and while it is still alive today it is not the same concept and has nowhere near the potential growth the original company had.
It is difficult to say why this particular company crashed and burned although it most may be a case of 1st to market is not always the best place to be. We only need to look at the likes of Facebook to see that the concept was solid and forwardthinking but maybe the timing was a little off and investors/consumers needed to be educated about the potential going forward.
Tax losses
Thankfully seed investment is seen by governments around the world as a necessity to build the growth companies of tomorrow therefore there are an array of tax incentives. In exchange for taking on potentially large risks investors can offset the cost/losses against future profits with some governments also offering additional incentives. This may seem as though wealthy investors are receiving favourable treatment but in reality this means that governments of the day do not have to invest taxpayer’s money to take on the role of seed investors. In effect governments simply allow investors to take on the risk and they are rewarded appropriately – or not, whatever the case may be.