Return on Capital: 10-20-30
As an entrepreneur who has been successful once, I am asked a question by many people – Why do I want to work hard again? Why go through all the ups and downs of running a business? Why not retire and enjoy life? Besides the answer that I do love running a business and that is life, there is another answer to these questions. Building and owning a successful business is the best path to wealth creation.
Let’s say you have some money. Where do you deploy it? One obvious answer is to invest it in the markets – maybe a mix of equity and debt. Since an entrepreneur is not necessarily an expert in investing, this will be done via portfolio managers or mutual funds. Long-term returns from such investments will be 10% per annum. Luck aside, it is hard to do passive investing that will give high returns.
One could then move to active investing – studying industries and stocks, and making long-term bets on specific companies. One could also invest in private companies – as an angel or via other venture capital funds. Given that this is likely to be in a basket of companies, some will succeed and others not. The ones which succeed will give very good returns. Long-term, one could perhaps hope for returns of about 20% per annum. Not easy but doable.
The third approach, which I favour, is to grow a proficorn. Once one has got past the initial stages of a business (where the mortality rate is highest), the odds of success improve dramatically with each passing year. Over a period of time, an entrepreneur should be able to deliver growth and returns of about 30% per annum. If dilution is limited, the upside is captured by the entrepreneur.
While a 10% difference may not seem much, apply the power of compounding over a decade and see the difference:
- 10% growth for 10 years will see Rs 100 become Rs 260 (2.6X)
- 20% growth for 10 years will see Rs 100 become Rs 650 (6.5X)
- 30% growth for 10 years will see Rs 100 become Rs 1,400 (14X)
For an entrepreneur, investing capital at 10% returns will yield less than a fifth of the returns than owning a successful and growing business growing at 30%. The decision to therefore keep running a proficorn is a no-brainer! Why would I sell (if I can see sustainable high future growth), convert it into cash and reduce my financial returns by 80%? A proficorn entrepreneur should therefore only sell if the prospects of growth diminish or the value paid by the buyer is extremely high.
Tomorrow: Part 62