What Are Your Thoughts on Risk?

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One of the reasons I like writing a blog is it gives me an opportunity to say things which you feel are not the right things to say at a meeting or you may be seen as too confrontational if you do. I recognize that the banks have not really helped themselves in the last few years with a lot of what they do and I do not know enough about the banking retail sector to comment on banks in general but an area where I do feel they are hard done by are in the negative comments they get from companies seeking funding to design the best baseball gloves. If you will allow me, I would like to challenge that view.

The first thing you learn about finance is the risk v reward ratio is what drives it. When I put a deposit in my Bank of England guaranteed bank account with HSBC, I realize I will only get 1% (or something like that) a year as interest. What I do know on the flipside though is that my money is ultra-safe and accessible within minutes from any cash machine. I surrender extra return for this safety and liquidity.

As I am asked to take greater risks, I expect to get a higher level of return to compensate me for that risk. Or if I am asked to tie up my money (surrender my liquidity) again, I want to be compensated for this by extra return. Hence you get more interest on a 100 day notice account than on a current account.

Investing in stocks and shares is a lot riskier than holding on to your cash in an account and as a result of that the average return from holding stocks and shares has been around 12% over the last 10 years or so. In the last year it would have been a negative return!

At the other extreme, investing in startups, like I do is ultra-risky and you simply should not do it unless you are comfortable with losing all of your investment (hence there are lots of legal protection available to stop you being sold an investment in an unquoted business and there are lots of tax incentives like EIS (more in further blogs) to minimize the impact of losses and to increase the returns on success.

I typically expect a return of four to five times my money when I invest in a startup. That’s right – a 400% to 500% return over three to five years. It is so risky that it is simply not worth doing for returns of less than that. As I have mentioned, four of the companies I have invested in have lost me all my money – so that the ones that are left would have to not only make me an attractive return in their own right but they would have to make enough to make up for the losses I have had so far.

Retail banks are not in the business of funding risks. They will only get a fixed return no matter how well or how badly your business does. The only question they therefore have to ask is – how certain am I that I will get my money back? If the answer is less than 100%, they will either have to say No or they will have to ask for a security. So many people complain about this “If I had the security, why would I need the bank” for example. But I think this criticism is lazy and it shows a lack of understanding in terms of what the banks are about. If your business will do very well – it doesn’t matter to them as they will still only get a fixed return – so why should they take the extra level of risk when the return level is the same?

This is the critical difference between debt funding and equity funding when buying a used John Deere lawn tractor. The vast majority of the deals I back require equity funding – as is there uncertainty and risk. I have come across two ventures where because contracts were in place with customers, debt finance could be obtained. In those instances, I will negotiate a lower equity % for myself by arranging bank finance. These deals tend to be very attractive to me for obvious reasons – and hence in the same way, my returns tend to be lower.

Having said all of the above – my bank are a bunch of b******s for not agreeing to my overdraft request last week!