We’ll never build a world-leading tech ecosystem without the support of our capital markets

This article first appeared in the Telegraph and the on-line Telegraph on 22nd February 2021.

After a dearth of IPOs in 2020, 2021 has seen a flurry of new listings — many of them UK tech companies — with more, including Deliveroo, Transferwise and Darktrace, slated to happen this year.

Meanwhile Lord Hill’s review of the listing regime in London, which is considering measures to ensure that London is getting its due share of IPOs, is drawing to a close.

There are broadly two opposing camps in the debate: those who wish to maintain the City’s reputation as a gold standard for listing, with little relaxation of the existing rules, and those who wish to make it easier to attract high-growth companies, typically in the tech sector, who might otherwise be tempted to list in Asia or the US.This all sounds like Groundhog Day to any venture capital investor who has been backing UK tech companies for any length of time.

Back in 2012, when I was at Index Ventures, we worked with stakeholders at the London Stock Exchange and in the Cameron-Osborne government to create a high growth segment on the main listing, to encourage high growth companies to list. Many of the issues that we discussed then are now being revisited and discussed with similar ardour as part of the Hill review.

Against the backdrop of the biggest rally in tech stocks since the dot com bubble, it is understandable that policy makers want to convince more companies to list here. The news last week that Amsterdam has streaked past London as Europe’s largest share trading centre stokes fears that the UK’s status as a global financial centre is potentially damaged. But there is a much bigger issue at stake, which we risk missing if we focus too narrowly on the requirements for listing.

Private markets have created value not recognised in public markets

Over the last eight years, there has been a massive shift of value from public to private markets, controlled by buyout and venture capital firms.

Many of the world’s high growth companies — or next economy companies — are owned privately — by their founders, their employees and by venture capital investors. Too often they have been reluctant to come to public markets, particularly in Europe, because those markets do not really understand how to value them. Also, with ready access to private capital, tech companies in particular have had no need to tap public markets.

Valuation metrics need to keep up with the times

Routinely, high-growth companies are judged by the standards that were developed over decades for valuing very different businesses. It is commonplace to say that next economy companies are overvalued, because they are not yet profitable. But that is to misunderstand fundamentally how tech companies create long-term value.

Michael Mauboussin, the Columbia Business School Professor and head of consilient research at Morgan Stanley, has perceptively detailed how over time next economy companies, including tech companies, are spending more of their capital on intangible assets and research and development, actions which are difficult to value but are powerful drivers of long-term market dominance and result in strong cash flows.

Let’s take spending on customer acquisition as an example. The concept of customer lifetime value (LTV) is a measure used by VC investors and most early-stage companies to justify continuing to invest in acquiring new customers adding to the growth of businesses. Simplistically, if the cost of acquiring a customer is lower than the lifetime value of that customer, then companies can and should continue to postpone P&L profits and dividends and keep investing. Companies as diverse as Netflix, JustEat, Farfetch and Zoom have used this accounting metric to good effect.

Now that every interaction with customers is known, tracked and recorded, cohort analysis is another important measure of the future potential for companies to maintain and accelerate value creation

Until analysts start to understand these and other drivers of value in high-growth businesses, they will continue to misunderstand high-growth companies, undervalue them and ultimately miss out on the long-term gains to be made from investing in them.

The issue we should be addressing is not whether we tweak the rules around free float but how we make sure that we educate asset managers and those who invest our pensions and our ISAs so that they are not missing out on the innovation economy’s long-term growth. Do we want our nest eggs invested in dying, moribund sectors or instead the sectors of the future like environmental technology, energy conservation, driverless cars and robotics?

Of course, there is a small minority of investors that have wisely allocated part of their capital to the US’s tech-heavy markets like the NASDAQ and NYSE, and who have formed the alliances that allow them to invest early in the companies that have great prospects. Nevertheless, too many funds and asset managers simply don’t have the expertise to properly evaluate the ‘next economy’ companies.

Tech sector has performed best — helping Nasdaq to record highs

Over the last decade, the companies that have performed best, not just on the LSE but globally, are these innovation economy businesses. Since Lehman Bros collapsed in 2008, the Nasdaq has massively outperformed the S&P, which in turn has massively outperformed the FTSE 100.

All about the Long Term

A shareholder letter I refer to from time to time dates back to 1997 and comes from Jeff Bezos, the founder of Amazon which last week revealed sales of $386 bn in 2020, and profits of $21bn.

Back in 1997 Bezos told shareholders that it would take lots of time and lots of investment to build the business that he envisaged. He signalled very clearly that if your investment philosophy did not align, then it would be best if you did not invest in Amazon. Bezos stuck to his guns in making investment decisions based on “long-term market leadership considerations rather than short-term profitability considerations or short-term Wall Street reactions” and in the process built extraordinary shareholder value.

Here in the UK, other than some rare exceptions like the amazing teams at Bailie Gifford and Mark Hawtin at GAM, investing institutions and asset allocators risk missing out on a booming UK and European technology and science sectors. And it is these companies, ultimately, that will provide the employment and pension dividends of the future. For the financial prosperity of our society, we need to understand better how value creation is changing.

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