Before starting HNC Capital in 2018 we took an in-depth look at the venture capital industry. What we learned was that venture capital companies generally invest in numerous different companies. Each company makes up only a small percentage of their portfolios. There is even a term for that course of action: Spray and pray.
But we also found out that the best and most successful real estate investors, hedge fund managers and private equity funds have fairly small portfolios, concentrating their bets on the most promising investments. There are several reasons for those different approaches, but two stand out. First of all, investing in start-ups is inherently riskier, therefore a diversified portfolio makes sense. But when we can make high-quality decisions, exclude the riskiest investments and don’t fall prey to herd behavior, a concentrated portfolio certainly makes a lot of sense. Second, the fund structure puts venture capital companies in a position to invest their investor’s money swiftly, because venture capital funds have to follow a certain timeline. That is one reason why we chose a corporate structure. Our capital is permanent, therefore we don’t feel the pressure to make investments. We can wait until great opportunities come along.
In order to minimize our risks and dodge the “money losers” we set out to follow five investment principles:
• Unique and easy to understand business models
• Talented, competent and committed management team
• Long runway for significant growth
• Highly attractive valuation
• A clear path to cash flow generation for HNC Capital
In theory, those principles are easy to follow, but in practice, you always have to make certain trade-offs. So we aim to be as strict as possible with our principles while keeping the flexibility we have with our corporate structure.
When looking at the types of investments we should make, we identified two sweet spots:
Compounders
These companies work in underserved niches and are already generating reasonable revenues. These niches are mostly too small for big venture capital funds, but still big enough to achieve attractive returns for HNC Capital. Another advantage of these niches is that competition is quite limited. We don’t have to worry about Amazon coming along to eat our cake. When we identify a compounder, we’re not afraid to bet big. The returns won’t be spectacular, but still be quite attractive. Our first investment, Werbezeichen AG, is a perfect example of a compounder. They work in the niche of promotional products. Most entrepreneurs and venture capitalists would regard this market as “unsexy”. We love unsexy! The market is underserved and technologically unsophisticated. In our view this serves as an excellent setting for an ambitious company to generate organic growth and do tuck-on acquisitions.
If you like to find out more about Werbezeichen's business model, click here.
Moonshots
These companies are pre-revenue, risky, extremely hard to value and work in huge markets. This setting creates a lot of opportunity for us. For most professional venture capital investors, these kind of investments are just too small.
We know some of those investments won’t work out, but those that do should more than make up for the flops. Besides money, these companies look for guidance. Through our know-how, experience and network we can provide exactly that.
To summarize our investment approach, we look for unique businesses with some kind of edge led by competent and honest management teams. Great investment ideas come rare, but when we identify one, we put our money where our mouth is.
If you like to find out more about HNC Capital, click here.