Alan Clarke: Tech start ups a risky business

Photo / Thinkstock

It is interesting how two separate news articles from across the world can coincide. Two recent items are about red hot new share listings in internet tech start-up companies. There have always been a lot of these about, but very few are actually making any money.

Since the growth of the internet is huge, anything new in this field gets investors really excited. "They may not be making any money yet, but they will, and then the profits will be massive," they enthuse.

Prominent venture capitalist Marc Andreessen has long insisted that Silicon Valley's tech boom is not a bubble, but he is now worried that start-ups are spending too much cash on flashy offices or excessive numbers of employees.

Andreessen's tweets make him the latest in a series of investors to warn about high burn rates at tech start-ups. A burn rate measures how quickly a company uses capital.

Whenever the market gets jittery, and it will from time to time, the flashy big spending start-up techs may well catch fire and vaporise.

Andreessen is not the only worried investor. Bill Gurley, another venture capitalist, and Fred Wilson, a partner at Union Square Ventures, are among those who are sounding alarm over these potential "burners".

Andreessen's 18 tweets on the topic warn that when markets get jittery, the bloated firms will fail. "There will be no Plan B. You will vaporise," he warned.

Andreessen said that although some companies with high burn rates will survive, they will be "few and far between". He concludes, "When it comes to investing in tech start-ups, worry."

Xero shares lose over 50 per cent
Xero is a New Zealand start-up cloud accounting company and a market darling which appears to have a really exciting future.

It is very much still in development and is not in profit yet -- indeed it is forecasting an annual loss of $55 million. Investors have been piling in since Xero floated and their shares peaked at $45 in March 2014.

Now they are down to $17.50!

Why? Two big local broking firms reportedly issued a sell recommendation.

Xero's share price has come under pressure partly because its recent half-yearly trading update showed it had won only 4000 net new customers in the US during the six months to September 30.

But CEO Rod Drury said it was disappointing people were focusing on that. "

"Do we have to prove ourselves in the US? Yes, absolutely, which we will do over time.We have been very clear the US will take a while, so we have executed our strategy of getting Australia and Britain into our growth engine," he said.

Drury is defiant and said Xero was "nailing its strategy. We have 1000 staff and are likely to take on at least another 500 staff over the coming 12 months," he said.

I hope Rod is right, because salaries for 1500 staff is certainly one way to burn investors' money if the hoped-for long term success and profits do not materialise.

Is Xero going to burn NZ investors?
I don't know, only time will tell.

Clearly, though, this type of company can burn investors, especially those who paid $35 or more for their shares only to see them fall to $17.50.

A 50 per cent loss in just a few months. Well, of course they could recover tomorrow, but ...

The moral of the story -- if you are going to invest in these "red hot" new opportunities, it would best if it was only a very small percentage of your investment capital.

And it needs to be money you can afford to lose.

Hold on, did you say afford to lose? Isn't that kind of silly?

• Alan Clarke is a financial and retirement adviser and author. His second book, The Great NZ Work, Money & Retirement Puzzle, is available at www.acfs.co.nz Alan is an independent authorised financial adviser (AFA) FSP26532; his disclosure statement is available on request and free of charge.