Startups, IPOs, acquisitions and takeovers, Peter Hodson has been through it all
Author of the article:
This week, I was a guest presenter for an MBA Entrepreneur Class at York University. When originally asked to present, I really didn’t know why. After all, I am just a stock guy. But then I realized that, from a corporate perspective at least, I have been through a lot in terms of types of companies I have worked at, transactions, transitions and challenges. So, suddenly I had a few more ideas to present to the class other than some of my favourite stock picks. For budding entrepreneurs, all will likely go through at least a few of these work/corporate transitions in their careers. Here are my thoughts on five corporate scenarios:
Being an employee
Most people, even the most-talented entrepreneurs, are going to start off working for someone else. In fact, having a bad ‘boss’ and doing things only a certain way is often the prime impetus for someone to quit and go the entrepreneur route instead. There are some pros to being an employee — nice benefit packages, paid vacation time, the ability to learn from others and so on — but at the end of the day, you are working for someone else. Everyone is replaceable. You are a salary man or woman, dependent on a boss and the company to keep your paycheque coming. I have worked for good companies and bad companies. I have worked for great bosses and horrible bosses. Making friends at a big company is the best part. Living with a bunch of office politics, and boring, useless meetings is the worst. The Lesson: If you want to be an entrepreneur, you can’t be an employee.
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I have been involved in two start-up companies, both very different. In 1997, I joined a start-up mutual fund company, Synergy. We started with $0 in assets to manage. We had a couple of key strengths. One, the initial founder, Joe Canavan, had done it all before at other companies. It was easy to join such a seasoned executive. Two, we had $13 million in capital, provided by a Canadian bank that owned part of the company. As far as start-ups go, Synergy had very good bones. Six years later, we managed more than $1.5 billion in assets, and the company was sold to CI Financial. In 2011, 5i Research was my other start-up, and current company. The genesis was quite different. I had to fund the entire start-up myself, and, for the first little while, I was the sole employee. There were some long hours and lots of stress, but hiring some very smart partners (thanks, Ryan) helped me get through the rough patch. We are not quite a giant conglomerate yet, but we continue to add staff and grow. The Lesson: With any start-up, look for lots of capital or lots of help. It’s pretty tough to succeed without these.
Going through an IPO
In 2008, the company I worked for went public. The IPO process was interesting, and I was involved in the road shows to investors. I was on the board of directors. I became a good salesperson that year, so much so that I never sold any shares in the company in its initial public offering. We went public at $100 per share (adjusted for a reverse split last year). Shares are now $47. Of course, going public two months before a global financial crisis wasn’t exactly good timing. But a public company is much different than a private company. Investors focus on three-month results, rather than a long-term strategy. It felt different after the IPO. Some employees were happy to have sold shares, some were miserable for not (the stock bottomed at $17). Some partners got rich, and left the company, or retired. Even myself, the chairman, was gone three years later. The company did not need capital at the time (IPO proceeds went to initial shareholders). While profitable, I can’t really say it was an enjoyable experience. The Lesson: Despite media hype, not all IPOs are great.
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Acquiring another company or asset
In 2011, just days after founding 5i Research, I bought Canadian MoneySaver magazine, a financial advice magazine that has been now publishing for 40 years. While with the 5i company start-up everything was new, I had now acquired a legacy company with an archaic website and old systems. While readers liked the magazine, the back office was a mess. I hired a consultant to evaluate possible changes. We counted 10 separate steps in order for a customer to buy a subscription to the time of fulfilment. We dropped this to one. We revamped the website at great cost. We acquired this giant computer filled with data, and the founding sellers said if it ever broke it would be “really bad.” We moved everything to the cloud. I really had no idea what I was doing at first. I had never owned a company before, nor published a magazine. I am happy I bought it, but boy it was tough. Shout out to my business partner Lana for getting me through those first two years. The Lesson: Acquisitions can be very difficult, don’t always work, and you’ll find tons of problems you never even expected. Get some help and make sure your acquisition price accounts for all of this.
In 2003, as noted above, my company Synergy Mutual Funds was acquired by CI Financial. It was a nice payday. But, only a handful of Synergy employees moved over to the new company. I was one of them. But I no longer worked with a lot of close friends and partners. CI was a great company and treated me very well, but it was different. Synergy had perhaps 80 people when it was sold, and CI had at least 700. There was bureaucracy — and less fun. We were no longer building and growing a company: it was already built. I lasted two years. Still, from CI’s perspective, the acquisition was a giant success. It got to retain most of the managed money, and margins went up as existing managers took over from departing managers like me. The Lesson: Acquisitions can work out very well, but there is a ‘people’ cost. Cultures have to match, and entrepreneurs may not stick around long.
Peter Hodson, CFA, is Founder and Head of Research at 5i Research Inc., an independent investment research network helping do-it-yourself investors reach their investment goals. Peter is also Associate Portfolio Manager for the i2i Long/Short U.S. Equity Fund. (5i Research staff do not own Canadian stocks. i2i Long/Short Fund may own non-Canadian stocks mentioned).
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The Canadian dollar strengthened to a one-week high against its U.S. counterpart on Thursday as investor sentiment picked up and domestic data showed that retail sales fell less than expected in July.
World stock markets rallied and the safe-haven U.S. dollar retreated from one-month highs as worries about contagion from property developer China Evergrande eased and investors digested the Federal Reserve’s plans for reining in the stimulus.
Canada is a major exporter of commodities, including oil, so the loonie tends to be particularly sensitive to investor appetite for risk.
“The assumption here is that (Fed interest) rate hikes are still a long way out and so equities markets can still perform with accommodative financial conditions,” said Mazen Issa, senior FX strategist at TD Securities in New York.
“Consequently, currencies that have a higher beta to the equity market, like the CAD, can do alright.”
U.S. crude oil futures settled 1.5% higher at $73.30 a barrel, while the Canadian dollar was trading up 0.9% at 1.2653 to the greenback, or 79.03 U.S. cents.
It was the currency’s biggest advance since Aug. 23. It touched its strongest level since last Thursday at 1.2628.
Canadian retail sales dipped 0.6% in July, compared with expectations for a decline of 1.2%, while a preliminary estimate showed sales rebounding 2.1% in August.
Canadian government bond yields were higher across a steeper curve, tracking the move in U.S. Treasuries.
The 10-year touched its highest level since July 14 at 1.335% before dipping to 1.330%, up 11.6 basis points on the day.
(Reporting by Fergal Smith; Editing by Nick Zieminski and Peter Cooney)
“DIVERSIFICATION IS BOTH observed and sensible; a rule of behaviour which does not imply the superiority of diversification must be rejected both as a hypothesis and as a maxim,” wrote Harry Markowitz, a prodigiously talented young economist, in the Journal of Finance in 1952. The paper, which helped him win the Nobel prize in 1990, laid the foundations for “modern portfolio theory”, a mathematical framework for choosing an optimal spread of assets.
The theory posits that a rational investor should maximise his or her returns relative to the risk (the volatility in returns) they are taking. It follows, naturally, that assets with high and dependable returns should feature heavily in a sensible portfolio. But Mr Markowitz’s genius was in showing that diversification can reduce volatility without sacrificing returns. Diversification is the financial version of the idiom “the whole is greater than the sum of its parts.”
An investor seeking high returns without volatility might not gravitate towards cryptocurrencies, like bitcoin, given that they often plunge and soar in value. (Indeed, while Buttonwood was penning this column, that is exactly what bitcoin did, falling 15% then bouncing back.) But the insight Mr Markowitz revealed was that it was not necessarily an asset’s own riskiness that is important to an investor, so much as the contribution it makes to the volatility of the overall portfolio—and that is primarily a question of the correlation between all of the assets within it. An investor holding two assets that are weakly correlated or uncorrelated can rest easier knowing that if one plunges in value the other might hold its ground.
Consider the mix of assets a sensible investor might hold: geographically diverse stock indexes; bonds; a listed real-estate fund; and perhaps a precious metal, like gold. The assets that yield the juiciest returns—stocks and real estate—also tend to move in the same direction at the same time. The correlation between stocks and bonds is weak (around 0.2-0.3 over the past ten years), yielding the potential to diversify, but bonds have also tended to lag behind when it comes to returns. Investors can reduce volatility by adding bonds but they tend to lead to lower returns as well.
This is where bitcoin has an edge. The cryptocurrency might be highly volatile, but during its short life it also has had high average returns. Importantly, it also tends to move independently of other assets: since 2018 the correlation between bitcoin and stocks of all geographies has been between 0.2-0.3. Over longer time horizons it is even weaker. Its correlation with real estate and bonds is similarly weak. This makes it an excellent potential source of diversification.
This might explain its appeal to some big investors. Paul Tudor Jones, a hedge-fund manager, has said he aims to hold about 5% of his portfolio in bitcoin. This allocation looks sensible as part of a highly diversified portfolio. Across the four time periods during the past decade that Buttonwood randomly selected to test, an optimal portfolio contained a bitcoin allocation of 1-5%. This is not just because cryptocurrencies rocketed: even if one cherry-picks a particularly volatile couple of years for bitcoin, say January 2018 to December 2019 (when it fell steeply), a portfolio with a 1% allocation to bitcoin still displayed better risk-reward characteristics than one without it.
Of course, not all calculations about which assets to choose are straightforward. Many investors seek not only to do well with their investments, but also to do good: bitcoin is not environmentally friendly. Moreover, to select a portfolio, an investor needs to amass relevant information about how the securities might behave. Expected returns and future volatility are usually gauged by observing how an asset has performed in the past. But this method has some obvious flaws. Past performance does not always indicate future returns. And the history of cryptocurrencies is short.
Though Mr Markowitz laid out how investors should optimise asset choices, he wrote that “we have not considered the first stage: the formation of the relevant beliefs.” The return from investing in equities is a share of firms’ profits; from bonds the risk-free rate plus credit risk. It is not clear what drives bitcoin’s returns other than speculation. It would be reasonable to believe it might yield no returns in future. And many investors hold fierce philosophical beliefs about bitcoin—that it is either salvation or damnation. Neither side is likely to hold 1% of their assets in it.
This article appeared in the Finance & economics section of the print edition under the headline “Just add crypto”
Blair Hyslop is the President of the Order of the Wallace McCain Institute. He is co-CEO, along with his wife, Rosalyn Hyslop, of Mrs. Dunster’s and Kredl’s Corner Market, New Brunswick-based companies that employ more than 200 people and have operations throughout Atlantic Canada.
As the Covid-19 pandemic raged around the world, the four Atlantic Canadian provinces came together in an unprecedented spirit of cooperation and collaboration to tackle the challenges it presented. The result was one the safest places in the world, with untold lives saved. That showed what we can do as a region when we work together.
Recently, a group of entrepreneurs from all four provinces came together to discuss ways to grow our economy and erase that gap that still exists with the rest of Canada.
It’s about controlling our own destiny and creating a region with more opportunities for our people.
The Atlantic Investment Bubble
The first item this group is proposing is the creation of an “Atlantic Investment Bubble” – a common equity tax credit to encourage investment across the region. Too often, businesses in Atlantic Canada struggle to find the investment needed to fuel growth compared to the rest of Canada. In fact, there is only $3 of Angel investment per capita in Atlantic Canada for every $28 invested nationally, according to the most recent figures.
That’s a huge gap, one that penalizes businesses in our region.
The challenge of finding investment affects all kinds of businesses – food producers like our company, Mrs. Dunster’s, as well as technology companies, manufacturers, tourism operators and more. We all face the same challenge – finding the capital needed to help our business grow.
Each province has its own equity tax credit aimed at encouraging local investment in local businesses. These work pretty well, as far as they go. They have different amounts of credit available and some outline support for only specific sectors. Yet the fundamental problem with this well-intentioned approach is that it ignores the regional nature of our business community.
As a region, we are simply just too small to operate only within our home provinces – we need to go to other provinces to find customers, vendors, employees, mentors and investors.
The provincial equity tax credits support investors who invest in a company in their home province. But if I wanted to encourage an investor in Nova Scotia, PEI or Newfoundland and Labrador to invest in Mrs. Dunster’s, they wouldn’t receive a tax credit. That becomes a disincentive to invest. A regional equity tax credit will address this problem and create a more robust investment environment within Atlantic Canada by promoting more interprovincial investment. That will help us close the gap with the national investment average.
How It Works
We propose a regional equity tax credit of 35 percent overlayed on the existing provincial programs and focused on sectors that will yield the most benefit to our region, including manufacturing, renewable energy, tourism, food and beverage, IT, aerospace, and cultural industries.
This approach will minimize the amount of legislative and regulatory changes required to implement the program. That’s important because speed matters here – one of the outcomes of the pandemic is there are billions of dollars on the sidelines looking for opportunities to be invested, including large amounts here in Atlantic Canada. By implementing a regional equity tax credit, we can repatriate our own money that too often gets invested in the public markets in Toronto or New York.
It means we can invest in our own potential.
We recognize, of course, that every dollar counts for provincial governments, and that they can’t spend scarce dollars on new programs without consequences. However, we believe that the Atlantic Investment Bubble will be self-sustaining, creating more new tax revenues than it costs.
We propose a four-year pilot program that is backstopped by the federal government, meaning it will have zero cost to the provincial governments. Based on our projections, this incentive would support nearly 50 companies in the first year. By year four after the first year of investment, this equity tax credit will have created over $50-million in labour income and added nearly $80-million to the region’s GDP.
Beyond the numbers, it will make our region more competitive and entrepreneurial. It will give Atlantic Canadian businesses the resources they need to grow, creating new jobs and new tax revenues.
Why You Should Care
Admittedly, a regional equity tax credit can seem like a niche idea. Why should you care about it?
I believe that Atlantic Canadians should be angry that our economy continues to lag behind the national average. It means our unemployment levels remain higher and our average incomes are lower.
It doesn’t have to be this way. We have the talent needed to grow our economy – we just need the fuel in the form of access to more capital.
The Atlantic Investment Bubble will make our business community stronger, creating access to more private sector investment that will help small- and medium-sized businesses grow and create more jobs for Atlantic Canadians, people just like you. It will make our region stronger, keeping your kids at home by providing them with meaningful opportunities.
The Government of Canada spends hundreds of billions each year providing services to Canadians. The modest expenditure to support the Atlantic Investment Bubble is a smart investment in the potential of Atlantic Canada. It is a short-term, not a long-term, expense that will deliver a strong Return On Investment by driving more private sector investment throughout Atlantic Canada.
The provincial governments in Atlantic Canada proved that they could work together in common cause during the height of the pandemic. They did a great job managing the crisis and have positioned the region strongly for the post-pandemic reality. We can build on that momentum with the Atlantic Investment Bubble.
There is already considerable support for the Atlantic Investment Bubble, including the Atlantic Canada Chamber of Commerce, Conseil économique du Nouveau-Brunswick, New Brunswick Business Council, the Order of the Wallace McCain Institute and TechImpact. They understand that this change will open investment in our region and help us achieve our true potential.
If you would like to learn more about this initiative, or to show your support, visit our website: www.atlanticinvestmentbubble.ca. If you are already sold on the benefits, speak to your MLA and MP and ask them to support this smart, cost-effective policy change.
Huddle publishes commentaries from groups and individuals on important business issues facing the Maritimes. These commentaries do not necessarily reflect the opinion of Huddle. To submit a commentary for consideration, contact editor Mark Leger: [email protected]
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