When investing in different industries (construction vs tech), it's often useful to think about them in the context of asset classes.
Specifically, construction is more tied to either real estate, hospitality or government contracts. These often raise money via a bond (debt) offering or an equity with a very well-worn finance model. These projects require a lot of upfront capital (billions not unusual for roads) and have long time horizons, with log() or linear returns, and have a very well understood model for packaging as a risk asset. These risk assets attract a certain kind of investor, or a certain risk profile in a large fund's portfolio.
Venture capital as an asset class is a bit different. The expectation is that an idea can be proven out relatively cheaply, and the business will scale since the major leverage is intellectual property (vs physical assets). The expectation is also that most business will fail, with maybe a handful of successes capturing most of your return. VC's investing in startups with risk-appetite LPs, is very different than a real estate developer going to a large bank to build a housing project. The VC model is closer to investing in a TV show than a construction project.
Put simply: Investing in a moderately sized government construction project ($2b or so for a toll road in latin America) is a totally different finance product than a startup that leverages IP. The aggregation of risk is also different (VC vs say, REITs) and the devices are different (equity vs debt / leverage). Most investors either run a balanced fund at a large size, or specialize, since they are so different.
EDIT: Also important is relative size of each investment asset class. VC is hilariously small (222 billion in 2022) in comparison to something like energy (2.4 trillion in 2022). VC gets a lot of press but for most professional investors "real funds" start at about a billion table stakes.
This doesn’t answer OPs question, IMO (or my interpretation of what OP was saying is wrong).
Sure, construction and high-growth tech startups are different investment opportunities. They have different risk profiles. As someone managing money, shouldn’t you be looking to mitigate risk to maximize returns? Why give money to the startup which has an idea and no experience running a business, managing capital, accounting, etc.? Wouldn’t money be much better spent on a startup that had all those things?
I have heard in the past that the majority of startups fail, and that successful startups are often founded by people who have founded (often unsuccessful) startups before. When looking for a company to invest in, shouldn’t these be top priority? I don’t buy that VC and high growth companies need to be as risky as they are. I suspect a lot of it is bad decisions and lack of due diligence.
> I have heard in the past that the majority of startups fail, and that successful startups are often founded by people who have founded (often unsuccessful) startups before. When looking for a company to invest in, shouldn’t these be top priority?
If they already are, either directly, or because “founding a startup” (as if it doesn’t get funded, its not really a startup) is heavily dependent on connections from the beginning, that would explain the effect itself.
You beat me to the follow-up! I actually answered this below. I'll address it directly but it may get flagged as copy / paste so apologies in advance.
> As someone managing money, shouldn’t you be looking to mitigate risk to maximize returns?
- Asset classes aren't just about returns, they also have other dimensions like volatility ("beta"), liquidity, correlation, and time horizon. Being able to sell something easily is valuable, and not being subject to crazy swings is also valuable. Unfortunately those two often are at odds. These features make for different investment mixes, and also affect how you can get leverage (loans) with them as collateral. Specifically, real estate is super easy to get a loan on since it's not very volatile. Pre-IPO startup shares are very hard to get a loan on, because they are both volatile and illiquid.
> Why give money to the startup which has an idea and no experience running a business, managing capital, accounting, etc.?
- Companies that have physical assets often have a focus on operations work (e.g., where do I economically source asphalt near Berlin?). Intellectual Property businesses often have a focus [exclusively] on product work (e.g., what new software feature does EMEA sales need to make their quarter?), where accounting, etc is less correlated with outsized outcomes. One is quite literally, building the value mile by mile at a relatively high cost. The other is more "unlocking" value that was so unbalanced something with minimal physical footprint can access it.
> Wouldn’t money be much better spent on a startup that had all those things? When looking for a company to invest in, shouldn’t these be top priority? I don’t buy that VC and high growth companies need to be as risky as they are. I suspect a lot of it is bad decisions and lack of due diligence.
- Ideally you have all those things, but sometimes you can't get all the things in a deal and shaping it is the value you provide. For non-public investments, a lot of the value is from either shaping the deal yourself or getting access to the right people. It's easy for me to invest $1000 in GE. I can't just walk up to Pixar and ask to invest $1000 in their next film. Same is true for startups. You either need to seed the deal (be the lead investor), or have the access to contribute. Building these relationships is a lifetime of work. This is why people specialize.
- Adding to above, VCs themselves are even more specialized, and different stages require different balances of due diligence vs speed. VC's typically stratify by company stage (seed, A, B, C, mezzanine, etc), industry, geography, thesis, etc. These are often driven by the philosophies of the partners, fund size, or by the LPs with specific expectations. To give a very direct example, GV with exactly one LP and invests in A-stage or later, has very different goals than YC, which has very different goals than the venture arm of a big-12 pharma company like Roche (Pharma is also intellectual property based). It's specialization all the way down.
Unfortunately, I picked most of this up from school (shout out to Babin's Engineering Entrepreneurship class @ Penn) and from my stepmother who is a capital markets attorney.
However the two finance podcasts I follow really closely are "Odd Lots" from Bloomberg [1] and "The Compound and Friends" from Josh Brown and Michael Batnick. Both take a more broader look at the economy than just venture capital, and are super smart folks. Also honestly, they're fun to listen to which makes it easier.
No problem! Some other thoughts I had after thinking more about your question.
- Companies that have physical assets often have a focus on operations work (e.g., where do I economically source asphalt near Berlin?). Intellectual Property businesses often have a focus on product work (e.g., what new software feature does EMEA sales need to make their quarter?). One is quite literally, building the value mile by mile at a relatively high cost. The other is more "unlocking" value that was so unbalanced something with minimal physical footprint can access it.
- Since outcomes in IP are so binary, it winds up that having all the ingredients geographically focused produces the best outcomes. This is definitely true for talent, but also the money, risk appetite, specialized services, government, etc, all contribute to the ecosystem. This is why SV (tech) and LA (media and entertainment) exist. By comparison, NYC is still large, but is a deep secondary (1/10th the size) for both industries.
- Asset classes aren't just about returns, they also have other dimensions like volatility ("beta") and liquidity. Being able to sell something easily is valuable, and not being subject to crazy swings is also valuable. Unfortunately those two often are at odds. These features make for different investment mixes, and also affect how you can get leverage (loans) with them as collateral. Specifically, real estate is super easy to get a loan on since it's not very volatile. Pre-IPO startup shares are very hard to get a loan on, because they are both volatile and illiquid.
- For non-public investments, a lot of the value is from either shaping the deal yourself or getting access to the right people. It's easy for me to invest $1000 in GE. I can't just walk up to Pixar and ask to invest $1000 in their next film. Same is true for startups. You either need to seed the deal (be the lead investor), or have the access to contribute. Building these relationships is a lifetime of work. This is why people specialize.
- Adding to above, VCs themselves are even more specialized. VC's typically stratify by company stage (seed, A, B, C, mezzanine, etc), industry, geography, thesis, etc. These are often driven by the philosophies of the partners, fund size, or by the LPs with specific expectations. To give a very direct example, GV with exactly one LP and invests in A-stage or later, has very different goals than YC, which has very different goals than the venture arm of a big-12 pharma company like Roche (Pharma is also intellectual property based). It's specialization all the way down.
One of the classics that explains the why behind VC backed tech companies is Peter Thiel's book Zero to One.
A big takeaway for me from reading that book was that the companies that become extremely profitable are basically monopolies with no or few competitors that focus on scaling up rapidly. That was counterintuitive for me because I would have thought you'd ideally want to be profitable at all times. I'd also assumed that competing against incumbents that have little or no competition was the best way to get a profitable business running. That's actually a bad idea unless you're at least 10x better than the incumbent which you probably won't be.
Specifically, construction is more tied to either real estate, hospitality or government contracts. These often raise money via a bond (debt) offering or an equity with a very well-worn finance model. These projects require a lot of upfront capital (billions not unusual for roads) and have long time horizons, with log() or linear returns, and have a very well understood model for packaging as a risk asset. These risk assets attract a certain kind of investor, or a certain risk profile in a large fund's portfolio.
Venture capital as an asset class is a bit different. The expectation is that an idea can be proven out relatively cheaply, and the business will scale since the major leverage is intellectual property (vs physical assets). The expectation is also that most business will fail, with maybe a handful of successes capturing most of your return. VC's investing in startups with risk-appetite LPs, is very different than a real estate developer going to a large bank to build a housing project. The VC model is closer to investing in a TV show than a construction project.
Put simply: Investing in a moderately sized government construction project ($2b or so for a toll road in latin America) is a totally different finance product than a startup that leverages IP. The aggregation of risk is also different (VC vs say, REITs) and the devices are different (equity vs debt / leverage). Most investors either run a balanced fund at a large size, or specialize, since they are so different.
EDIT: Also important is relative size of each investment asset class. VC is hilariously small (222 billion in 2022) in comparison to something like energy (2.4 trillion in 2022). VC gets a lot of press but for most professional investors "real funds" start at about a billion table stakes.