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Chapter 9. The Next Big Thing: New Busin... > Theoretical Roots: Risk and Potentia...

Theoretical Roots: Risk and Potential Growth

Is there a theoretical basis for believing that an investment strategy focused on private firms, initial public offerings, or smaller, less followed companies will generate high returns? You could legitimately argue that these firms are likely to be riskier than larger, more established firms and that you should expect to earn higher returns over long periods. This, by itself, would not be justification enough for such a strategy since you would have to show not just high returns but excess returns, that is, the returns should be higher than would be expected given the higher risk.

Additional Risk

What are the sources of additional risk of investing in private or small, publicly traded companies? First, you will generally have far less information available about these companies at the time of your investment than you would with larger companies. Second, a greater portion of the value of these firms will come from future growth and a smaller portion from existing assets; the former is inherently more uncertain. Third, investments in private or smaller, publicly traded companies are likely to be less liquid than investments in large, publicly traded companies. Getting in and out of these investments is therefore a much more expensive proposition.


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