In early 2000, SoftBank founder and CEO Masayoshi Son invested $20m into a little known Chinese ecommerce company otherwise known as Alibaba. Even after this year's sell-off in Alibaba's stock, that initial stake is worth in excess of $100bn.
Less well known is the story of Shirley Lin at Goldman Sachs. Goldman actually invested in Alibaba a year before SoftBank and at a much lower valuation. Having been offered 50% of the company for $5m, Goldman ultimately decided to invest $3m and sold it five years later for $22m and a seven-fold return. Not bad. But earlier this year those shares would have been worth nearly $200bn before dilutions - far in excess of Goldman's entire market cap which currently sits at $127bn.
This is an extreme example demonstrating the power of extraordinary, nonlinear returns from a tiny minority of investments. But it also serves to highlight the folly of selling a great investment too early. "You can't go broke taking a profit" is an oft-repeated aphorism in the investment world. Taken literally, those words might be true, but they're unlikely to make you very rich either.
For the tax paying investor considering the sale of a successful investment, there are further penalties to consider for exiting too soon.
Consider the following example:
Two investors each start with $100 and invest it for 30 years.
Investor A invests $100 and earns 10% a year on her investment. Investor A is happy with her choice, sits tight for 30 years and does not sell at any stage.
Investor B invests the same $100 in year 1 but in the belief that good investments don't last forever, he sells and reinvests his money every two years into something new. As it so happens, Investor B ends up with a 10% return on all of his investments. However, his switching comes with a cost and he has to pay capital gains tax at 20% every time he sells and reinvests his money.
At the end of 30 years Investor B is left with $1,064 from his initial $100 investment. This seems pretty good until you realise that Investor A has amassed $1,745. The difference is a whopping 64%. Crucially, even if both were to sell their entire investment at the end of 30 years and pay all the taxes due, Investor B would have $1,027 whilst Investor A would have $1,416 - nearly 38% more.
In the institutional investment world where fees and promotes are largely dictated by pre-tax IRRs there can be something of a divergence between the interests of the sponsor / general partner and the best interests of the limited partners / investors . A sponsor may be incentivised to sell a particular asset "early" in order to crystallise their own performance related fee. This results in the limited partner interrupting the compounding of their investment capital with a taxable event as well as missing out on any future gain in the value of the asset.
One caveat to this is that many (or even most) of the limited partners in the world's biggest mega funds are tax exempt entities (think pension funds, endowments etc.).
But for the non tax-exempt limited partner where taxes need to be paid upon the realisation of investment gains, it is usually better to hold for much longer time periods. Indeed, in the corners of the real estate market which are not subject to wild changes in fortune based on technological progress, the best hold period may in fact be forever. After all, London's Grosvenor Estate encompassing Mayfair & Belgravia has been owned by the same family since 1677. It would have been quite some mistake if Sir Thomas Grosvenor had sold up in 1690.
Our firm is currently just a little smaller and a little less storied than Grosvenor but between Masayoshi Son, Goldman Sachs, Alibaba and Sir Thomas we won't be selling any of our investments anytime soon.
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