⚓️ Venture Capital & The East India Company
Economic posts are back, and today we’re discussing the history of the stock market and Venture Capital as we know it today ⬇️
🇳🇱 The Dutch East India Company
We go back to around the year 1600, during the height of commercial expansion and colonization by European powers such as Spain, Portugal, the United Kingdom, and the Netherlands.
In the Netherlands, there was a company leading the trade routes with Asia: the Dutch East India Company. It was the company responsible for chartering the merchant ships that left Amsterdam en route to India, Sri Lanka, Persia, Malaysia, Thailand, and Indonesia.
*Note: There were also the British East India Company, the French, the Portuguese, etc. In this post, we will focus on the Dutch one: the Dutch East India Company.
Ships left Amsterdam with European textiles, metals, alcohol, and various manufactured goods in high demand in Asia. And when they returned, they did so with Asian products highly valued in Europe, such as porcelain, silk, tea, spices, and sugar cane.
However, it is important to mention that one of their main ‘commodities’ at that time were slaves, mainly from Sub-Saharan Africa and Indonesian islands, to be later taken to trading centers, plantations, and agricultural estates (source).
🌏 Here are their main trade routes (source):
At that time, expeditions to Asia were very expensive. It was necessary not only to recruit and pay sailors capable of successfully navigating the ship there and back but also to secure sufficient funds to cover all the operational and logistical costs of the journey.
Additionally, it was usual for individual investors or small companies to provide the necessary capital to finance specific expeditions or individual ships.
The problem was that ships often sank or were attacked by pirates. And this meant that a single trip could result in the total loss of the investment made in the ship and its cargo, representing a great financial risk for merchants and investors.
It became necessary to find a way to diversify these risks, because otherwise, no one in their right mind would continue financing ships without knowing what would become of them.
Then the East India Company came up with an idea that would revolutionize financial markets: instead of financing individual ships, a kind of ‘shares’ would be issued that would represent small percentages of a larger number of expeditions.
This way, it would be much more likely that some of those ships would return to Amsterdam and that their investors could profit from the money invested.
It was the first time that a diversified financial market was being articulated.
This financial innovation took place in 1602, the same year the Amsterdam Stock Exchange was founded (considered the first stock exchange in history).
Several interesting things happened as a result of this change in how expeditions were financed:
- The reduction of risk attracted amateur investors, leading to a greater overall injection of capital, and the financing of more expeditions.
- Investors began to diversify their ‘investment portfolios’ by combining shares of safe expeditions, with close destinations and lower value in goods but a higher probability of return, with those of risky expeditions, going to distant places with valuable goods but a higher risk of sinking or being attacked by pirates.
- Investors began to buy and sell shares among themselves. If an expedition was delayed, the price of its shares fell due to suspicion of problems. This offered an opportunity: to buy shares at a low price and, if the ship returned, obtain a substantial return on the investment.
Over time, the type of shares traded on the stock exchange became more complex. And stock exchanges also opened in different cities, like New York, London, Hong Kong, or Shanghai.
It is worth mentioning that there are two especially intense periods during which there were giant leaps in financial markets (both in private companies and those listed on the stock exchange):
- The Industrial Revolution (18th century)
- The 1970s, with the strong growth of the financialization of the population
In future posts, we will talk about this, especially the second point 🤔
📋 Diversification and Venture Capital
The idea of diversifying investments from the Amsterdam Stock Exchange remains valid to this day. Nobody knowledgeable in finance puts all their capital into one asset.
Remember when we talked about how Venture Capital works, being the main investors in startups?
Their model follows the same logic that governed the investors in the expeditions of the East India Company ⬇️
Suppose an investor invests in 10 startups, which, returning to the case of the East India Company, would mean they have invested in 10 different expeditions:
- It is assumed that of these 10 startups, 4 will fail completely (the ships will sink and the total investment will be lost).
- Another 3 will return the initial investment (they will return to port with enough cargo for the investor to neither lose nor gain money).
- 2 of these startups will be quite profitable investments (the expeditions will return to port with valuable merchandise, allowing the investors to double or triple their investment).
- There will be 1 startup that will be the queen of the portfolio, with record growth and astronomical returns for the investors (and in our case, the expedition will return to port with extremely valuable merchandise, enriching the investors).
After all, there isn’t much difference between a startup and an expedition thousands of kilometers away.
In both cases, they face uncertain conditions and both require a high degree of innovation, adaptability, and courage to navigate uncharted territory.
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