Pricing Advice for the Entrepreneur

Experienced venture capital investors have a good idea of which industries are in fashion, and of the risk/reward profile for the particular industry and stage of the deal. They will also have a good idea of what price the deal may bring from another VC. Generally, it’s best to find an investor who will pay a fair price (not necessarily the highest) and who brings other added value to the investment, including a workable, if not close, relationship with the entrepreneur.

The following approach has worked well for many aspiring fundraisers:

• Bring your deal along to the highest stage possible on your own prior to seeking venture capital. This will help maximize your price.
• Discuss possible valuations of your deal with your attorney, accountant, investment banker, and any friendly venture capitalists prior to establishing the price.
• Select a valuation that is reasonable in light of market realities, a bit on the higher side perhaps, so there is room to negotiate. Not so high, though, that the venture capitalist will feel that working with you is a waste of time.
• Try the valuation on several VCs, including at least one who would be a good prospect as a lead investor.
• If the valuation fails to pass “the snicker test” with several venture capitalists, revise the valuation downward.
• Remember that most VC-funded ventures require more than one round of equity infusion prior to positive cash flow or exit. Don’t sell so much of the company that there is none left for the team.

 

If you sell one-third of your company for $1 million, the valuation or value of your company, at least on paper, is set at $3 million. Remember, the higher the perceived quality, the more likely the higher the price.

 

Ken Freeman is the co-author of:
Building Wealth through Venture Capital: A Practical Guide for Investors and the Entrepreneurs They Fund

Why the Effective VC Should Be Able to Beat Buffett’s Returns

At this point, you may be asking the question, if the principles of successful venture capital investment are so similar to Buffett’s rules, why should one expect the effective VC to be able to go beyond matching Buffett’s performance and to beat his results? The answer is based on the very essence of venture capital investment.

One simple reason the effective VC should be reasonably expected to have a shot at beating Buffett long-term is that venture capital investment is inherently a high-risk/high-reward endeavor. The superior returns possible through venture capital, on average, appropriately offset the inherent risk. . . .

Buffett’s investments in mature industries are tailored to deliver more consistent and predictable returns. He looks to buy consistently strong performers when their stock, or maybe the whole stock market, is temporarily out of favor, and then to hold those investment positions for the long-term, magnifying potential returns as well as their reliability. . . .

That is fundamentally different from venture capital’s focus on startups and early stage businesses, before they reach the public trading markets and whose very reason for being is to capitalize on new technologies and often new markets.

 

Len Batterson is the co-author of:
Building Wealth through Venture Capital: A Practical Guide for Investors and the Entrepreneurs They Fund

Fairy Tales Can Come True

“Fairy Tales Can Come True, It Can Happen to You…”

. . . It may have taken a bit longer than we expected, and ultimately $100 million in investments over time, but when Cleversafe was sold to IBM in late 2015 for $1.3 billion, there were an awful lot of smiling faces in Chicago; 80 millionaires were minted among friends, family, and Cleversafe employees, and numerous already accredited investors suddenly became a lot wealthier.

Gladwin’s big idea and its intersection with practical need resulted in market demand, and brilliant execution resulted in a home run win for the entrepreneurial Gladwin, the company’s employees, and its venture capital investors. Many got back more than 10 times their investment. The very earliest investors made a multiple of 40 times their early investment. Cleversafe proved that a major high-tech company could be created in Chicago in the 21st century, and so lots more are ready now to skip Silicon Valley and build their dream in the Midwestern heartland.

Opportunities like Cleversafe, while rare, are not unique. They are all around us, hoping for the risk funding—because venture capital is unquestionably risk capital—to enable them to turn their dreams into realities. This book will help you find them, understand them, and, with some pluck and luck, become a successful venture capital investor or VC-funded entrepreneur. The result could be personal wealth, job creation, and a capital contribution to our country. Simply stated, we hope this book will help you win!

 

Ken Freeman is the co-author of:
Building Wealth through Venture Capital: A Practical Guide for Investors and the Entrepreneurs They Fund

Co-author Len Batterson a Leading VC for Individual Investors

Len (Batterson) has been one of the nation’s leading entrepreneurial venture capitalists for over 30 years.

. . . Len’s series of notable successes began while at Allstate, where he played an integral role in the financing and restructuring of Control Video Corporation, which became America Online, Inc. (AOL). On its merger with Time Warner, which remains the largest merger in U.S. business history, AOL was valued at $364 billion. While at Allstate, Len also introduced to the venture capital community Allscripts, which was funded by Allstate after Len left the company, and which also grew to unicorn status and still generates over $1 billion in annual revenues.

After leaving Allstate, Len went on to found or co-found a number of highly successful entrepreneurial venture capital funds, pioneering venture capital investment for high-net-worth individuals. His long-term success is exceptional. Len has generated investor returns averaging 28%/year over nearly 30 years, with annual gains in the double digits in every decade, even through the 2000 tech bubble as well as the financial crisis of 2008–09. In addition to AOL and initial involvement with Allscripts, his investments that became unicorns include CyberSource and, more recently, Cleversafe, a data storage innovator sold to IBM in late 2015.

Most recently, Len founded VCapital LLC (www.VCapital.com), providing contemporary online access while continuing to focus on early stage, institutional quality, technology investment opportunities for individual accredited investors.

 

Ken Freeman is the co-author of:
Building Wealth through Venture Capital: A Practical Guide for Investors and the Entrepreneurs They Fund

New Online Venture Capital Firms Mean Greater Funding Availability for Entrepreneurs

A truly new development in venture capital is the recent emergence of . . . online venture capital investment portals. These firms have increased significantly the accessibility of investment opportunity for the roughly ten million Americans who qualify as accredited investors. This in turn has increased accessibility of funds for entrepreneurs seeking venture capital funding.

These online firms actively invite entrepreneurs to seek funding from their investors. Some of these firms offer their investors dozens, and sometimes even a hundred or more, portfolio companies. Focus tends to be at the seed and early stages. Their investments in each company tend to average considerably less than $1 million, far less than more traditional venture capital firms and closer to what one might expect from an angel group. Some of these online equity crowdfunders even charge the entrepreneurs for the right to raise funds on their portals, so watch out!

A few of the leaders in this field include FundersClub, SeedInvest, and AngelList. These firms operate almost like venture shopping malls, bringing together potential investors with large numbers of ventures. They often fill the role of super-angel groups, serving as a conduit for experienced angel investors to build syndicates of individual investors on their sites.

These firms claim to perform substantial due diligence, and unquestionably some do, though we wonder about how much rigor is possible given the large numbers of portfolio companies offered. For perspective, our firm offers only four to eight deals per year, and reviews more than 100 ventures for every deal we offer. We also wonder how much value these new firms can add in helping to guide and mentor venture leaders, given the large number of ventures in their portfolios.

Nevertheless, for the entrepreneur whose money needs are more modest, this more accessible source of funding may work. However, of course, the presumed lesser degree of subsequent involvement with portfolio companies may reduce success odds for the entrepreneur. Because these firms are relatively new, it is too soon to demonstrate a meaningful track record in terms of successful exits for their investors and the entrepreneurs they are funding.

 

Ken Freeman is the co-author of:
Building Wealth through Venture Capital: A Practical Guide for Investors and the Entrepreneurs They Fund

Even More Opportunities Are Coming

Even Greater Innovations and Inventions Still to Come

For anyone who thinks the greatest innovations are behind us and questions how much is still left to “invent,” we say thank you for leaving the wealth opportunity from future innovations in the hands of those of us who can still dream and think big. Humankind’s ever-increasing expectations and aspirations will inevitably motivate continued innovation. Add to that the needs resulting from natural resource constraints, climate change, and other environmental concerns, which we believe will drive even more innovation than we can imagine.

Here is a list of a dozen categories we believe will be huge opportunity areas for future innovation and new wealth creation, and we’re betting there will be even more:

  1. Advanced materials
  2. Artificial intelligence
  3. Big data and predictive analytics
  4. Biological computers
  5. Biomedical
  6. The conquest of aging
  7. The genome
  8. Immunology
  9. The Internet of Things and of Everything
  10. Nanotechnology
  11. Robotics
  12. Virtual reality

. . . As we mentioned earlier, the accessibility of venture capital investment opportunities is becoming democratized. Today there are roughly a half million individual venture capital investors in the United States alone, and that number should expand dramatically in the coming years.

. . . Entrepreneurs will be helped further by advances in software and Internet technology already behind us, which have brought down the costs of initial startup requirements.

 

Len Batterson is the co-author of:
Building Wealth through Venture Capital: A Practical Guide for Investors and the Entrepreneurs They Fund

Batterson Track Record High Quality Investments

Batterson’s Outstanding VC Track Record

. . . Venture capital fund returns have averaged about 12% per year over the long term and 19.7% over the past 20 years according to the Thomson Reuters Venture Capital

Research Index. Nevertheless, returns on individual deals, and even on pooled funds holding a number of ventures, can vary considerably from negative to highly positive.

Len’s various funds and investment pools over 30+ years have delivered gross annual returns ranging from 14% to 159%. We had to be both good and lucky to never have a losing fund.

Investing in individual deals, though, is difficult, and that’s what VC firms do. The venture capital industry norm is that only about 15–20% of all investments will make any money at all, and about half of those money makers will be considered home runs, returning five times the money invested or greater. As we’ve said more than once in this book (sorry for the repetition, but we’re proud of our record), our record is better, with over a third of our investments making some money and almost half of those money makers considered big home runs, with either an IRR of 100%+ or a return multiple on the money invested of greater than 10. Four of our investments and/or companies that we have helped start have reached values of over $1 billion, with America Online at one time having a market capitalization of over $350 billion!

Our average annual gross IRR over 30+ years is 28%, beating Warren Buffett’s 20%+ IRR (although he has done this for 50 years). To accomplish such high returns, we had to find the highest quality investments at the right price, and then exit the investments smartly for an excellent gain. Some would say that this is just another form of “buying low and selling high.” However, in venture capital investing, this often-sage financial advice grossly oversimplifies the challenges and can easily miss the highest quality investment opportunities.

 

Ken Freeman is the co-author of:
Building Wealth through Venture Capital: A Practical Guide for Investors and the Entrepreneurs They Fund

Batterson Principles Very Similar to Buffet Rules

You’re probably wondering now how the venture capital investment principles Len and his team have learned and followed over the years could be similar to “Buffett’s Real Rules.” After all, the Oracle of Omaha buys insurance companies, railroads, soda pop, and chewing gum while Len’s team pursues categories, like the digital tech sector and bio-technology, which Buffett historically has avoided. Let’s go back through Buffett’s rules one at a time and compare.

  1. Buy at low-to-fair prices. Don’t overpay.
    While we stated earlier that in the case of the biggest home runs, like AOL, the initial investment price paid doesn’t matter much, there aren’t many AOLs. The singles and doubles are greater in number, and for them the price paid does matter. . . .
  2. Invest in companies with vigilant leadership.
    We couldn’t agree more with Mr. Buffett on this one. Our team places huge importance on a venture’s management, its ownership commitment, and its operating capabilities. Vision and technology alone are not enough. . . .
  3. Invest in business you understand.
    Again we are on the same page. Len’s teams over the years have always focused on high tech and hard science—in industries including digital products and services, cloud computing and big data, media and telecom, and biomedical and drug discovery—because those are sectors the team understands. . . .
  4. Invest in companies with solid long-term prospects. Buy and hold.
    This is at the core of venture capital. We invest for the long-term. . . .
  5. Don’t shy away from revolutionary investments. Just be sure you understand them.
    This, too, is the very essence of venture capital investment. We aggressively seek revolutionary investments. We subscribe to PayPal and Palantir co-founder Peter Thiel’s strategy of investing only in ideas and companies that appear to have home run potential.Thiel’s philosophy, which we share, is to consider, “What important truth do you see that very few people agree with you on?” . . . If you see it first and others do not yet see it, you can start a company and build a monopoly position before others can get too close to your heels. . . .
  6. Look for companies with top brands and the ability to “control” prices.
    This rule admittedly is a tougher one for us to claim comparability with Warren Buffett on. We don’t invest in leading established brands like Buffett has done . . . But our practices still do hold some similarity with Buffett’s. We seek products and technologies with the sorts of preemptive marketplace insulation that will permit them to capture and hold leadership positions and set the kind of pricing that enables rich margins and lucrative profit potential.
  7. Always be liquid. Have a source of low-cost money ready to invest.
    Like Buffett, we strive to have cash available, or investors ready to entrust additional amounts to us quickly, to pounce on outstanding investment opportunities as quickly as the marketplace demands. Also like the Oracle of Omaha, we don’t borrow to enable such liquidity. . . .
  8. Be very selective. You don’t have to move on every opportunity.
    We couldn’t agree more with Mr. Buffett on this rule. We are inundated with potential deals, and generally act on perhaps one out of a hundred. . . .Our team’s philosophy has always been, if we miss what turns out to be a great deal, c’est la vie. We are not motivated by FOMO—Fear of Missing Out. We are motivated far more by determination to minimize losing deals . . .
  9. Keep doing the above in good times and in bad.
    Again we are in lockstep with Mr. Buffett. We do not let macroeconomic cycles get in our way. Like Buffett, we are in it for the long run, not trying to time the market. . . .
  10. Minimize your mistakes, and learn from the ones you make.
    That’s one more principle where we feel strong concurrence with the Oracle of Omaha. . . . A key to minimizing mistakes in venture capital investment is to avoid FOMO mentality. It’s also essential to learn from the mistakes you do make. Experience is vital in venture capital investment, just as it is in conventional equity investment or in most professional fields.

Ken Freeman is the co-author of:
Building Wealth through Venture Capital: A Practical Guide for Investors and the Entrepreneurs They Fund

Due Diligence Importance to Entrepreneurs

Due Diligence Important . . . Even for Entrepreneurs

Venture capitalists are both hunters and gatherers. They seek out the best and the brightest among entrepreneurs and their ideas. Once they have an initial intuition that they have found a likely winner, they go into data gathering and analysis mode, which in the industry is known as due diligence. All professional VC investment firms perform due diligence to some extent.

Is Due Diligence Really That Important?

How critical is due diligence to the probability of investment success? Since most VC investments fail, might rigorous due diligence be just a waste of time? Are there too many variables and chance events, particularly in a seed- or early-stage investment, for diligence to tilt the chances of success one way or another?

. . . In our minds there is no question that due diligence definitely does matter—a lot. Those VC firms that year after year produce big returns do it at least in part because of superior due diligence. While they may also see better deals earlier and have the reputation to sign them up before others, it is their due diligence skill and discipline that enable them to recognize which ones are indeed better deals.

A Warning to Entrepreneurs: Beware of Limited Due Diligence

As an entrepreneur, you may wonder why we’re stressing the importance of due diligence here with you rather than emphasizing this point in the first half of this book, which was directed more to investors. The answer is because a VC’s commitment to solid due diligence should be important to the entrepreneur, too.

If you come across a firm that does very little due diligence, you should avoid working with them even if you’re an entrepreneur who really needs funding. Try selling others instead. Firms that do little due diligence will have little credibility among their peers, whom they may need as co-investors with them. They may in fact be driven largely by the management fees they charge their investors (regardless of results)—or the fees that some of the equity crowdfunders even charge the entrepreneur—rather than being focused on achieving exceptional gains for their investors and for the entrepreneur by helping to build major companies.

Without solid due diligence, the investor may not understand what the entrepreneur is trying to accomplish, may not be able to evaluate the venture team’s ability to execute, and may not know when and how to help the venture management team when the going gets tough, which it so often does.

 

Ken Freeman is the co-author of:
Building Wealth through Venture Capital: A Practical Guide for Investors and the Entrepreneurs They Fund

Venture Capital: A Hedge Against Inflation and Lengthy Bear Markets

My original reason for thinking about including more aggressive growth vehicles in my overall asset allocation was a concern with potential future inflation. While inflation has been extremely tame in recent years, I remember well the hyperinflation of the late 1970s and early 1980s. Back then, prices were rising nearly 10% a year, mortgage rates reached 15% and higher, and if you didn’t get double-digit raises every year, you were falling seriously behind.

Maybe that won’t happen again in our lifetimes, but the near-zero interest rates over the past several years and never-ending government deficits scare me, as they could trigger a big inflation run-up. The experts are already warning that policies expected from the Trump administration, including substantial tax reductions and substantial infrastructure expenditures, are likely to keep government deficits high and drive at least some increase in the recent benign inflation rate.

That’s good reason to include at least some aggressive growth elements even in overall conservative financial plans for anyone who can afford the risk that more aggressive growth investments always entail.

And inflation is not the only worry. I also still remember vividly the sting of the broad collapse in both stock and bond prices in 2008–09.

. . .  Our 2008–09 market scare got me digging through historical data and uncovering some long stretches when the stock market—the place we’ve been taught to look to for reliable growth—either went down sharply or simply went nowhere positive for extended periods.

You may be surprised. I was.

I looked at stock market levels at the start of 2000, the New Millennium, and then again at the start of 2017. Despite all we hear about extended bull markets, the S&P 500 index over that 17-year period grew at just 2.7% per year.

. . .  Then I remembered the economy’s difficulties back when I was still in school in the early 1970s. Fortunately I wasn’t in a position yet to worry about investing and building wealth, so the market’s travails didn’t mean much to me then. The historical data, though, sent a shiver down my spine. The S&P 500 index began a long-term drop at the start of 1973, and that index finally recovered back to its January 1973 level in 1983, and then dropped below that benchmark again later in 1983 and into 1984.

In a presentation Warren Buffett gave at a major investors’ conference in 1999, at the height of the dot-com frenzy, his memory and historical digging proved even sharper than mine. As Alice

Schroeder described so eloquently in her book, The Snowball: Warren Buffett and the Business of Life (published in 2008 by Bantam Books), Buffett reminded that audience, a savvy group made up of many of the country’s most successful movers and shakers, about market risks. . . .

As recounted by Ms. Schroeder, Mr. Buffett’s comments did highlight the timing risks of stock market investing. He explained, “In the short run, the market is a voting machine. In the long run, it’s a weighing machine. Weight counts eventually. But votes count in the short term. Unfortunately, they have no literacy tests in terms of voting qualifications, as you’ve all learned.” He then displayed on the conference room screen a simple PowerPoint slide.

 

Dow Jones Industrial Average

December 31, 1964 874.12

December 31, 1981 875.00

He went on, “During these seventeen years, the size of the economy grew fivefold. The sales of the Fortune Five Hundred companies grew more than fivefold. Yet, during these seventeen years, the stock market went exactly nowhere.”

 

Len Batterson is the co-author of:
Building Wealth through Venture Capital: A Practical Guide for Investors and the Entrepreneurs They Fund