After you have made money, there are numerous opportunities to invest your money – stocks, bonds, money market funds, real estate, private equity, venture capital funds and the list goes on. The reason why you might be interested in venture capital funds is the possibility of gaining multiple levels on your investment. You can pick up the stock for pennies and sell it for in the high 30’s and more. That is the good news, the bad news most of your investments will not even make money, but you only need one or two to make multi millions. If you want to put it in baseball analogy, singles are for dividend investing; doubles are for real estate; triples are for private equity and grand slam home runs are venture capital firms. There is an interesting book called The Power Law – Venture Capital and the Making of the New Future by Sebastin Mallaby published by Penguin Press, NY, 2022.

In the venture capital world, if the idea is to hit grand slam home runs or the company’s equity eventually becomes public and the shares go towards north of $100, how does a company find the up and coming companies? Which one do you choose? for if you think about social media there were hundreds of companies doing the same thing but only a few truly dominate. In the book, the author profiles a number of venture capital companies and they have many different strategies. The game plan is always the same, invest in a company that is a start up preferrably disruptive; help in grow by being on the Board to allocate resources and bring in experienced people to grow the company. To find these companies that have the potential is the key for many companies will be in the space, but why these ones.

One method is to understand the trends and why. For example, in 2009 Facebook was the hot company and had recently passed 100 million viewers. The company had grown at a very high rate, questions were being raised will the rate continue to rise or will saturation happen? DST believed the growth would continue because his team had complied spread sheets on consumer-internet business in multiple countries with cells tracking daily users, monthly users, the amount of time spent on the site, and so on. The information was showing Facebook type websites in countries around the world were in the top 3 websites in the country. Facebook in the US was not in the top 5. This meant growth was possible.

In the US, Facebook had found it easy to raise money, this meant unlike its foreign social media sites, Facebook lagged behind in converting users into revenues. Mr. Milner’s spreadsheets showed foreign companies needed to maximize revenues and had tried a multiple number of avenues which Facebook had never done. If Facebook followed the foreign companies and was successful, then Facebook had enormous room to monetize revenues or it was worth more than other venture capital companies thought it was worth. Some of the other venture capital companies were valuing Facebook at $5 to $7 billion, Mr. Milner believed $10 billion was closer to what it was worth. Mark Zuckerberg also wanted closer to a $10 billion valuation and DST bought $200 million for 1.96% share. He purchased secondary employee stock at $6.5 billion valuation pushing the blended valuation to $8.6 billion. It was accepted. 18 months later, Facebook was valued at $50 billion and DST’s shares were up $1.5 billion and the stock was continuing to rise.

In all markets once something is seen as making money, there will be lots of alternatives. Sometimes the money is made being a contrarian. Peter Lynch wrote a book describing Stalking the Tenbagger. If you like a stock that the other professional investors did not own, when others found the stock, it would go up based on their enthusiasm when they discovered it. If the stock is not covered by many analysts, the stock maybe mispriced or should eventually rise to the normal multiple for the group. The third buy signal is when the CFO tells you that they have not talked to an investor in ages, you may be onto something. One of the many stories, Mr. Lynch talks about is when the cellphone became portable, Mr. Lynch invested in companies related to cellphones infrastructure including in countries such as Mexico and China.

In Universities, professors come up with a theory, do research to test it and then write about it and teach it. Brian Arthur, a Stanford professor studied network business, Companies that enjoyed network effects inverted a basic microeconomic law: rather than facing diminishing marginal returns, they faced increasing ones. In most sectors of the economy, producers that supplied more of something sees prices fall: abundance meant cheapness. In network businesses, the consumer experiences improved as the network expanded, so producers could charge more for their products or margins improved. Moreover, the improving consumer experience was matched by falling production costs because of the economies of scale in building a network. Examples are ebay and Uber.

Linking to dividend paying stocks, understanding the business model is the key to investing, why and how does the company generate revenues to make a profit to pay shareholders. Once you understand the model, you can ask how does the company increase margins? how does it lower costs? Once you have an understanding, you can rest easy with your investments ensuring when the company does its quarterly reports it is executing on its business plan.

There are more questions than answers, till the next time – to raising questions.

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