Making Sense of Venture Valuations: Understanding the Basics for Smart Investing

With all the excitement about today’s unicorns – privately held, venture capital-backed companies valued at over a billion dollars – and the anticipated stream of IPO’s this year, smart investors need to understand what venture valuation is all about. We’ll try here to arm investors with that understanding.

Valuation Fundamentals 101

Venture capital investing is simply buying shares of a privately held company. Investors may think of their investment as a lump sum rather than as buying a discrete number of shares, but conceptually it is no different than buying shares of a publicly traded company. (more…)

Where Venture Capital Investment Is Heading Over the Next Decade

If the world of venture capital were to be set to music, Bob Dylan’s “The Times They Are a Changin’” might be chosen. The venture capital industry has changed in important ways over the past few years. We believe change will continue over the next decade. We expect venture capital investment over the next decade to reflect these major themes:

  1. Industry structural changes — bigger deals, greater concentrations of capital, new sources of venture capital, new investment intermediaries
  2. Growing venture capital investment especially in artificial intelligence, automotive/transportation, advanced robotics, and pharma/biotech
  3. Broadened geographic participation in venture capital, with emerging centers outside of traditional California and Northeast markets providing access to early stage deals for individual investors
  4. Information – more of it, more accessible, and more actionable

Let’s consider each of these broad themes in some depth.  (more…)

Internet of Things Startup Raises $3.1 million – Crain’s Article

Xaptum, founded by a UIC bioengineer, is tackling security for smartphones, sensors and other devices.

Rohit Pasam has been working on a way to make the internet of things safer, and he’s got another $3.1 million to do it.

His startup, Xaptum, has built a secure cloud that would keep devices, such as sensors and smartphones, from being hacked or being used to break into the closed networks to which they’re connected via the internet. VCapital, a venture fund operated by Len Batterson, led the round. Other investors include Illinois Ventures, as well as Purple Arch Ventures, Loud Capital, Hyde Park Angels and former U.S. Robotics executives Casey Cowell and Michael Seedman

Click here to view the full article by John Pletz in Crain’s

Artificial Intelligence and the Intelligent Investor

Artificial Intelligence (which we will shorthand as AI) is the rage of the venture capital industry. For the past decade, our industry’s mantra was “Software Eating the World. The new mantra is “Artificial Intelligence Consuming the World.”

Our mission here is to make sense of all this for investors. Just what is AI (or, for that matter, intelligence itself)? Where is it now? Where is it heading? What does all this mean for investors?

What is Intelligence?  How is it demonstrated?

Christopher Evans, in his illuminating book, The Micro Millennium (published in 1979 by the Viking Press), defined intelligence as “the ability of a system to adjust appropriately to a changing world.”  Our world is in constant change.  “The more capable a system is of adjusting — the more versatile its adjusting power – the more intelligent it is.” (more…)

Would You Like Some HONEST Investment Advice?

To be clear, neither of your authors is suggesting that you should invest a large share of your net worth in venture capital. It is inherently a high risk/high reward potential proposition. You shouldn’t invest more in venture capital than you can afford to lose without meaningfully changing your life.

If you are an accredited investor, and most venture capital firms limit their investor rosters to accredited investors due to the strict restrictions in dealing with those who are not accredited investors, you should be able to risk, say, 5% of your net worth without potentially jeopardizing your financial health and future. If you’re not an accredited investor, the SEC limits your venture capital investments anyway, precluding you from taking undue risks in this asset class.

. . . (But) aggregate returns for the (venture capital) asset class have historically been outstanding, and there’s no sign that will change anytime soon.

This is demonstrated well by the Thomson Reuters Venture Capital Research Index, launched in 2012 to replicate the venture capital industry as a whole. Based on that index, venture capital investment has on average returned 19.7% per year since 1996, notwithstanding the 2000 dot-com collapse, versus modest single-digit returns for traditional equities and bonds.

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What It Means to Be an Accredited Investor

The SEC defines an accredited investor as: (1) an individual or couple with net worth, excluding their primary residence, of at least $1 million; or (2) an individual with an income of at least $200,000, or a couple with an income of at least $300,000, for the past two years and with a reasonable expectation of that continuing.

Being an accredited investor means you are well-off . . . not necessarily super-wealthy, but you do have some financial discretion. It also means that you’re allowed to invest in asset classes like venture capital and other private securities that, until recently, non-accredited investors were not allowed to invest in. Recent regulatory developments from the SEC now allow individuals who have not attained accredited investor status to invest in venture capital as well, albeit in very limited amounts.

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Why Returns from Hedge Funds and Private Equity Lag Behind Venture Capital

By the way, if you think you can out-fox the market by hitching your wagon to the hedge fund and activist investor icons, think twice. So much has been written about activist hedge funds and their wealthy leaders – like Carl Icahn, William Ackman, and Barry Rosenstein – that you may have assumed these guys were winning big and that investors in their funds could feel confident of big gains.

Some of the activist hedge funds were big winners years ago, hence their founders’ personal fortunes. However, it looks like there may now be just too many dollars chasing not enough great ideas and so, of necessity when so many dollars flowed into their funds, some pretty questionable ideas received investment dollars too. As a result, these funds are not doing so great these days.

. . . Here’s more surprising disappointment. Private equity funds aren’t doing too well these days either. Based on a white paper published by the Center for Economic and Policy Research, private equity funds’ performance advantage relative to the S&P 500 has been shrinking in recent years.

. . . Again, the problem has become too much money chasing after too few good deals.

. . . Importantly, venture capital is the lifeblood of major, fundamental innovation, the key to substantive economic growth. Think about the big business success stories of the past dozen years – Microsoft, Alphabet, Facebook, etc. All were spawned by venture capital investment . . . and there are many more that have not yet gone public and are still operating on their own as well as ventures that were acquired by established companies who recognized and valued their growth potential. As a result, aggregate returns for the asset class have historically been outstanding, and there’s no sign that will change anytime soon.

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What It Takes to be a Successful Venture Capitalist

Successful venture capitalists have intuitive and analytical skills. They must be able to assemble and digest large amounts of data – some precise but some pretty vague and incomplete – and integrate all that information in order to make seriously consequential decisions.

. . . The venture capitalist must often be a skeptic, as he is likely to reject a hundred deal opportunities for every one in which he invests funds. He also must temper the optimistic fervor of the entrepreneur. That’s important at the start in order to negotiate a good deal and then later to foster the entrepreneur’s management discipline and ensure the entrepreneur recognizes key risks and addresses them thoughtfully.

. . . Importantly, the venture capitalist must be highly knowledgeable about business development. That means sometimes being a patient nurturer of growth, but at other times being the impatient, sharp prod pushing the entrepreneur. Most people involved in business creation create just one business in a lifetime; the venture capitalist is involved in building many.

The venture capitalist must be an astute strategist. The ventures in which he invests are inevitably on the cutting edge of markets and technologies, so often those ventures need to make sharp strategic turns as more is learned. The successful venture capitalist must be able to participate in driving the venture’s strategic path.

Perhaps surprisingly, the successful venture capitalist must sometimes display exceptional operating acumen as well. While in most cases the venture capitalist will not get heavily involved in portfolio companies’ day-to-day operations, there are times when the VC must step in, right an errant venture ship, and spearhead the turnaround of a venture that still has valuable potential but has lost its way.

There aren’t many individuals who have all these tendencies and skills.

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Why Institutions Love Venture Capital

On average (venture capital) returns are terrific. That’s why most sophisticated pensions and endowments have come to the conclusion that allocating a portion of their total portfolio to venture capital (and other private equity investments, particularly when private equity funds were doing better) makes sense. Yale University’s endowment, often held up as a standard of investment excellence, has generated nearly a 30% average annual return on its venture capital and private equity investments since 1973. Their commitment is so great that the university has invested in a large satellite campus, west of Yale’s hallowed downtown New Haven, Connecticut campus, dedicated largely to scientific and technological research, has actively fostered entrepreneurial development in in its graduate business school, and has invested with thriving venture capital firms which have sprouted right in New Haven.

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