How to Invest Like a Venture Capitalist

Venture capitalists, those who risk funding relatively young companies, can easily lose money in most of their investments. As venture capitalist Paul Graham writes, "effectively all the returns are concentrated in a few big winners." But those winners can be huge. Take Accel Partners, which invested $12.7 million in Facebook (Nasdaq: FB  ) in 2005. The IPO netted the venture firm $2.2 billion, well over a 10,000% return, and afterward it still owned a hefty amount of the company.

How can you emulate these risky, but sometimes extremely rewarding investors?

Different tenets of different investing
Paul Graham also says that he backs founders over ideas, meaning the people behind the idea matter more than the idea itself:

Ideas are just indicative of how the founders can think. We look for relentlessly resourceful people. That combination is key. Relentlessness alone is useful. You can relentlessly just bang your head against the wall. It's better to be relentless in your search for a door, and then resourcefully walk through it.

Obviously, this approach to looking for investments is the opposite of what someone like Peter Lynch advocates when he says, "I like buying companies that can be run by monkeys -- because one day they will be." This highlights a few key differences if you want to invest like a venture capitalist. Whereas long-term investors like Warren Buffett preach that their favorite holding period is forever, venture capitalists cash out once a company gears down its growth. And whereas you could invest in a stable, dividend-paying business that a monkey can run, you can also take more risk by betting on the right leadership while the underlying business may need work.

What kind of leadership?
The qualities you should look for include integrity, honesty, and an ability to solve customers' problems. And while it's easy to rattle off a list, let's look at some real leaders to get a better idea of what to look for.

Pivoting on a disc
You may have heard that Reed Hastings, CEO of Netflix (Nasdaq: NFLX  ) , came up with the idea of a DVD-by-mail service after getting dinged by a $40 late fee from the traditional movie rental option. You may not have known that before Netflix, Hastings made $75 million after selling a software troubleshooting company. Hastings has a history of creating solutions for customers, albeit with some setbacks along the way. The important thing is that he's honest about the difficulties.

He began Netflix by charging per disc rented, then pivoted to a subscription service. Then he pivoted the company to streaming movies, and tried to pivot too far by splitting the mail and streaming businesses. Netflix once was worth over $15 billion, and now sits with a market cap of a little above $3 billion. If Hastings lives up to his history and pivots correctly again, the risk of Netflix could be well worth the future reward.

Money, cars, space
Another visionary CEO with a track record for success is Elon Musk, former PayPal founder and now CEO of Tesla Motors (Nasdaq: TSLA  ) and SpaceX. Musk also isn't afraid to tell the truth about his business. In a recent Autoblog interview, Musk explained how Tesla was so close to bankruptcy in 2008 that he had to invest so much of his own money that he had to borrow money for rent. After a story like that, which describes the negative, it's easier to believe in the positive side that Musk gives -- like how the company should be able to reach cash-flow breakeven with no extra funding, and how the company aims with its products to achieve three hours of driving with only 30 minutes of charging.

A new job market
Another PayPal alum, who left after it was acquired by eBay (Nasdaq: EBAY  ) in 2002, is LinkedIn (NYSE: LNKD  ) founder Reid Hoffman. Hoffman, who made $111 million on a $37,500 investment in Facebook, took the idea of a social network to the workplace. Hoffman adds another possible asset of a good leader: their professional network. As Hoffman told NPR, "Part of the reason I think there's been such success from the PayPal crew has been that we were all really intensely helping each other with all of these classic entrepreneurial problems."

Investing in leaders
You can start to find out more about the leaders of public companies through a company's proxy filings, and I highly recommend you do that for every stock you own or consider. Even if monkeys can run a company, you shouldn't trust those monkeys with your money. Take a note from venture capitalists, and look for the type of leadership represented by the above founders.

If you wonder what Reed Hastings needs to do to turn around Netflix, or even whether he can, get your copy of our new premium report that details the threats and opportunities Netflix must address to succeed, along with a free full year of updates from our top analysts. Click here to learn more now.

Fool contributor Dan Newman probably should've answered Zuckerberg's call in 2004. He owns shares of eBay, but does not hold shares of any of the other above companies. Follow him @TMFHelloNewman.

The Motley Fool owns shares of Facebook, Netflix, Tesla Motors, and LinkedIn. Motley Fool newsletter services have recommended buying shares of Tesla Motors, Facebook, Netflix, eBay, and LinkedIn, as well as creating a bear put ladder position in Netflix. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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  • Report this Comment On September 18, 2012, at 4:22 PM, kahunacfa wrote:

    I invest like a Venture Capitalist because I AM a Venture Capitalist. -- Specifically, a Venture Capital Portfolio Manager since January 1977.

    Early days VC investments: Amdahl Corporation(AMDH, bought by a Japanese Computer Company), Amgen(AMGN), Genentech(GENE, DNA, bought out by a foreign Big Pharma Company. More recent VC investments: Inhale Tehreupedics(INHL. bought by Eli Lilly), Nextel(NXTL, bought by Sprint), PetsMart(PETM), and Google(GOOG).

    Last Venture Capital portfolio retirned 58.4% compounded <Audited> over 1992 - 1995. inclusive.

    Kahuna, CFA

    Venture Capital

    Founding General

    Partner 2012 - 2019

    Kailua-Kona 96745

  • Report this Comment On December 17, 2013, at 11:10 AM, tgpsillas wrote:

    I am the author of Millionaire Boot Camp, sold on Amazon.com, with over 100,000 copies sold. I am not a billionaire yet, but reaching for the stars.

    I am the fund manager for Dolphin Venture Fund I, LP. www.dolphinventurefund.com

    Venture Capital Funds have done poorly over the last ten years. Many investors have pulled out of that market. Guess what? Those that are getting in now are poised to profit the most over the next 10 years.

    It is obvious the global economy tanked. This is the deleveraging that Ray Dalio, manager of Bridgewater Hedge Fund in Westport CT talks about. Now, the country is poised for growth, not destructions, as many doomsdayers will lead you to believe.

    Even I fell in the trap. I agree with Mr. Dalio, that the USA is headed for enormous growth over the next 10 years. We will beat out China and all the other hyped economies. Why?

    It is all about demographics. The next generation to be larger than the 70 Million Baby Boomers, is about to come into the mainstream, with over 100 million millenials.

    When you have such as large demographic, you have 2 things: More Workers and more consumers. Millions of new jobs will be created. The millenials will be in a position to take on these new jobs, due to their better knowledge of the Internet and other newer technologies. The know gadgets well, whereas baby boomwers struggle with gadgets.

    As a babyboomer, I struggled to figure out what the new consumer wants. They do not use the Yellow Pages; they use Google.

    To that end, I have designed the Dolphin Venture Fund to take advantage of these demographics; investing in upcoming trends in US and global markets.

    Who said Greece is a bad investment? Hedge Funds have already made a killing in Greece in 2012-2013, while the rest of investors put their head in the sand.

    It is this mentality that Dolphin Venture Fund uses to return 12%-34% annual returns to its investors.

    I have learned alot from the most succesful Hedge Fund Manager in the world: Ray Dalio. I am putting his principles to work to create an even better fund.

    Business ventures are paying 60% interest on merchant cash advance loans. Hedge Funds are funding these cash advance companies. Payday loan companies are funded the same way.

    These companies get investment from Hedge and Venture Funds; borrow additional funds from banks and return astronomical returns to the Funds that invested in them.

    There are numerous proven concepts out there with excellent management that need the right funding. We are ready to fund them as capital is available.

    It took having the right team of advisors. Lou Markopolos, my cousin, works with Family Offices around the country. Others, like Ray Dalio, are inspiring me to invest in the right companies at the right time.

    The time is now for growth, with the recession behind us. Get to work doing your research and investing correctly.

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