When it comes to investing, I like to imagine dudes in Patagonia vests sitting in a packed floor on the 72nd story of a Wall Street investment empire, frantically monitoring the 10 screens in front of each of them while calling their clients. It’s a career that, in many people’s perspectives, seems wildly unattainable — such that you need a degree in Business or Economics just to get started. You might think that you need decades of experience just to learn how to make your money grow for itself. You might think that you need decades of studying the trades of the best investors just to understand the overly complex terminology that they throw around. You might give up, thinking that investment isn’t for you because you don’t have the necessary background to get started.
I’m here to tell you that this is not so. We’re going to spend today breaking down the world of investing and focusing on a specific sector that has been wildly gaining popularity today — Venture Capital.
Venture Capital, whether we realize it or not, has had long-lasting effects on our modern lives: virtually any piece of modern technology, be it hardware or software, was likely funded using money from Venture Capitalists. Think of the payment systems you use at cash registers. Think of SpaceX’s reusable rockets. Think of the social media apps you use and the algorithms that enable machines to understand us. All of these exist today because of Venture Capital — money that is invested in ventures dedicated to innovating the future of the world through technology.
But, to understand what Venture Capital really is, we need to understand the difference between Public Equity and Private Equity.
You might not have heard the term Public Equity before, but you’ve almost certainly heard of the stock market, a virtual entity that enables you to trade stocks, which all represent “shares,” or percentages of companies. But upon inspecting the stock market, you might have wondered why you can only buy shares of certain companies — that is, those that are listed in the stock market.
Companies that are listed in the stock market are considered Public Companies, and they’re named so because anybody can go to the stock market and buy a share of these companies. We therefore define Public Equity as shares of public companies — anybody who owns shares of public companies are said to own Public Equity. There’s no need to be an accredited investor (a fancy way of saying that you must have a net worth of at least $1M or income exceeding $200K annually) to invest in these companies; furthermore, it’s not just people — governments and other corporations play a major role in investing in this particular asset class.
There’s one very important thing to know about Public Equity though! It is absolutely illegal for people to do insider trading with Public Companies — that is, you are making your investment decisions based on information you know about the company that is not public. Many, many people have gotten in trouble with the SEC for engaging in insider trading — don’t do it.
Now that we understand what Public Equity is, we can easily define Private Equity to be the opposite of Public Equity. Private Equity is simply investments made into Private Companies — that is, companies that are not traded on Public Exchanges.
“But wait,” you might be asking: “How can I make an investment into private companies when the only shares of companies that I can own are from public companies?”
You can own shares of private companies in the exact same way that you can own public shares of companies: the only difference is that you can’t buy those shares directly through the stock market — you’ll have to find a different path. These paths can include being an investor at a Venture Capital firm, at a Private Equity firm, becoming an angel investor, and the like. There are many more ways by which private equity investments can be made, but for the purposes of this article we’ll focus primarily on a new and rapidly growing subset of private equity: Venture Capital.
Virtually all venture-backed startups begin their lives as Private Companies, and when they grow big enough and want to raise a significant amount of capital to expand their operations, they will raise the money from the public instead of investment firms by listing their company on the stock exchange and conducting an Initial Public Offering (IPO) — which sells shares of the company to the public and invests the resulting capital within itself. Generally speaking — if you have listed your company on a stock exchange, you aren’t considered to be a startup anymore!
Let’s play a game: On your birthday you receive a present from a mysterious figure — a check of one million dollars! Now, the world is your oyster. What will you invest the money in? Feel free to be as creative as you want!
A few examples of Private Equities:
Flying cars. Let’s say that I want to invest in flying cars. If I was to be making flying cars in my garage, then my investment could be considered a form of private equity — I own what I work on, and nobody can buy a share of the work I did from me.
Commercial Real Estate — you obviously cannot buy real estate on the stock exchange. In fact, anything that is not publicly tradable can be considered a private asset.
As an investor, your role is to define yourself by the asset class that you invest in. If you only invest in the startup asset class, you can call yourself a venture capitalist. If you invest in larger private equities through institutionalized trading firms, you can call yourself an LBO/PE investor. If you are investing in real estate, you are a real estate investor.
As an investor, you might play in our little circle of competency, because what would life be without competition? To make sure that you are a better investor in the specific asset class you specialize in, you want to show that you can use your deeper knowledge to make decisions that will net you higher returns. This is the underlying principle of Market Alpha, which we will discuss in-depth in the next lesson.
It’s really important to realize that as an investor, you NEVER box yourself in! The best investing firms have specific branches where they look at a plethora of distinct asset classes, and as an investor, you might have to reinvent yourself multiple times over as you dabble with all the types of asset classes that you can play with. The best investors often need to break down this “superiority complex of investing” in order to see truly where the opportunities lie.
As an example of this principle, let’s take a look at the origins of my firm, Romulus Capital. We started out as a generalist firm, with the primary aim to be the lead investor (the investor that often contributes the highest share of capital and has the most say in decision-making) of all the companies we invest in. This resulted in our portfolio being full of companies from a myriad of industries — though the ones that were represented the most were consumer-targeting, commercialization-of-science companies in healthcare or “unsexy” industries like Agriculture and Real Estate Tech. After discovering and understanding the tremendous opportunities that lay in digitization of the Construction Industry, we jumped ship a couple of years ago and have been investing primarily in Construction ever since — more on our jump to Construction Tech later! Needless to say, while it’s been a huge challenge to have our focus shift from generalist investing to sector-specific investing, it’s also one of the most thrilling journeys we’ve ever been on.
What are some of the pros and cons of playing in either the Private or Public equity spaces?
On the public side, you have access to all the information about a company that has ever existed (barring trade secrets and other confidential documents, of course). Some examples of the documents that you’ll be able to access include a comprehensive trade record of earnings, revenue, etc. This allows for higher predictability in terms of growth, which is instrumental for investors who are making a decision of whether or not to invest in this company.
On the private side, you can’t see any of this information from the outside at all. Investors usually gain access to some of these documents through a data room during the due diligence process, but in most cases (and this is ESPECIALLY true for very early stage companies), other criteria will be employed to judge the feasibility of an investment.
Now that we understand the pros and cons of investing in public and private equities, how would we gain a competitive edge against the market, otherwise known as the Alpha, in Private Equity? Gaining market alpha as an investor is equivalent to “beating the market” in the world of Public Equity, and we need to learn how to leverage the information available in front of us, use them to form inferences about what we are seeing, and use these inferences to create a sound prediction and opinion: What load options are available to you? What red flags, validations, and disproofs could your due diligence raise? What is the revenue that the company will obtain and how big can they grow? How will you predict the income curve? At the end of the day, your role as a money manager is to convince the higher-ups — those who actually own the capital — that a particular company or technology is worth investing in.