Growthink Blog

The Early Exit


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The next big private equity investment idea is the “Early Exit.” The best articulation of it comes from Basil Peters, a serial technology entrepreneur, co-Founder of Nexus Engineering, former Canada Entrepreneur of the Year, and Managing Partner at 3 venture capital funds – Fundamental Technologies I and II and the BC Advantage Funds. His blog is one of the best resources on technology investing out there.

Aptly to the point, Basil is the author of a great new book – “Early Exits: Exit Strategies for Entrepreneurs and Angel Investors.” His core thesis is that successful private equity investing is now driven by quickly getting to the smaller investment exit.  Or, as he says it, "Today, the optimum financial strategy for most technology entrepreneurs is to raise money from angels and plan for an early exit to a large company in just a few years for under $30 million."

I love this strategy because it is realistically attainable for the individual investor. Here's why:

You, Mr. or Ms. Main Street Investor, are NOT getting a piece of the next big IPO: The 2 best known venture capital funds –Sequoia Capital and Kleiner Perkins - because of their reputations and massive bankrolls – will continue to get the lion’s share of the deals with rockstar IPO potential. Try these names on for size – Electronic Arts, Apple, Google, NVIDIA, Rackspace, Yahoo!, Paypal, Amazon.com, America Online, Intuit, Macromedia, Netscape, Sun Microsystems.
They were all Sequoia and/or Kleiner investments that became mega-successful IPOs. To give a feel for the power of their investment model, estimates are that Kleiner’s investment in Amazon scored returns of 55,000%!

YOUR big problem – your friendly neighborhood stockbroker (if they exist anymore) isn’t getting you in on any of these deals anytime soon.  And if you don’t have a $100 million bankroll and the very right connections to become a Kleiner or Sequoia LP, you’re not joining their club.

Hit’em Where They Ain't:
The size of most modern venture capital funds has increased, with the average sized fund now having more than $160 million under management. As a result, the vast majority of professional investors simply can’t and won’t invest in smaller deals. The new VC model has, for better or for worse, become “Go big or go home.” As such, competition for smaller deals is much less and the deal pricing on them far more favorable.

Small Deals Rock:
You don’t need a lot of money anymore to build a technology startup – not with outsourcing, viral marketing, and the Software as a Service (SaaS) revolution. And if your business isn’t cash flow positive REAL FAST, you probably don’t have a very good business.

So the new technology investment model is to place small amounts (under $1 million) into companies that a) develop intellectual property and compete in markets with lots of active strategic acquirers (think Internet, software, biotechnology, digital media, and energy) and b) have management with the mindset and track records to ramp-up and exit FAST and at very attractive but not pie-in-the sky multiples. 

Not a game that big private equity or venture capitalists are interested in playing because it is just too hard to put large amounts of money to work in such a fragmented marketplace.
But if done right, an EXTREMELY lucrative one for thoughtful entrepreneurs and the investors that back them.


Here Comes The Sun


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In my role as the CEO of Growthink, I get asked variants of the same questions a lot, namely:  "What do you think about this economy?”  “Do you see things turning around?” “Are there any deals getting done out there?”  I answer these questions based on a number of factors:

  • How is the Dow Jones Doing?  While the performance of the index of the 30 biggest industrial companies is no way near as indicative of the health of the U.S. economy as is popularly imagined, it has enormous psychological importance.  While still massively off its highs, the trickle-down benefits of the market moving to its current 8,300 level from its March 9th low of 6,440 (an uptick of 29%) cannot be overstated.  If we can see the rally continue to the 10,000 level by the end-of-the-year, we can declare this recession officially over.

  • How is Consumer Confidence?   The Conference Board’s Consumer Confidence Index this month jumped to an 8-month high in May, spiking from a 40.8 level in April to 54.9.  The index had hits its lowest level in February (25.3) since tracking began in 1967.  As Lynn Franco, the Conference Board's research director, said "While confidence is still weak by historical standards, as far as consumers are concerned, the worst is now behind us.”

  • What is The Level of Venture Capital Funding Activity?  Venture capital funding activity in the 1st quarter of 2009 hit its lowest level since 1997, with venture capitalists investing just $3.0 billion in 549 deals (National Venture Capital Funding Association).  Signs are very strong that the 2nd quarter will be appreciably better, with the buzz created by the $10 billion valuation on a $200 million investment in Facebook by a Russian investment firm adding significant buoyancy to the overall emerging technology company arena.

  • How is the IPO Market Trending? The successful IPOs of venture capital-backed companies OpenTable, the online restaurant reservation service, and SolarWinds, a network software company are contributing long-awaited liquidity and bull market sentiment to the long-suffering IPO market.  Big valuations and big money being made by early investors in deals like this is what angel and venture capital investing are all about – so see more IPOs like these coming down the pike in the near future (Twitter and LinkedIn, anyone?)

  • How is Growthink Doing?  Because as a firm we touch so many entrepreneurs and angel investors every day, our business and investment activity has historically been a very good leading indicator of overall economic activity and equity investment performance.  And after going through the most challenging 6 months in the history of the company from September through March, business has picked up significantly. May 2009 already has been Growthink's best revenue month since last summer, and our deal pipeline is right now the strongest it has been since late 2007.

 

What does this all sum up to?  The Beatles say it much better than I ever could:

Little darling, it's been a long cold lonely winter
Little darling, it feels like years since it's been here
Here comes the sun, here comes the sun
and I say it's all right


The Future IS Ours To See


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"Those who cannot remember the past are condemned to repeat it" - George Santayana

The financial panic of 1873, which set off a severe nationwide economic depression that lasted for 6 years, included The New York Stock Exchange closing for 10 days, 89 of the country's 364 railroads going bankrupt, and unemployment as high as 14%.  During this extremely challenging time, a gentleman by the name of Thomas Edison started a company called General Electric. You may have heard of both of them.

The Great Depression of the 1930's is even scarier in statistics than in legend.  Industrial production fell by 45% between 1929 and 1932. Homebuilding dropped by 80%. 1,000 of the nation's 25,000 banks failed. US GDP fell by 30%. 

And during these dark days, DuPont created new products and indsutries including rayon, enamels, and cellulose film. RCA invented television.  And a little company called IBM started pouring research dollars into something called the computer.

The 1970's are commonly remembered as a dark period for American finance and business - stagflation, negative stock market returns for the decade, and hits to the national psyche including Vietnam, Watergate, and the Hostage Crisis.  It was also the era that 2 ambitious and visionary young men named Bill Gates and Steve Jobs got their start.

My 20 years in angel investing, small business and entrepreneurship have taught me to separate the world into two kinds of people: Those that comment and complain on how things are and those that do something about it.

Unluckily for all of us, television and the always on Internet give those that comment and complain bigger megaphones than ever to spread their false prophesies of doom. It is only human nature to be affected, depressed, and even scared by their strident negativity.

Very, very luckily for all of us, however, there always be budding Bill Gates and Steve Jobs and Thomas Edisons and Thomas J. Watsons amongst us. And where are these future shining stars devoting their prodigious energies to these days? I promise you that most of them aren't working at General Motors, nor are they drawn to politics or working in the public sector, nor to non-profits.

No, they are capitalists. They are entrepreneurs.  They start and work at Internet companies, they research alternative energy technologies they discover new drugs to make us all live longer and healthier lives. They are and they discover Black Swans.  They - in the words of Voltaire - make "life throb to a swifter, stronger beat."  

And you know what else? They're in it for the money. They want to build companies like Pure Digital (makers of the FlipCam) did and sell out to Cisco Systems for $590 million.  Or Facebook, on the verge of a public offering that will make its early investors billions. Or Integreon, whose business plan was perfected in a small Growthink conference room 10 years ago, and is now the largest legal outsourcing firm in the world (and saving a lot of folks a lot of money on their legal bills).  

With apologies to Doris Day, the future is in fact ours to see. As long as little boys and girls are raised to grow up to do something great with their lives, progress will march on.  Technologies will be commercialized.  New industries will arise.  Companies will be born and will grow and grow and grow. Fortunes will be made.  

The question, of course, is what will be in it for you? Will you be on the couch with the critics? Or will you be in the game with the builders and the doers?


These Truths About Angel Investing Will Surprise You


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Scott Shane, one of the world's most respected statisticians regarding entrepreneurship and angel investing, has a new book out - "Fools Gold? The Truth Behind Angel Investing in America."  It is without question the finest compilation of statistics and cold, hard facts regarding the REALITIES - as opposed to the myths - of the keys to successful angel and emerging company investing.  Some amazing statistical nuggets from Scott's book:

  • The book's 12 chapters have a combined 692 source references!  Compare this to the average "this is what I think with absolutely no basis in numbers" opinions that pass for wisdom on CNBC, on the world of Internet financial blogs, and from your friendly neighborhood financial advisor
  • Average portfolio return for angel investors participating in organized angel groups: 27% annual return (quoting this study)
  • Return expectation per deal for investments by successful angels: 30x
  • Proportion of business angels that expect a 10 times or better return: 45.4% (what they actually get is another matter...)
  • Number of companies founded each year that achieve $10 million or more in sales in 6 years: 3,608
  • Number of companies founded each year that achieve $100 million or more in sales in 6 years: 175
  • Share of drug start-ups that go public: 20.3%
  • Portion of venture capital dollars invested in the top five industries for venture capital: computer hardware, software/Internet, semiconductors and other electronics, communication (including mobile) and biotechnology - 81%
  • Top reasons why people invest in private companies:  To make money (obviously), to learn new things, to pay it forward
  • Number of companies financed by business angels in a typical year: 50,700-57,300
  • Amount invested by business angels in a typical year: $23 billion
  • % of Angel Investors with net worths of LESS than $1 million: 66.7% (really an amazing statistic as the SEC definition of an accredited investor is a person with a net worth of greater than $1 million)
  • 45 to 54 - Age range with the highest odds of making angel investments - disputes the myth that most angel investor are retired
  • Proportion of angel investments that involve co-investment with VCs - less than 1.1 percent
  • Proportion of angel investments made in retail and personal service businesses - 37.5 percent.  (Note: If you just make a rule to NOT invest in these 2 areas, your probability of emerging company investing success goes up dramatically)


As working with and investing in entrepreneurial companies is my life's work, I read this book extremely closely and found it both invigorating and challenging.  Invigorating in that it confirmed, with statistics, the superiority of private company investment returns vis a vis all other investment classes.  And frustrating in that it starkly outlines the very basic mistakes that most private company investors make over and over again that prevent them from being a successful investor in this asset class.

My overall takeaway: If you want to invest in private company deals, only do so via one of two avenues: 1) Via a GOOD angel investment group like The Band of Angels or the Tech Coast Angels (if you can get in) or via a managed portfolio approach such as a private equity or venture capital fund targeted toward the space or via a hybrid, operational approach like Growthink.


Obama Stimulus Package Stimulates Renewable Energies Across the Nation


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While you probably have heard about the Stimulus Package and President Barack Obama’s push toward increased usage of renewable energies, you may not be aware of how this initiative can help your business and where the money is in fact going. The following information will explore the specific allocations of the Energy Stimulus and how you, as a business or as a consumer, can take advantage of this unique opportunity.

One of the most significant components of the $787.2 billion stimulus package signed into effect by President Obama in February 2009 is the initiative to spur development of “Clean, Efficient, American Energy”.  Of the total sum, more than $30 billion will be allocated to transforming the nation’s energy transmission, distribution, and production systems by improving grid design and investing in renewable energy and another $5 billion will be spent on home weatherization. The energy component of the initiative is aimed at reducing the country’s dependence on fossil fuels, spurring innovation, and creating jobs nationwide.

The following outlines the specific initiatives the energy stimulus money will be dispersed to:

  • Improvement of Electricity Grid Design - $11 billion to build new power lines and deliver renewable energy
  • Grants for Local Governments - $6.3 billion to state and local governments to reduce carbon emissions in their localities
  • Renewable Energy Loans - $6 billion for funding renewable energy projects
  • Home Weatherization – Weatherization is the process of protecting a structure’s interior from the exterior elements and improving interior energy consumption efficiency through highly effective insulation. The government has allotted $5 billion to lower income housing
  • Eco-Friendly Government Buildings - $4.5 billion to make government buildings more energy efficient
  • Fossil Energy Cleanup - $3.4 billion for carbon capture technology development
  • Green Research – $2.5 billion in grants for universities, companies, and national laboratories that will demonstrate advancements in technology to foster energy independence
  • Advanced Battery Grants - $2 billion to spur development of advanced vehicle and other battery systems
  • Green Job Training - $500 million to train workers in the green energy sector
  • Electric Transportation - $400 million in grants to develop electric vehicles
  • Smart Appliances - $300 million in customer rebates for the purchase of energy efficient appliances
  • Federal Vehicles - $300 million to replace or retrofit government vehicles to use renewable energies
  • Department of Defense - $300 million to develop more energy efficient military equipment and bases
  • Local Transportation - $300 million to local governments to purchase buses and trucks that use alternative fuels, and $300 million to replace or retrofit vehicles that use diesel fuels
  • Energy Efficient Housing - $250 million to increase energy efficiency in homes, particularly low-income housing

Historically, companies have been reluctant to invest in renewable and clean energy technologies, because they require tremendous economies of scale to be profitable. Since these systems require large capital outlays upfront, it takes a long time to see return on investment. The Stimulus Package aims to combat these hesitations toward switching to renewable energy systems. The initiative will benefit various members of the energy sector from large utility companies upgrading energy grids to small businesses installing solar panels. It also benefits end consumers striving to make their homes more energy efficient through tax breaks and government subsidies.

Federal Involvement will Spur Investment, Growth, and Job Creation

The influence of government grants, loans, and tax breaks, will help encourage progress for both the supply and demand side of this sector. On the supply side, the government will provide research grants and funds for investing in promising existing and new technologies. On the demand side, the Stimulus Package will help companies and homeowners purchase new green energy systems by making them more affordable. The Stimulus Package will also create thousands of new jobs across the nation fulfilling these initiatives, helping to fuel unemployment and the overall status of the economy. According to Nancy Pelosi, investment in the green sector will create close to 500,000 jobs in 2009, 67,000 of which will be in the solar and wind power installation sector. Ultimately, the energy portion of the stimulus package will reduce American reliance on foreign nations for fossil fuels, generate domestic jobs, and promote innovation and adoption of new renewable energy technologies nationwide.

Access to the Allotted Funds

Whereas other areas of the stimulus package will be distributed through company applications and competitions to receive the funds, the money attributed to the energy sector will be primarily dispersed through tax credits and purchase incentives. For example, within solar and wind energy, the government is now offering a 30% tax credit to offset the cost of installing a solar energy system or wind farm, whereas previously the tax credits had a cap of $2,000 and $4,000, respectively. Some additional credits include up to $7,500 for buying a plug-in hybrid electric car or a 50% tax credit for gas stations or other businesses that install alternative fueling pumps. For more information on the specific types of grants or tax credits offered, please find more information at the following website: http://www.greentechmedia.com/articles/obama-signs-stimulus-package-5736.html.

So What Does This Mean for You?

Energy Companies

If you are involved in the clean energy sector, Growthink recommends additional research into the specific provisions of the stimulus to see if your business will qualify for federal subsidies or research grants. Additionally, Growthink suggests putting together a strong marketing campaign that highlights government support and tax credits for purchasing your products. This will educate the many unaware businesses and consumers that believe switching to alternative energies is outside of their affordability. Additionally, it is a wonderful way to draw positive publicity for your business. Growthink is happy to provide you with complimentary feedback on your current marketing program. We can also assist you by utilizing our expert group of marketing professionals to work with you on creating a Marketing Plan to target your customers in the most effective way possible.

Contracting, Construction, Eco-Friendly Transportation, and Electrical Infrastructure Companies

If you own a contracting, construction, eco-friendly transportation, or electrical infrastructure company, Growthink recommends seeking additional information on how you may bid for funds allocated to electricity grid design, weatherization, environmentally friendly transportation development, energy efficient housing, and building renovations. Growthink can help you with conducting this research and help articulate how your business is the most suited to perform the specified work or receive a government grant.

Consumers

As a consumer, you can reap the benefits of the energy sector stimulus by utilizing the tax incentives to switch to renewable energy systems, such as installation of a solar or wind energy system in your home. The government is also offering customer rebates for those who purchase energy efficient appliances for their homes.

The Obama Stimulus Plan is an unprecedented program that has created unique opportunities for tremendous innovation and growth within energy efficiency. Please contact Growthink for more information on how we can help you position your company to benefit from the billions of dollars allocated to this sector and within your reach.


Where to Find Alpha


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Adobe. Akamai. Amazon. Amgen. Apple. Baidu. Bed Bath & Beyond. Biogen. Broadcom. Check Point. Cintas. Cisco. Citrix Systems. Dell. eBay. Electronic Arts. First Solar. Flextronics. Garmin. Genzyme. Gilead Sciences. Google. Hansen Natural. Infosys Technologies. Intuit. Juniper Networks. Logitech. Maxim Integrated Products. Microsoft. NVIDIA. Oracle. Paychex. QUALCOMM. Research in Motion. Seagate Technology. Sigma-Aldrich. Starbucks. Symantec. Urban Outfitters. VeriSign. Xilinx. Yahoo!

What do these companies have in common? Their stocks are all components of the NASDAQ 100 – the “biggest and the best” of the mostly technology-focused companies that make up the overall NASDAQ Composite Index.

Quite simply, this is a list of some of the most dynamic, most innovative, most technological, most forward-thinking, highest “IQ” companies on the face of the earth.

And know what else? If you had been invested in any relevant basket of these stocks in the last ten years, your investment returns would have been HORRIFIC. Here are some sample returns:

In the period from January 1st, 1999 to December 31, 2008, the overall NASDAQ composite index went from 2,192.69 to 1,577.03, or a 10-year return of MINUS 28.1%. Microsoft, down -45%, Yahoo down 71%, Akamai down 86%. Even the winners haven’t down all that hot – Starbucks up only 18% for the decade. Electronic Arts – riding the global gaming wave – up a pretty mediocre 52% for the whole decade.

So the obvious question is - what is going on here? The companies on this list have certainly been innovating and growing these last 10 years. And the #’s here are not overly distorted by the bubble of 1999-2000 and the great crash of 2008. If you normalize for these two factors, the numbers are somewhat better, but still no way NEAR the mid-teens annualized returns that the mutual fund and insurance industries would like you to believe you will get via a standard basket of public stocks investment approach.

Like Mickey Rourke’s character in “The Wrestler,” the stock-picking industry can’t keep themselves from talking about their glory days of the 1980’s and 1990’s. These two decades saw consistent double-digit broad public stock market returns.  In those days, making good, and sometimes great returns, was as simple and easy as buying virtually any index or broad-based market index fund. To illustrate this, let’s look at the NASDAQ return by decade:

  • In the period from January 1st, 1979 to December 31, 1988, the NASDAQ returned 223%. And in 6 years during this 10-year period, the index returned greater than 14% annual returns.
  • In the period from January 1st, 1989 to December 31, 1998, the NASDAQ returned a whopping 475%. And in 8 years during this 10-year period, the index returned greater than 14% annual returns.
  • In the period from January 1st, 1999 to December 31, 2008, again the index returned a depressing -28.1%, with only 2 years (1999 – with a whopping 85.1% and 2003 with 50.01%) returning greater than 14%.


What is interesting, however, was that the last 10 years – the “00’s” – were far, far from a lost decade for the professionals. In fact, while the Main Street investors were left holding the bag, the hedge fund and private equity businesses boomed. Little and sometimes well-known money managers like Bruce Kovner, Edward Lampert, Eric Mindich, George Soros, James Simons, Louis Bacon, Marc Lasry, Paul Tudor Jones, Ray Dalio, Stephen Feinberg, Stephen Schwarzman, Steve Cohen, Steve Mandel, T. Boone Pickens and William Browder earned personal compensation packages that regularly exceeded 10 figures – as in billions of dollars of earnings. And to make it even more of a kick, when the bottom fell out these last 6 months, they didn’t have to give back all of the money they had personally earned over those years. No, conveniently those losses were born by a combination of their investors and the American taxpayer. Nice gig if you can get it.

So what does this all ad up to? A few action points:

  1. NASDAQ market investing is NOT emerging company investing. By the time these companies earn the kind of attention, trading volume, and brand to be NASDAQ-listed, it is simply too late to make breakout returns investing in them. 20 years ago, maybe. But today the combination of free-flowing information sharing in these stocks and having to compete with huge hedge fund players like the above, you don’t stand a chance.
  2. As the famed batsmen Wee Willie Keeler once said about his hitting prowess, I just “hit ’em where they aint.” To make any investment return beyond the averages, you have to fish where the sharks above aren’t. You won’t beat them and unless you have $10 million liquid, you don’t have enough money to join them.
  3. Luckily there is a MASSIVE investing arena where a) the big guys aren’t and b) where market efficiencies haven’t sucked out all of the opportunity for alpha return. It is, of course, the emerging and distressed private company sector. Most of the deal sizes here are simply too small for the big institutional players (hard to put a $1 billion to work in an owner-operated private company). And if you work hard and know where to look, you can exploit a LOT of market inefficiency and find those wrinkles of alpha return that will transform your portfolio.

What is an Emerging Company?


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Over the years, descriptions, or "boxes," for various type of privately-held companies like "middle market," "venture-backed," "startups," "small and medium-sized enterprises (SME's)," to name a few, have been tossed around so much as to obscure and confuse their original meaning and intent.

This is highly unfortunate, as it creates opaqueness and inefficiency in an asset class already plagued with too much of both.

Let's leave the official classifications aside for now and focus on developing an identification process for the kinds of private companies that are worthwhile for the growth investor to consider for their portfolio.

At Growthink the catch-all term we use for the private companies we like best is "emerging." It does not suffer from "commentary fatigue" as do private equity and venture capital, and it effectively carves out the large mass of startups and small businesses destined to stay small.

Webster defines "emerging" as follows:

1. To rise from an obscure or inferior position or condition
2. To rise from or to come out into view
3. To become manifest
4. To come into being through evolution

Let's elaborate on these definitions in the context of an investable company.

1. To Rise From an Obscure or Inferior Position or Condition: Emerging companies are, in their most common and interesting form, small and obscure. Microsoft and Google were once just a small group of programmers and were deep under-the-radar. And if you were invested in them then, your life changed dramatically for the better as they emerged. Less famously but still extremely lucrative were companies like the below that emerged to significant exits for themselves and their investors:
  • About.com: acquired for $410 million by the New York Times
  • Advertising.com: acquired for $435 million by AOL Time Warner
  • Affinity Labs: acquired for $61 million by Monster Worldwide
  • AllBusiness.com: acquired for $55 million by Dun & Bradstreet
  • Aruba Networks: IPO at a $1 billion valuation
  • Club Penguin: acquired for $350 million cash (and possible $350 million earnout) by Disney
  • FraudSciences: acquired for $169 million by PayPal
  • Glu Mobile: IPO at a $371 million valuation
  • Last.fm: acquired for $280 million by CBS
  • Mellanox Technologies: IPO at a $579 million valuation
  • Orbital Data Corp.: acquired for $50 million by Citrix Systems
  • Overture: acquired for $1.63 billion by Yahoo!
  • Photobucket: acquired for $300 million by Fox Interactive Media
  • Speedera Networks: acquired for $130 million by Akamai
  • Skype: acquired for $2.6 billion by eBay
  • The Generations Network: acquired for $300 million by Spectrum Equity Investors

2. To Rise From or To Come Into View: Emerging companies are often ones that have fallen on hard times and are seeking to "rise from" their current distress via turning around and restructuring their businesses. The banking and real estate sectors are right now treasure troves of fantastic distress and turnaround opportunities, as are arenas like publishing and the automotive industry.  As adversity intensifies, so does emerging opportunity.

3. To Become Manifest: Here we need Webster's help again - to become manifest, or to be "readily perceived," or to be "easily understood or recognized." Emerging company businesses are SIMPLE businesses. They make things or provide services, and sell them for more than they cost to make or deliver. And every quarter and every year, they just "chop more wood" and "carry more water," and thus drive revenue and earnings growth. It usually isn't fancy nor often even terribly interesting. But it almost always is easy-to-understand and recognizable in the company's financial statements. An important note here is that emerging companies, contrary to popular belief, are usually NOT venture capital-backed companies. Why? Because they don't need to deficit finance their businesses because they are cash flow positive. In fact, the very sign that a company needs outside financing (see GM, AIG, et al.) is often the best sign that it is NOT an emerging company because they can't make any money. 

4. To Come Into Being Through Evolution: This is perhaps my favorite because it references the essence of any business - the talent of its people and the quality of its corporate culture.  The best emerging companies are always run by a group of hard-working, thoughtful, creative, persistent, and fantastically committed owner-operators. They devote their lives to their businesses for multiple, non-contradictory motives. They want to offer true value to the marketplace with their product and service offerings. They want to leave a legacy via building enterprises of lasting value and character. And they want to make a lot of money. Accomplishing these 3 objectives in a big way involves a lot of trial-and-error and a lot of figuring out all of the ways not to invent the light bulb. While popular business culture is fascinated with the "golden boy entrepreneur" stories (i.e. Microsoft and Google), these are much more the exceptions than the rule. Far more common are stories like Amazon, Kinkos, The Body Shop, Outback Steakhouse, or even Wal-Mart and Hewlett-Packard - companies that had reasonably long gestation periods, and a lot of slow or no growth periods, before evolving to successful forms. And then continuing to evolve as market and competitive conditions dictate.

If you are a fundamental investor, look for the above qualities in companies you are considering for your portfolio.  Look for them quantitatively with the key metric of operating cash flow growth (everything else is subject to accounting whim) and look for them qualitatively in the mindset of management and in the tenor of the corporate culture.  If both the numbers and the business tone align and you can get in before the whole world knows about it, then you have yourself a money-maker.  Or, another way of saying it, an emerging company. 

Idealistic Capitalists


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Investing in startups and emerging companies is the process of identifying and backing the entrepreneurs and executives with the best ability to move efficiently and profitably from ideas to execution, and then from execution back to ideas and then back to re-focused execution. And finding those that do so on all aspects of their businesses -- marketing and sales, operations and finance.

The entrepreneurs to avoid are those overly focused only on ideas or only on execution. Those focused only on ideas often let the desire for the perfect negate the doable.  They don’t quickly and rigorously subject their ideas to the rumble and tumble of the marketplace. Here we are referring to the great idea person that never gets around to actually executing upon an action plan. 

On the other hand, those entrepreneurs focused on just execution, while at some levels far more effective than the ideas set, are often too slow to react to changing technological, marketplace or competitive conditions. They often define their value offerings so narrowly that they miss adjacent opportunities. Classic examples of this include IBM defining themselves as a computer hardware as opposed to a technology solutions company in the 1980s, thereby ceding the operating system software market opportunity to Microsoft. Or the traditional phone companies in the 1990’s not leveraging their huge patent portfolios to profit in the emerging mobile communications and Internet marketplaces.

Contrastingly, the best entrepreneurs and successful executives are constantly finding the balance between ideas and execution. They are masters at what we at Growthink like to call, “The Business of Ideas.” They are both creative and task-focused, but not too little or too much of either. They make plans and they work them, but they are not slaves to them. They understand that great businesses are inspired by ideas, but their success is counted in cash.  They are, in essence, “idealistic capitalists,” believing that the best ideas, the best products, and the best services make the most money.

Entrepreneurs running businesses like these are few and far between for sure. But when it all comes together, legends are born and fortunes are made.


Effort is Everything


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Stanford psychology professor Carol Dweck in her book "Mindset: The New Psychology of Success," addresses the fascinating issue of why some people and companies achieve their potential while others equally talented and positioned don't.

The key, interestingly, is not ability.

Rather it is whether ability is viewed as something inherent that needs to be demonstrated or as something that can be developed and increased over time, through persistence and experience. Incredibly important for entrepreneurs is the corollary idea to this -- namely that if you take on the belief that ability can and must be developed (as opposed to being something that you either are or are not born with) that great strides in performance are possible.

This "effort effect" is really a key success metric for emerging and middle market companies. In today's globally competitive, fast-changing marketplace, great companies are built not simply via aggregating talented teams, but via aggregating talented teams and creating a corporate culture that rewards thoughtful risk-taking and "learning on the fly" -- thoughtfully incorporating market and competitive feedback into managerial decision-making processes.

Another way to think of the Effort Effect is that business in the 21st century is not a place for resting on one's laurels, resume, or past successes. Rather, it is an increasingly global, level playing field where individuals and companies can rise from the humblest of circumstances, and via effort and imagination, rise to compete and win on the grandest of stages.

And make themselves and their investors a lot of money in the process.


Seeking Alpha


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The overriding body of statistical research conducted over the past 30 years shows that the vast majority of all venture, private equity, hedge, and mutual fund manager's investment return performance is worse than that of the market averages.

Stepping back for a moment, one should really be struck by how absolutely amazing this fact really is.

Think about it - here are some of the highest-paid and theoretically smartest people in the world, and yet if you take their advice you will most likely have a below-average performing investment portfolio. A famous feature in the Wall Street Journal for many years had a cross-section of well-regarded investment analysts pick stocks head-to-head against a monkey and a dartboard.

And this randomly-generated portfolio did, on average, appreciably better than the portfolio assembled by the top-shelf analysts.

Now, once-upon-a-time in a more innocent age, these results could be taken in an almost light-hearted manner. Overall stock market performance was generally good enough to overlook the reality that the huge infrastructure of Wall Street brokerages, analysts, and commentators essentially added no value. Over the past 25 years, there was so much money to be had by all as the investment management industry grew from a relatively quiet backwater to the behemoth that it is today, institutional and individual investors did "well enough" to not rock the boat on this issue.

As an aside, I think the main reason for the relative quiet has been that the investment industry has always been truly the ultimate old boy's club. Pension fund managers, the family office guys, the analysts at the big wirehouses and those that ran mutual and hedge and venture and private equity funds all traveled (and still do) in the same social circles. They all went to the same Ivy League colleges. Same golf clubs. Same charity banquets. It has been, for a long time, a nice, lucrative, relatively low stress, insider's game.

But the event of the last 6 months have taught us that those days are over. And from the perspective of believing that entrepreneurs and the operators of companies, and not financial intermediaries, should get the lion's share of a capitalistic economy’s financial rewards, it is about time.

We here at Growthink, as any regular reader of our contributor columns know, are not interested in being sideline commentators or market prognosticators. We'll leave that to the talking heads. Rather, we focus our effort in identifying, in investing in, and in helping startups and emerging companies grow and prosper. Why? First, because we believe that entrepreneurship is by far the greatest force for positive social and economic change in the world today. And second, because in modern, efficient markets, it is ONLY via investing in these companies that investors can consistently earn alpha returns.

Startup and emerging company investing, when done right, offers a unique combination of both value and trading-based fundamentals. Value-based because entrepreneurial companies, on average, offer a far higher probability of revenue, asset, brand, and cash flow growth than larger enterprises.

And trading-based because the equity in these companies can be bought in highly inefficient markets. These inefficiencies are two-fold. First, these companies trade in inherently lopsided markets - there are always a lot more sellers of startup and emerging company equity than there are buyers of it. 

Second, because there are so MANY of them - more than 500,000 new companies in the U.S. coming on-line every month (startups) and more than 2.2 million firms with between 5-100 employees (emerging companies), the savvy, hard-working investor can consistently achieve significant information advantage in diligencing these deals.  

So, to seek alpha, turn off CNBC. Put down the Wall Street Journal. Or, chuckle-chuckle, tune out Washington. Entrepreneurial America has, and will continue to be, your best bet. And in the process of making a lot of money, you just make help change the world for the better. Enough said.


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