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Frank A. Weil

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How Can You Tell a Real Venture Investor From Your Neighbor?

Posted: 07/24/2013 12:04 pm

They very likely look alike. They may even have been roommates at college and grown up next door to each other on Ohio farms. They both are good talkers; each is bright and personable. One of them is VP in the local bank with a solid career ahead, while the other just seems to float around, in and out of town, and does nothing to hide the evidence of his rolling in big bucks. They are married to twin sisters, daughters of the local Episcopal minister.

Which one would you trust with a 20 percent piece of your recent inheritance of $500,000? Your aim is to invest with the goal of an outsized return to help round out your retirement plans for 20 years out. You have read that venture investing is really the only way to make big money unless you are your own genius.

What questions do you need to ask? And, what credence can you attach to the answers?

FIRST, how do you sort out actual evidence of trust from normal human instinct and judgment? Start by tamping down any sense you have from superficial factors.

The floater appears to be the more successful guy and often the best thing to do is follow a winner. But, you do not really know how, or even if, he was so successful. Even he tells you, his answer will be "complicated" and probably impossible to verify

The local banker is surely a solid and reliable guy but he makes little local loans and not much else. What could he know about venture investing?

The floater appears to be a winner; the banker appears to be solid and prudent.

Call it a draw so far.

SECOND, what questions can you ask to draw out what they know, think and are prejudiced about?

Try "What do you consider critical considerations in making an investment for me?" and "Are your interests and mine aligned?"

The floater says the key is the skill of the entrepreneurs who run the companies he invests in and although your $100,000 is below his normal minimum investment, he will make an exception and take you in. Your interests are exactly aligned, he assures you, because he has his own money in the same fund. and he makes several investments to spread the risks.

The banker says a key is skill of the entrepreneurs AND the odds of getting a major return if a bet works out well. He points out that there are two ways to make ten times your money: [1] from 1-10; the other [2] from 10-100 -- the difference is how early one becomes an investor. If one gets in at 1 there is a chance to get to 100, so look for early stage investments. His bank may not do this but he can help you find funds and the bank does not take fees, so they are completely objective. He also said one has to be aware of the cost of management fees and 'carried' interests (share of profits), which give managers of venture funds a BIG advantage over their investors over time, even if they have their own money in the funds too.

Now you have some reasons to be concerned about the floater: he did not mention fees or carried interests at all and he seemed more concerned about risk spreading - which is good but probably helps the managers more than the investors because a mediocre return is better for managers who get fees too.

The banker makes solid sense about better odds that go with early stage investing and having the potential for higher returns. And, he has no stake - either success or failure-- in what he might recommend which seems wise.

OK, which way do I go?

Then an inspiration springs into your mind: ask the floater to advise me about the banker's suggestion and the banker to advise me about the floater's fund.

Let them duke it out a bit, listen and then decide.

 
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