What is Venture Capital and 3 Ways to Reduce Its Risk

(Episode 1 of 2 with Andrew Romans)

What is Venture Capital and 3 Ways to Reduce Its Risk

Andrew Romans is a venture capitalist, entrepreneur, and advisor for governments and corporations on Corporate Venture Capital programs. He is the CEO and General Partner of 7BC Venture Capital and the co-founder of Rubicon venture capital, a venture capital fund focused on investing in and supporting artificial intelligence (AI), FinTech, and software infrastructure startups. By the time he was 28 years old, he’d raised more than $48 million for tech startups he founded. 

Andrew is also the author of three books: The Entrepreneurial Bible to Venture Capital, Masters of Corporate Venture Capital, and Masters of Blockchain. He also hosts the podcast Fireside with a Venture Capitalist. In today’s episode, we’ll discuss the difference between venture capital, angel investing, and private equity, three ways we can reduce risk in venture capital, how entrepreneurs can leverage data and technology, and Andrew’s career. 

Venture Capital vs Angel Investing vs Private Equity

Here is the difference between venture capital, angel investing, and private equity.

Venture Capital

Venture capital is a form of private equity financing that investors provide to startup companies with high growth potential. Venture Capitalists buy a minority position. The startup typically sells between 10% and 33% of the total company when they’re raising a single round. Because of this, VCs might take a board seat, but they don’t take control of the company at the governance board level or on the capitalization table.

Angel Investing

Angel investing comes from an individual accredited investor, someone who has a high net worth who’s investing with a check from their own savings. Sometimes people misuse the term by calling themselves an angel fund when investing early in a company, but they’re actually investing other people’s money with a management fee.

Private Equity

Private equity, typically, is investing other people’s money but acquiring 51% or more of the shares in the company that’s not listed on a public exchange. So, there’s a change of control when private equity buys a company.

3 Ways to Reduce Risk in Venture Capital

Andrew often hears people say things like, “I have a lot of money to invest, but I don’t know how to invest it. Venture capital sounds really risky.” Andrew thinks there are much riskier things to do with our money than the way that we can invest. Here are three ways Andrew discussed to reduce risk in venture capital.

1. Diversify Our Investments

With his investors, Andrew diversifies them in a way that makes it mathematically and statistically less risky than the stock market or real estate or any other asset class. They invested into Daily Harvest at a $30 million valuation, and Daily Harvest’s publicly disclosed revenues for 2020 were $250 million, which was more than doubling revenues from 2019.

Andrew said, “Just on a discounted cash flow, you could play around with what multiple of 250 million to evaluate that, but if it was 10x, it’s a $2.5 billion valuation and we got in at $30 [million]. You’re not going to get that investing in that company after an IPO. If you diversify across 25 companies with 30% of your fund capital, you can lose eight of them but four would pay it all back. One could be a Daily Harvest [and] pay it back multiple times.”

Let’s think of it like a horse race. If I invest in 25 horses, five of them can be in the lead and one of them could be the lead horse on revenue. “Never put more than 10% of the fund into one deal,” Andrew said. “If you go all chips in of 10% into your top five horses, you’ve now got 30% really nicely diversified to ride some winners [and] make up for your losses, [and] you’ve got half the money into companies that really look like they’re going well, but you’re still diversified across those five.”

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There is a lot less risk when we invest into multiple different companies. Chances are one of the things we invest in will do really well and pay the money back multiple times.

2. Double Down on the Winners

Andrew said, “We’re basically legal insider traders. If I fund the Nathan.com website, and . . . I introduce you to Telkom Indonesia, they’re about to put you on 200 million handsets, and you’re the king of how to monetize that, . . . I should say, ‘Why don’t we do a fundraiser right now, let us lead it, and put more money in your company, so you can really nail it in Indonesia.’”

It’s a lot like insider trading, but it’s legal because these are privately held companies. Andrew said, “Venture capital is like the last bastion of legal, good, positive vibes. We’re helping you as much as possible, and we know which ones we can double down and invest in or how to get conviction and fund you through a storm.”

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3. Get the Fish on the Shore

Andrew compared this strategy for de-risking to fishing. When I’m fishing and I catch a fish but don’t have a net, I’m going to get that fish out of the water and onto the shore before it gets away.

Sometimes our investments look really good at the moment, maybe the company is doing really well, but there’s that voice in the back of our head that worries. Andrews said, “You were in at $12 or $30, it’s now raising money from Tiger at $500 million, maybe sell 10% of the position now, get that fish onshore, give all your investors all their money back with a bump for tax, and then say, ‘By the way, what you’ve got left in the fund is worth this multiple of your check. Don’t you like us, because you got all your money back in two years.’”

If we’re feeling worried about an investment, we can always sell a portion to get some money back, and then wait to see how it does. We can do what we need to to make sure the fish is on shore.

How Entrepreneurs Can Leverage Data and Technology 

Andrew is passionate about entrepreneurship and how entrepreneurs can leverage big tectonic shifts in technology. “I kind of believe that we’re still cave people in a cave, and we’re about to get out of the cave and get enlightened,” Andrew said. “It’s so frustrating to see how things are done so foolishly, and technology can address that, and entrepreneurs can make that happen.”

One of the biggest tectonic shifts Andrew is seeing today is the ability to leverage data with artificial intelligence (AI). We can take the data we already have, marry it with other data we have access to, and use AI to make sense of it. Then we can use that to work much more efficiently, leapfrog our competitors, and create great monetization.

“A machine can read a thousand pages in a second,” Andrew said. This means that we can process data at incredible speeds. Andrew compared it to the movie Moneyball. In the movie, they sourced their people with an old guy with a moustache sitting against a chain link fence watching high school kids play baseball.

Andrew said, “Now imagine self driving, autonomous vehicle technology or . . . surveillance [technology] that watches every video of every kid that ever played soccer from Latin America to Spain. They can continuously monitor, not just three stats on the player, but every elbow recovery. . . . Someone’s going to seriously do that.”

When someone utilizes technology like that, it will be so hard to compete. This can apply to getting a mortgage on or refinancing a house or any big industry. “There is the ability for new companies to completely dominate industries to be the next Amazon, and there is the ability for corporations to end up like Kmart getting crushed by Walmart,” Andrew said.

Along with processing data through AI, there are many other ways we can use technology to automate our workflows. Why would we send a person to defuse a bomb if a drone can do it? With technology we can simplify things so instead of it taking 90 days to get a mortgage it could take only 60, and that will make customers happier.

New technology gives us a chance to revolutionize how we do business, just like the internet did. We can leverage technology to make our processes faster and simpler.

Andrew’s Entrepreneurial Story

Andrew started off with a few startups in high school that didn’t need any investors. He thinks it’s great if we can start a good company without any investors, but he realizes that sometimes we need a lot of capital to build AI or hire data scientists. 

When he was 27, Andrew realized he needed $50 million for his business. He got $25 million in vendor financing that was contingent on getting $5 million of cash equity financing from an investor. He found VCs on the National Venture Capital Association website. He managed to get a $15 million Series A.

Andrew did a lot of public speaking. He often mentioned that he’d raised all that money. Afterward, people would line up to ask him if he would help them get funding from VCs since he knew them. Andrew raised money for a number of companies, meeting both good and bad VCs along the way.

After the dot-com crash, VCs asked Andrew to help some of their portfolio companies raise money from other VCs because all of a sudden it wasn’t so easy to raise money, and they knew Andrew understood how to do it because of his experience. He started joining boards, and began trying nonstop to fundraise.

Andrew created the Founders Club as a way for founders to put their eggs in multiple baskets. He would have founders that had raised money from top VCs to put up to 10% of their shares into the Founders Club as a pool, and he would issue them with ownership in the pool. They’d all go out to dinner, and he’d say, “You all own part of each other’s companies; help each other be prosperous.”

As his career continued, he had a lot of entrepreneurs call him for advice because he owned founder stock in their companies and they trusted him. He heard a lot of stories, saw a lot of things happen, and gave a lot of advice. People started telling him that he should write a book, and it got to the point where someone was telling him that almost every day. So he wrote a book and then started his own VC fund called Rubicon.

Key Takeaways

Thank you so much Andrew for sharing your stories and insights with us today. Here are some of my key takeaways from this episode:

  1. We can reduce the risk of investing by diversifying our investments.
  2. We can double down on our winners to help make sure they succeed.
  3. If we are worried, we can sell a portion to get some money back.
  4. New technology gives us a chance to revolutionize how we do business. We can leverage technology to make our processes faster and simpler.

Connect with Andrew

To learn more about or connect with Andrew:

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    About the author

    Nathan Gwilliam

    Nathan Gwilliam

    I help organizations navigate tectonic shifts that are transforming the business landscape, so they can optimize marketing, accelerate profits, and make a greater difference for good.

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