Episode #332: Mebisode – Journey to 100X

Episode #332: Mebisode – Journey to 100X

 

 

Guest: Episode #332 has no guest, it’s a Mebisode.

Date Recorded: 7/18/2021     |     Run-Time: 54:25


Summary: Episode 332 is a Mebisode. In this episode, you’ll hear Meb talk about his journey investing in over 250 private companies since 2014. He explains why he chose to do so and his framework around sizing, timing, and diversification. Finally, he shares his advice on how to craft a plan if you want to get started yourself.

To read the post related to this episode, click here.


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Transcript of Episode 332:

Welcome Message: Welcome to “The Meb Faber Show,” where the focus is on helping you grow and preserve your wealth. Join us as we discuss the craft of investing and uncover new and profitable ideas, all to help you grow wealthier and wiser. Better investing starts here.

Disclaimer: Meb Faber is the co-founder and chief investment officer at Cambria Investment Management. Due to industry regulations, he will not discuss any of Cambria’s funds on this podcast. All opinions expressed by podcast participants are solely their own opinions and do not reflect the opinion of Cambria Investment Management or its affiliates. For more information, visit cambriainvestments.com.

Meb: It’s time for another Mebisode y’all. We wrote a recent piece on my angel-investing journey, now over 250 companies, called “Journey to 100X.” And we’re going to read it for you today. You can of course find it on the blog at mebfaber.com. But first, would love, love for y’all to leave a review. I’ll read a couple right now just because I think they’re so fun, and we really honestly appreciate it. The first is from Peter Pan 310 who said, “This podcast took out 90% of my Facebook time.” Love that. “Great content, outstanding guest speakers. Nerdy or otherwise, all fascinating. I hate you, Meb. I even had to reallocate my smartphone time budget, about 250 episodes to catch up. Keep up the darn good work.”

And second one is, “I feel smarter. I’m an artist through and through. From dancing hula with my mom at age five till now as an actor, I’ve never had someone in my life growing up to talk to about stocks. My now stepfather and I talk about stocks, and when I talk to my stepfather, I feel a little smarter. Thank you for this great podcast.” T Boa. We love these. You guys keep them coming. I promise we’ll read them all, and I’ll read a few of these reviews in the future. So, you ready to dive in? Here we go.

“Journey to 100X.” When’s the last time you made 100X on an investment? Not 100% on your initial investment, 100 times your initial investment? That means you sink $10,000 into an investment and pull out a cool million bucks. For many investors, this could be a life-changing outcome, I think for most investors. That’s 100X return, and in the investment community, we refer to this rare event as 100 bagger. Viewed in the context of average investment returns, it’s nothing but fantasy or wishful daydreaming. When I polled my Twitter followers, as you all know I’m apt to do, 94% said they’d never had 100 bagger, and in fact, most said they’d never even had a 10 bagger. And however, while quite rare, these massive winners are within the realm of possibility for angel startup investors.

For example, when Snap went public back in 2017, Lightspeed Venture Partners saw their 8 million early investment grow into about $2 billion. That’s a 24,900% return, or roughly a 250 bagger. Or imagine investing in Google’s angel round in 1998. A little known investor plunked down 250K into that round, and with the stock now over a trillion dollar valuation, that return is, I don’t even want to do the math. PS, that little known investor was none other than Jeff Bezos. Thank goodness he got the win. He really needed a break. Finally, we could look at another early Uber investor, Jason Calacanis. We chatted with Jason back on the show in 2017 about his angel-investing journey.

He boldly lays it out in the title of his book, “Angel: How to Invest in Technology Startups-Timeless Advice from an Angel Investor Who Turned $100,000 into $100 Million.” In Jason’s case, that’s not 100, but 1000 times the investment. By the way, Jason was also an early investor in Thumbtack, Calm, Desktop Metal, Trello. Talk about hitting some winners, that he is certain to remind you about, by the way. We love Jason.

Before we move on, a quick nit-pick side note. Many commentators assume that if a company goes from a 10 million valuation to a billion dollar valuation, that the investor automatically returned 100X. Rarely is this true, as most companies raise money along the way, which results in dilution to investors. So, the investor may have received a 50X, or a 20X, or only a 2X, or even less, depending on the funding raise. Think of it like your pizza slice getting smaller, and smaller, and smaller every time the company announces their series A, B, C, D, E. There’s also different share classes, and those can have different returns too.

Most startups and VCs brag about how much money they’ve raised in follow-on rounds, but the most ideal investment is the one in which you invest, the company takes off like a rocket ship, and then they never need to raise money again. Now, with my nit-pick side note over, the bottom line is, startups offer the potential for vastly greater investment returns than just about anything else you’ll find. There’s no mystery behind this, and it’s just basic math.

Is it more feasible for a startup to grow from a $10 million valuation to unicorn status of a billion dollars, or an established giant to grow on the same scale? Apple could potentially have great returns in the future as they invent teleportation, flying cars, maybe holograms for future Zoom meetings. But how likely is it they’ll go from a 2 trillion market cap to 200 trillion? Well, maybe the aliens will be big fans of Apple products, but mega size is usually a hindrance to scaling. But what if Apple decides to give a key supplier contract to a small company valued at just 20 million? Think you’ll see some growth there? When you catch a small company in its infancy, you’re at least giving yourself a chance at this type of monster return. Mathematically, it’s vastly more challenging for a company to amass this type of return after it gets bigger and goes public. And even if it happens, it’s likely to take a decade or more.

So, let’s back up. Why am I even talking about this? I’ve tried to be transparent about my own investing experiences over the years through various blog posts, podcast episodes. And on that note, you can Google, how I invest my money. We’ll add the link in the show notes. You’ll see the full picture of exactly how I invest and in what. With farmland, angel investments, coins, collectibles, crypto, and of course, a global allocation with value and trend-following ETFs. And don’t miss the other three parts in the series, I produced these last year during the pandemic. There’s the “Get Rich Portfolio,” The “Stay Rich Portfolio,” and “Investing in the time of Corona.” I promise these are all worth a listen or a read. We’ll put them in the show notes.

Despite the airtime I’ve given to my angel investments, it seems new questions and curiosities trickle in from readers and podcast listeners. I can understand the interest. Historically, the world of startup investing has been opaque and limited to accredited investors and venture capitalists. Fortunately, this is changing thanks to relatively recent regulatory changes. It’s no longer a closed-door old boys club. But in response to the interest, I decided to talk about this in one fun, catch-all piece that walks readers and listeners through my experiences, the good, the bad, and the ugly.

It’s now about seven years into my angel investing experience with over 250 investments under my belt. So, while there’s much more I still need to learn, I’m no longer a complete newbie. I’ve experienced some rocket ships, some unicorns, some gravestones, and lots of TBD, to be determined, to be continued. A lot of companies muddling along, some growing nicely. But what I feel confident saying from these experiences is that, in my opinion, the world of angel investing deserves your genuine consideration as a potential asset class for your portfolio. From the outsider’s return potential, to tax benefits, which we’ll get to later, to portfolio diversification, to the built-in guardrails of illiquidity, to plain old fun, it’s worth it.

So, in this long podcast, let’s get into more details about why I believe all investors should give this asset class a hard look. First, let’s take a quick walk through the stats. If you’re more of a recent listener, or you may need a refresh on what I’ve written and talked about before about my angel investing experience, here’s the latest overview. I began putting money into private companies back in 2014. AngelList was and remains my primary platform, though I’ve done deals through a handful of other platforms, including Wefunder, EquityZen, Republic, Bioverge, and Jason Calacanis’ Syndicate. I’ve also co-invested with friends like Howard Lindzon, who’s been on the show, and made various direct investments with founders I know.

I’m now invested in over 250 companies that have run the gamut of industries and geographies all around the world. Aerospace, robotics, logistics, finance, healthcare, food and beverage, blockchain, biotech, SaaS, education, media entertainment, payments, real estate, and transportation, to name a handful. And I’ll get into my preferred deal specs later. There’s been a similar diversity of geography, from California to Miami, to Pakistan, Africa, Mexico, and other far-flung locales. In making these 250 investments, I’ve reviewed over 3,000 companies. So, by the numbers, I’m only investing in a small fraction of the deals that cross my desk. And since these deals are also usually led by VC firms and syndicates that also filter through and invest in only about 5% of the companies they see, one could argue these finalists came from a potential pool of tens of thousands of candidates.

As the performance returns, it’s way too early to draw strong conclusions, but for simplicity’s sake, let’s keep it only to my exits. Since calculating pre-liquidity event deals is premature and subject to change, you can’t count on mark-up or valuation until you realize a liquidity event or that public stock hits your brokerage account. I’ve had about 20 exits so far, with the highest cash-on-cash return clocking in at a little under 20X. Cool. There have been three total wipe-outs, so, a loss of 100% on each. There are also a couple of near complete wipe-outs. After that, the returns have bounced around from near flat, to some doubles, a quadruple, a roughly 12 bagger, and then the aforementioned 20 bagger.

The cumulative cash-on-cash return of these exited companies, including the money losers, is a shade over 100%. And the average holding period from money in to money out was a little under three years. So, if you look at that holistic return and hold period, that’s probably interesting enough for most readers to perk up. But just to try to hook you even more, I’ll tease you with a few examples of companies that haven’t had liquidity events yet but they’re enjoying massive growth. First, there’s FabFitFun. I invested in a seed round in 2015 with Draft Ventures when the company was just getting some early traction. Fast forward to today, where they reported over 2 million customers and 600 million in revenue in 2020, and they’re still growing.

You can listen to a podcast with one of the founders, Katie, who is an incredible force of nature, a few episodes ago. Trust me, listeners, if you’re a female, you should sign up for the box. If you’re a male, you should sign up one of your female friends, mom, grandma, daughter, sister, cousin. They will love it. There’s a code on the episode we did with FabFitFun, you can Google it, we’ll put it in the show note links for a special discount.

Then there’s PlushCare. That was another 2015 seed round investment with Moso Capital. They were recently acquired by Accolade for 450 million in cash and stock. I didn’t include them in the exit list before as it hadn’t closed yet, but it has potential to surpass the biggest winner status. Podcast with the founder, Ryan, was also about a year ago. We’ll add it to the show note links.

Another company going public includes a tie. We had the founder of Grove Collective on the podcast recently. Grove was a 2016 investment via Phil Nadel, another podcast alum. He’s been on twice. He mentions Grove back in the episode in 2018 by the way. They focus on eco-friendly home essentials and have executed with laser focus. Blowing by unicorn status, well on their way to greater heights. I think there’s real decacorn potential for Grove. That means a $10 billion plus valuation.

There’s also ShipBob, a global logistics platform that fulfills ecommerce orders for direct-to-consumer brands, which was a 2016 seed investment. And I used to say they’ve raised over 100 million in follow-on financing, but it’s now hundreds of millions with the new recent announcement in funding with a unicorn valuation and are continuing to grow like a weed. You’ll notice many of these are from early vintages. So, perhaps I was simply lucky during the early days. I’ll take it though. But there have been some recent rocket ships too.

Chipper Cash is a fun one. I invested alongside none other than Joe Montana and others in both the seed and Series A in 2019 and 2020. Chipper has kept growing, recently raising 100 million in their series C. They were recently described as one of Africa’s most valuable startups. We had the founder, Ham, on the podcast to tell his story too. I’ll add it to the show note links. Given how many times I’ve tweeted about finding lost assets on unclaimed.org. By the way, if you’re new, go search. And if you have it, let me know what you find. We found millions for followers. If you are a longtime listener, you’re probably sick of me talking about it.

I’d be remiss not to mention MainStreet. I invested in their seed round just last year in 2020. And oh my goodness. They have such a cool story where they help companies claim tax credits, and such an obvious product market fit, which is zero cost to the company if they don’t find you any money, and they take a cut if they do, that I’ve invited the founder on the podcast twice already. Doug is awesome. The average company saves over 50 grand and they’ve collectively saved, drumroll, U.S. companies over $100 million.

Now, before you start thinking these types of success stories are all over the place, let’s adjust for some expectations. Let’s be clear. I am fully aware that I’ve been investing during a romping stomping bull market. At some point, if and when the broad U.S. stock market goes down 20%, 40%, 60%, or even 80%, angel investment returns may not look so rosy. Funding will dry up, exits will become scarcer, VCs will stop being super douches on Twitter, and many companies will go out of business.

But the flip side of this bear scenario is, valuations will go down too. So you’ll get more bang for your buck. And some of the best companies in history were founded during stock bear markets. Uber famously was founded in March of 2009. I’ve committed to investing all the way through the full business cycle, which is just another form of diversification. To me, an investor has to, A, diversify across numerous investments. B, diversify across multiple sectors. C, diversify across geographies, including international borders. And lastly, and on our current point, D, diversify across time.

Right now, I have investments ranging from brand new seed startups, raising at $5 million, all the way up to mature unicorns doing hundreds of millions in revenue. Some companies in my portfolio have benefited from COVID lockdowns, while others got crushed. Some of these biotech companies will live or die by results that won’t even be presented for half a decade and more. Their success is unlikely to be correlated to a delivery app in Venezuela. Yep, I just said Venezuela. So, circling back to the point here. I’ve included all this detail to emphasize that I’m no longer a newbie. So, let’s dive into why I’m endorsing angel investing to you today.

The good and the bad details of angel investing returns. While I’m obviously happy with my biggest exit being a near 20 bagger. In the broader context of what’s possible in the private markets, that’s not a massive outcome. Say what? Most of us will be dancing a jig, or perhaps in the more modern world, bragging on Twitter with the stock doubling or tripling, let alone going up 20 times. This is perhaps the most exciting distinguishing feature of startup investing compared to the later-stage markets, and we can thank one thing for it, power laws.

When it comes to investing in startup companies, power laws play a huge role in the distribution curve of returns. Now, it’s important to understand, this can be both a blessing and a curse. In a normal bell curve distribution, it’s impossible for a single data point, or even a handful data points, to have an outsized effect on the overall distribution. That’s because the distribution averages heavily centered. With so many data points falling in the fat part of the curve, a single outlier isn’t going to impact the overall average much at all.

Power laws don’t work that way. There’s far more in keeping with the 80/20 rule, where 80% of an outcome is determined by 20% of the input, or more accurately, for angel investing, it’s a 95/5 rule. With the power law distribution, just one or a few extreme readings can have a profound impact on the average of the entire dataset. Consider the average net worth of you and your golfing buddies, maybe it’s a million dollars each. Nice crew, by the way. Now, let’s say Warren Buffett and his $100 billion fortune joins you for a round, so you recalculate the group’s average. How is Warren, the outlier, going to skew the number? Well, you’re now all billionaires on average. But is the new average even remotely representative of your personal net worth? If so, you clearly don’t need to be reading my blog and listening to the podcast.

I saw this dynamic myself with the 20X winner helping pull up the average of my portfolio of exited companies, despite having a handful of investments that lost 100% or near 100%. But keep in mind what this means. Given how just a few outsized returns in a power law distribution can radically skew the return of the whole portfolio, it becomes critical that you, as an angel investor, land one or more of these long tail massive winners. That’s because they’re not just fun, they’re required in order to bring up the average return of a portfolio that will have a great deal of ho-hum and money-losing returns.

And what that means is you need a lot of data points. In other words, your money spread out over lots of private company investments. Last summer, AngelList published a study, we’ll link to in the show notes, conducted on this. In short, the platform selected all of its investments prior to series C that were at least one year old and had a valuation change, or that had already exited. These parameters gave them a universe of almost 2,000 investments.

AngelList tried a strategy based on VC vet, Peter Thiel, and his approach, which is to concentrate on seven or eight companies. AngelList upped it to 10. Here’s a quote from AngelList, “Here, the distribution of returns for hypothetical investment managers that roughly followed Peter Thiel’s advice and made 10 investments out of the universe of 1,808 that we originally selected.”

You can’t see this, but, “The black vertical line represents the market return, which is what you’d get from writing an equal-sized check to all the potential AngelList investments. All the probability density to the left to that vertical line represents hypothetical portfolios that underperformed the market return. The most frequently observed outcome from a 10 investment portfolio, the peak of the curve is slightly positive portfolio performance, but well under the market return. This is a consequence of the power law returns of venture capital. The typical manager fails to pick any outside winners in their 10 chances, whereas the market portfolio is assured of selecting all of the return-driving winners.”

Given this for the average private investor, you’d be better off reducing your bet size so you can spread your capital over more deals, than you would be concentrating your money in a smaller portfolio. The study found that the best simulated 10 investment portfolio from 50,000 random draws had around a 20X multiplier miles off the chart, and of course, that’s before fees. But circling back to the original point. Startup companies offer greater potential for these massive outlier returns that are part of the power law distribution. Hunting for them and watching one appear to be developing, it’s a lot of fun and very exciting. Some of the top angel investors understand this very simple concept. Calacanis, we mentioned earlier, has invested in over 300 companies. And Fabrice Grinda, who’s also been on the podcast, has invested in over 700. Again, it’s not a unique insight, but it is a critical insight. Make sure you implement this more-is-better rule when you begin with your own angel investing portfolio.

And before we move, on one final note, power laws also work in the public stock market. This is a common misconception amongst many VCs that this characteristic is unique to private investments. It is not. In fact, power laws are one reason why market cap-weighted indexing works. You’re guaranteed to own the winners. And research shows that about 10% of stocks delivers all the returns. Your average stock probably underperforms T bills. Let that sink in. There are some good papers on power laws and public markets. We’ll link to these in the show notes. JP Morgan, Vanguard, Long Board, the Chris Meyer podcast was a great one we did with more information on public 100 baggers. And just to be clear, if you’re skipping over this information and resources, please don’t. Print them out, read them, listen to them. They are extremely insightful.

The second reason why I’m a huge advocate for angel investing may surprise you, it’s illiquidity. So, we just said that power laws apply to public markets too, case in point, Amazon. If you’d invested in Amazon’s IPO, you’d be up somewhere in the tens of thousands of percent at this point, a huge outlier compared to the broad market. But, and this ties to our next point, even if you had invested in Amazon on its IPO, the odds of you not selling it before it hit that monster return would be next to nil. The reality is, unless you received your Amazon stock as a physical certificate, lost it for a couple decades and found it again, it’s a near certainty, you wouldn’t still own it.

After all, would you have held from Amazon’s 1999 peak of $113 as it crashed all the way down to 5.51? That’s a 95% loss. Remember Amazon dot bomb? Would you have held a few years later in 2008 when it fell from 101 bucks to 34 bucks? That was only a 66% loss. And there’s two other 50% drawdowns by the way in Amazon’s history too. You’re going to sit through all four of these collapses despite your mortgage, your kids braces, college tuition, retirement, or who knows, you name it? I doubt it.

On the flip side, how tempting would it have been to cash out on those Amazon shares when they first doubled? Think of all the things you could buy. The vacations to go on. A 10X investment would likely have been life changing. Who’s going to hold on back on that? Investing in private companies provides a wonderful solution to this, which is our second point, illiquidity. In other words, you can’t sell, even if you wanted to. And this is actually a feature, not a bug.

After you invest, that money is gone until the company enjoys a liquidity event of some kind or locks its doors for good. So, you’re in it till the end. But again, I see that’s actually a good thing. It prevents the self-defeating investment behavior that the academic studies highlight year in, year out. Illiquidity can be a gift that saves us from ourselves. It’s easy to get rich with even 10% compound returns as we’ve demonstrated in our get rich portfolio. The problem is, you need time. And most people want their riches now. Now used to mean quarters and years, but in this Robinhood world, it means minutes and hours.

Seeing huge overnight winners from meme stocks can make investors lose focus, make foolish choices in their public portfolios. You won’t have such an option in your private portfolio. Instead, those companies will have all the time and breathing room necessary to develop their full potential. Instead of you deciding that selling your shares for a new Tesla and golf clubs is the right move.

Now, think about it for a little bit. Angel investing is the ultimate trend-following strategy. Your stop loss is zero, and your upside is uncapped. It reminds me of the old David Ricardo quote from the 1700s, cut short your losses and let your profits run on. And by the way, it’s always been interesting to me that there’s not more overlap between the macro trend followers and the angel startup crew, as they’re both essentially have the same philosophy. Is the ultimate portfolio, by the way, a half trend and half angel investing? The trend side, by the way, should help hedge the long equity bear markets too.

The third reason I’m a huge advocate for angel investing is no daily anxiety. Though we all recognize that investing should be a long-term multi-year endeavor, too many of us treat it more like a daily casino. Thanks to our investment apps, we’re able to watch every little market movement. That puts us at risk of our emotions getting hijacked by the volatility, leading to knee jerk emotion-based decisions. Confetti cannons, everyone.

People used to ask me at cocktail parties, “Meb, I bought one of your ETFs. And it’s down, it’s not doing so great. How long should I give it to see if it works out?” And I used to respond, “Ten years.” To which they would awkwardly laugh, assuming I was joking. After a few moments of silence, they would respond, “Wait, you’re serious?” And then they’d usually go find someone else willing to talk about something more interesting or immediate like Dogecoin.

But now, returning to a stock like Amazon. You think you could be the one to hold through the ups and downs? Let me rephrase that, through the many years of ups and downs? If so, the stats are against you. I polled Twitter to ask, what stretch of underperformance by a portfolio manager would you be willing to tolerate before selling? 85% said under six years, 53% said under three years. That is everything wrong with investing wrapped into one poll.

By the way, remember when Amazon took it on the chin back in 2001? It took nearly a decade before it made its way back to a new all-time high in late 2009. Only to get chopped in half again. Every asset class, or strategy, or specific investment, can go years, even a decade underperforming. Take the most universally held belief in all of investing, which is, stocks outperform bonds. Well, guess what? Just last year, in 2020, stocks had experienced similar returns as bonds for not three years, not six years, but for 40 years. That is four decades of the most universally held investment belief not being true. Zero equity premium. But you’re telling me you can only wait three? Get the fuck out of here.

Circling back to our main topic. Here too, the private markets have a built-in when. Unless there’s a recent price round or liquidity event, the market value one of your private investments is vague at best, but this lack of detail encourages a wonderful investment practice called forgetting about it. This concept was best described by Robert Kirby in the 1980s essay, “The coffee can portfolio,” in “The Journal of Portfolio Management.”

There’s something nice about not being able to price your portfolio week in and week out, or hour in and hour out. It’s in keeping with my favorite quotes, you can find on the blog from George Mallory, “And joy is, after all, the end of life. We do not live to eat and make money. We eat and make money to be able to live. That’s what life means and what life is for.” As I see it, private investing is vastly superior to public market investing when it comes to helping you focus on what’s important in life.

The fourth reason I’m a huge advocate for private investing, massive tax advantages. These advantages relate to an IRS designation known as QSBS, which stands for qualified small business stock, or Section 1202. We polled our Twitter audience, and over 90% had never heard of QSBS, and yet it may be the most impactful tax move you can make in your entire portfolio. A qualified small business is a company whose gross assets valued at the original cost don’t exceed 50 million immediately after the stock issuance. Plus, to qualify, you got to hold it for five years.

There are some additional restrictions, for example, certain sectors like gold mining or farming are ineligible. But when the company and the investor meet the requirements, capital gains are exempt from federal taxes. Say that again. It’s pretty amazing. Investors can exclude 100% of their taxable income on either up to 10 million, or 10X the original investment, whichever is greater. Now, there are some other fine-print details. So, consult your CPA or attorney about how they relate to your specific financial situation.

That said, the takeaway remains the same. The government is incentivizing startup investing in a massive way, especially when compared to the public markets, wherein the government is looking to double federal capital gains taxes for wealthy Americans. This alone is a big enough reason to think seriously about angel investing. For those that want to invest in private companies through retirement accounts, I use Alto IRA for two of my own retirement accounts, and I’m also an investor in the company. Peter Thiel was recently in the news for growing his IRA to a whopping 5 billion, all tax-free.

The fifth reason why I’m a big advocate is the simplest, it’s just fun. I think browsing startup offerings is loads of fun. I find it thrilling to see what products and services are being cultivated. Many times you’re at the cutting edge of a technology or product. In other words, you’re one of the first people to see what’s coming. In addition, I’ve incorporated countless company services, products, and ideas into my own life and businesses. Most of my friends and family are so sick of hearing me say, “Hey, have you heard of this cool new company?”

Plus, it breeds an optimism that all too often isn’t there with public market investing. Turning on your average business network or browsing news sites is a depressing experience filled with shouting, short-term thinking, partisan views, and overall negativity. Plus, it trains you to focus almost exclusively on the short-term market price. With angel investments, the inability to value a company daily and your powerlessness to have liquidity, even if you could value it, put the focus back where it should be, on the idea and the leadership team. On building something on the future and what could be.

For example, here are a few companies I’ve invested in that are simply doing ridiculously cool shit. First one, take Axiom Space. They’re building the first commercial space station. We’re not talking about completing it in like 2050. Private flights begin next year, with their first module attaching to the ISS in 2024. You think their total addressable market, the TAM, is big? How about the entire universe? You can listen to more on the Lisa Rich podcast we did, I’ll put it in the show note links. And we have an upcoming show with Axiom.

Or how about Fellow. Name something grosser or more awkward than a dude going to a clinic and having to produce some sperm. Yuck. This might be the ultimate in frustration arb you’ve heard me talk about before. Fellow is enabling thankful guys everywhere to do the deed from home. Eventually, it will have the world’s largest sperm storage, testing, and bank for pharmaceutical research. We also have the founder on the show coming up.

Number three, perhaps you’re worried about global warming, care deeply about the planet and reforestation, want a quick way to plant a forest the size of a country. You can make it happen with drones. Yep, I said drones. Check out the investment in DroneSeed.

Number four, I always thought 23andMe is a cool idea, but there’s two big flaws, in my opinion. One, it’s basically mostly U.S. and European samples, and less than 3% of genomic data available is African. Two, they also charge you to take your DNA and then turn around and sell to pharma companies and they keep all the money, wtf. 54gene is focused on collecting samples from Africa, but also returning a portion of the proceeds to local communities and institutions. Win-win.

Number five, check out bubble hotels, just google them. You’ll want to go and stay in one of these just for the Instagram. Number six, do you support youth sports? Honestly, minus the parents. It’s one of the best ways to teach kids important life lessons. LeagueSide was built as a marketplace to match sponsors and teams. Want to sponsor a local team or even do a national campaign focused on under-sponsored demographics? LeagueSide can help. We also did a podcast with the founder, you can find in the archives.

Number seven, speaking of sports, how much would you like to watch your grandchild play high school basketball live? Many can’t travel due to distance, health, or they simply hate their in-laws. BallerTV is fixing that. Number eight, here’s a link to a biotech developing a drug for severe COVID patients. Will it work? I don’t know. It’s never certain with these sort of things, but they’re in clinical trials and they just dropped some positive phase two data, Ashvattha Therapeutics.

Number nine, loneliness is an epidemic, especially for many grandparents. Greatest generation. Papa tries to solve this with family-on-demand. Papa pairs seniors with Papa pals to help run errands, play chess, or just have someone to talk with. Think about how beneficial it is for younger generations to learn from all the wisdom of our elders too? I honestly think this company has decacorn potential.

Number 10, how about surgeons training via virtual reality? That’s our investment in Osso VR. Number 11, you’ve probably heard about this one, metaverse horse racing, that’s right, I said it. That’s a thing with Zed Run. Number 12, I love tattoos, I don’t have any, but I love them. For many people, tattoos are cool for about a week, then the regret starts to creep in. Inkbox fixes this with gorgeous two-week tattoos. Also, I promise you, parents, if you have kids, they go bananas for them. Number 13, obviously, we’re going to need gas stations in space, check out Orbit Fab.

Look, I could go on and on and on. But I hope you’re getting the point, which is, it’s just more fun. So, quick summary and why you should consider angel investing. Number one, potential for outsized returns. Number two, illiquidity may help you hold on long enough to realize the really big winners. Number three, the long-term perspective can remove the daily anxiety of the stock market. Number four, potentially massive, massive, massive tax benefits. Number five, it’s fun to invest in and support kick-ass founders building world-changing companies. This sounds a lot like the Warren Buffett approach, doesn’t it? Except at a much smaller scale. So, maybe young Warren Buffett. Invest in great businesses, hold on to them forever, and as my friend, Wes Gray, would say, compound your face off.

So, how about some practical advice for getting started. When I began investing in angel startups seven years ago, I knew there was much I needed to learn. So, my mindset going in was basically, follow the top investors, read about companies and founders, learn, develop some experience. When comfortable, begin placing lots of little bets, and then repeat. I’m influenced by Charlie Munger’s quote that graces the back cover of one of my books, which, by the way, is free to download, “Invest With the House.” If you go to mebfaber.com, you can download most of my books for free.

He says, “I believe in the discipline of mastering the best that other people have ever figured out. I don’t believe in just sitting there and trying to dream it all up myself. Nobody is that smart.” So, when I started, my primary goal was to learn and to enjoy myself. I was not trying to hit it out of the park financially. And from this perspective, I viewed my invested capital as a reasonable tuition or entry fee. You can listen to old podcasts when I say my goal was to break even. If I make a few bucks, great. If I beat the S&P 500, even better.

So, I would answer, how to get started, by asking a return question, what do you want from it? And what are you willing to give to it? By give to it, I’m not only referring to money, I’m talking about time, study, what role, allocation of your overall portfolio, and so on. Some may see all of it as work, but I don’t. All of this points towards creating a personalized plan.

And creating this plan, you’ll want to answer some questions. How much will you invest? There are two sub-questions here. The first is, how much cash do you have right now that you want to use to seed your portfolio? And word of advice here, do not feel the need to blow all your investment capital into a batch of companies at the very beginning. Every deal you’re likely to see in the first few months will sound amazing. A better plan is design a 5 to 10 year roadmap with target dollar amounts and target number of companies per year. Yes, the power law distribution needs you to have lots of investments. But no, that’s not a license to throw money at any opportunity that fills your browser. People disparagingly like to call this spray and pray. If you’re like me, you’re going to pass on roughly 90%, 95% of the deals you review. So your goal should be to get fully invested, but to do so deliberately.

The second related question here is, how much capital will you commit to adding each year? Again, this is not a one-and-done process. As just noted, you need lots of investments as you try to find those long tail power law monster winners. So, commitment to that challenge is important. What will that mean for you? Maybe that means you’re just going to invest 100k total per year across 100 startups for the next 10 years. Or maybe it’s 20k per year in 20 startups for next five, and then you’re going to reevaluate. Some months you may do no deals, and some months you may do multiple.

Next, ask yourself, how will you judge the process to be a success or a failure? By return percentage? By how much you’re enjoying it? By how much you’ve learned relative to a benchmark such as your public portfolio? It’s worth jotting down all the various ways you could judge it, after which you could try to ascribe some quantifiable metric to each one. A sort of line in the sand for evaluation. Even if you can’t measure it, writing down what you hope to achieve will be helpful. Beyond that, will you focus on any specific sectors, or will you go anywhere an attractive deal takes you? How will this fit in your broader portfolio? What percentage of your investable assets will this take up? Look, there’s plenty of other questions. They’re all largely focused on one thing, setting and managing your expectations.

To that end, prepare to see your money locked up for years. Prepare for the unpleasant feeling of watching some of your portfolio companies go bust. Prepare for some wins along with plenty of ho-hum returns. Prepare for dilution. Prepare for three to seven years of twiddling your thumbs before any fireworks happen, hopefully sooner. Prepare to be surprised when your favorite deals don’t do much and the boring ones take off. Prepare to be humbled, and to learn, but to have a great time in the process.

I like to make an analogy to farming. I plant some different seed and at different fields every year. Some of the crops produce in year one like wheat, whereas some take years to mature, like almonds. Others, well, they get hit by drought and disaster and you just have to start over with something else. Or perhaps a better analogy would be winemaking with various vintages. Let’s say you start out making wine in 2015, but that vintage doesn’t seem like it’s going to reach peak drinkability for 5, 10 years. But what about that 2016 vintage, in which there was local fires and the smoky wine may be a total write off? Meanwhile, 2017’s vintage was unexpectedly delicious right out of the barrel. Fast forward to 2021, and you now have seven years of vintages all maturing from different times and of varying quality. This is an illustration of an earlier point, diversification across time is very important.

In terms of some more actionable advice. I recommend joining AngelList, and whatever other platforms you like. There’s even some standalone syndicates out there, like the one I referenced earlier from Jason Calacanis, called The Syndicate.

You should also consider signing up for his Angel University workshop. It’s 300 bucks to attend, but all proceeds go to charity.

When you’re on any of the platforms, you can begin browsing the deals from various syndicate leads. Often, the deals are confidential for various reasons. Terms are not published, the company is in stealth, they don’t want to alert competitors, etc, etc. At least once, I saw a syndicate lead try to raise money for a company without the company’s knowledge. Yeah, definitely a no no. At first, I’d recommend you follow as many syndicates as possible. After all, your goal should be soaking up information and seeing deal flow. I follow over a hundred on AngelList, and I’m invested alongside dozens, which results in hundreds of deals crossing my desk each month. I like the flow. But understand, for many, this would be overwhelming. Because it’s a lot to track. I commit more headspace and attention to my favorite investors. So, perhaps get started with a few of the syndicates we’ve interviewed on the podcast, as I’ve invested alongside all of them.

After enough of this, you’ll begin to gravitate towards a specific type of deal that resonates with you. Here’s my playbook. First, target size. I like a company between 5 million and 20 million market cap. That’s my sweet spot. So we’re basically talking a seed round or series A, or what used to be a seed round and series A. Valuation has been going a little batty lately. You may prefer lower-risk later-stage companies, and look, that’s fine. I’ve done a number of deals as low as 2 million, and a handful above 20 million, but nearly all my deals are in that below 50 million range. Again, I want the possibility of the big 100X outcome.

I reserve some later-stage mark cap deals for companies I love, aka, the Peter Lynch method. If you listen to the podcast, you’ve probably heard me talk about some of these later-stage companies I’ve invested in like Impossible Foods, Omaze, Lyft, HotelTonight, which is now Airbnb. A good example of a stock going public and ending up in your brokerage account. I try to avoid paying carry on later-stage companies and many secondary markets have liquidity for these companies like EquityZen. However, most of the products I love were investable at seed stage valuations, like MUD\WTR, which we did a podcast for. If you use code Meb, you get 10 bucks off, and Ugly Drinks, upcoming podcast, and uses the code Ugly Meb, maybe that’s my favorite code so far for a discount.

I tend to stay away from pre-launch companies. That’s because I want to see an existing product or service with around a million bucks of revenue as proof of concept. If all you have is an idea and a dream, a lot can go wrong. So, many startups tell you what they’re going to do, but I prefer to see ones that already have a little bit of that product market fit. I tend to bypass pre-seed companies unless I know the founder or absolutely love the idea. Other investors are willing to bet on just an idea or founder, and that’s cool too. You just got to find what works for you. This is not a one-size-fits-all operation.

And by the way, a quick note on deal write ups, you may want to spend the first few months simply reviewing deals. You’ll notice some familiarity with the jargon, notice some pattern recognition, you’ll develop some preferences, and you’ll get triggered by some red flags too. You’ll learn to put little weight on a memo that reads, “This is one of the fastest growing companies I’ve ever seen. I expect them to reach $100 million annual recurring revenue by 2023. In fact, the deal is three times oversubscribed, so we only have this allocation thanks to my value-add to the CEO. I’ll do my best to ask for a larger allocation. We need to wire the money in the next 24 hours to make sure to get your commitment in as soon as possible.” And you’re probably laughing because that seems preposterous. But I see these almost daily.

You want the possibility that a company can reach 100 million in revenue per year, which potentially gets them to a unicorn valuation of a billion. There’s lots of great companies that may only get to 10 million in revenue. Which, by the way, amazing business, but you, odd as it sounds, mostly want to avoid them because that will not drive the power law outcome. Strange to say, but true.

Target sectors or themes. A few of my favorite category sectors are aerospace and biotech, which, no surprise, given my background. Mental health and happiness, emerging markets, food 2.0, decrease consumption, and of course, FinTech and asset management. You also will find yourself gravitating towards investment themes and not just sectors, for example, I’ve labeled a type investment theme I prefer as frustration arbitrage. Basically, I’m investing in a company that’s making a process smoother or frictionless. Think, something we all need but hate dealing with. What industries have a low NPS score, or said more technically, what out there just sucks? You can see how frustration arb works across countless sectors, though the specific solution varies. The bigger the frustration that the company is relieving, the bigger the potential payday.

For example, real estate has endless frictions with high fees. It is just littered with spots for disruption. Recall your real estate agent who just got paid 120 grand for doing what exactly? Think those 6% real estate commission’s are toast like I do? Good example is HomeLister. They’re disrupting that market and fast. Sorry brokerage friends, you’ll have to finance that Aston Martin somewhere else.

Anywhere people still do business in Excel, or even better, pens with yellow notebook paper is ripe for frustration arb. Lots of emerging markets qualify, but plenty of U.S. industries are overlooked. Think about billboard advertising, a notoriously inefficient and fragmented market. Enter AdQuick, which you can listen to the old podcast episode, for a fun Serena Williams story too, in the archives.

Here’s an example of how creative these solutions are becoming. I can’t think of anything more frustrating or embarrassing than being a terrible dancer, not speaking from experience. Okay, I might be. Many people will take dance lessons, except for the part, again, it’s too embarrassing to do in public. Check out STEEZY. It’s revolutionized dance instruction straight to your living room. Nobody cares if you’re dancing in your underwear looking like Elaine from Seinfeld. So, just go ahead and let your freak flag fly.

Now, looking at all this from the opposite side, what doesn’t grab my attention as a potential investment? Maybe something that’s like a product that just helps Google sell more ads, barf, boring, yuck. I want to have a portfolio of companies I actually care about. You can go listen to an old podcast we did with the syndicate lead Tom Williams. And you can just hear in his voice how passionate he is about helping founders and his portfolio companies. I’ve invested in a lot of deals with Tom, he’s great. I want to be excited about the idea, and cheering for the founders to succeed at every turn. You’ll develop your own preferences, and these may be guided by your own value-add too.

Target portfolio management. My personal goal is to make about 50 investments per year. I have a default unit size for my initial investment. You should decide ahead of time what that number is for you. It could be $1,000, 5, 25, 100 grand, whatever is appropriate for your situation. Sometimes if I really love the company, I’ll go double or even triple my default unit size. But I have a hard cap that is the max multiple of four times my standard unit. On the flip side, sometimes I’ll invest in a company with a lower amount than my default just to follow along with its progress, something like a quarter of a normal unit. This reminds me of an old school stock investors that will just buy one share of a company to get the annual report, so they’d remember to follow along and track the progress.

Further investment for me is usually milestone-based, such as, hey, look, if they hit these milestones in the next 12 months and raise another round, I’ll fully invest more. I tend to rarely join in a follow-on investment, however, and this diverges from most people’s advice. If I invest say 5k in a startup, and they raise in the next round at 10 times the valuation of the last one, I already have a large position relative to my initial unit size, and again, this ignores dilution. But another way to think of it is like having no position and then all of a sudden deciding to invest like 30 or 50 grand from the start, would you do that? Probably not.

So, it’s rare that I do a follow-on round. I believe I’ve only invest in about a dozen of them out of my 250 investments. And to me, the opportunity must be especially compelling. But for the right opportunity, I believe it’s worth it to throw some more money at a company that’s doing something special. If there’s a company that’s an absolute rocket ship, where the opportunity is so compelling, I’ll invest multiple times. You know, an example of a follow-on round I participated in was the company Chipper, we mentioned earlier, a payments app. It’s a bit like PayPal for Africa. It’s growing so much and so fast, I felt it warranted multiple investments. In addition to Chipper, the other companies I’ve invested in multiple times are Albert, Ten Spot, Inkbox, HomeLister, Grove, Possible Finance, RoboTire, Yummy, WaveTV, and Yassir.

I’ll note, as I keep seeing valuations are going stratospheric in the dozen companies I’ve invested in twice, it’s interesting to remember that almost all of them began with a seed round of less than 10 million bucks. It’s also hard to look back at all the big winners and necessarily correlate my initial excitement, like, “Dude, this is going to be the next Uber.” And then the actual outcome, “Hold on, wait. The founder decided to pivot to what?” You can hear Peter Livingston talk about this in the podcast, “All my best investments were the ones I couldn’t get anyone else to do.” Again, show note link in the archives.

And while we’re on the topic of valuations, how does one even value these early-stage companies? Certainly not 100-page discounted cash flow and 10,000-row Excel model. Most seed rounds range from 5, 10 million total, although, this can easily change based on the business cycle. I just saw a pre-revenue seed recently at 50 million, and by the way, since I wrote this article, I just saw one at 80 million pre, 120 million post, which might be a record for me, as well as intangibles like founders traction, etc. Most of the recurring revenue stock companies tend to get valued around 10 times sales, ballpark, with adjustments made for industries with worse margins. Some consumer products companies you’ll see down to like three times revenue, etc.

I keep a running list of most of the investments I’ve done on a public Twitter list, which you can see linked to this article. I’m not going to read them all off, but you can find them. Feel free to follow along. I don’t know why you would, but just FYI, a fair amount of the companies referenced are not even on Twitter, they are based abroad or still in stealth. But overall, focus on the process, and the learning, not necessarily on your perceived outcome. In time, you’ll develop a system and deal parameters that align with your goals. You simply have to start and then stay committed.

Learning lessons and things to know up front. Five final thoughts, one, sometimes founders like to update their investors on progress and setbacks, sometimes they don’t. It’s odd to me why they wouldn’t utilize an engaged shareholder base as a resource. But many founders go full turtle, pull their head in the shell. During hard times, retreat, call it also the ostrich. On the flip side, I’ve seen many founders fail with grace and courage, and I would 100% invest in those founders again. Think of all the lessons they learned for the next go around.

Number two, if you invest through a syndicate, realize the syndicate leads may have their own incentives to guide them. So you might find a lead selling a holding earlier than you prefer because he or she wants to lock in their carry. Or the lead might sell a company that you love, even though it’s having trouble getting traction, because they want a mediocre performer just off their books, they want to move on. You won’t have much say in this, it can be frustrating, but it’s just part of the process.

Three, do not immediately dismiss ideas that sound stupid or too ambitious. I passed on the seed round for Boom Aerospace because in my head I thought, you know, a startup tackling supersonic travel, no chance. Way too much assets, that’s been acquired. Too capital-intensive, well, they just recently reported, United is going to buy 50 of their planes, dope. There’ll be lots of missed unicorns on your failure resume, that’s fine, because you don’t have to invest in all of them, just one.

Number four, I’m asked occasionally about investing in angel investing funds. Now, by design, I don’t invest in funds as it doesn’t check the box for why I’m investing in the first place, which is, learning, reviewing deals, making picks of my own, etc. So, I only have one fund investment to my name from the early days. What I will say is that it’s a wonderful reminder about the power law dynamic of angel investing in this case. This particular fund I invested in was back in 2015. It’s got 19 holdings, it was actually through Wefunder. A full seven of them have already gone belly up. A complete 100% loss. Another seven are surviving or muddling through, or likely to return maybe their initial investment amount. So, no real big gains, but also at least no losses.

So, out of the 19 holdings, we now have 14 that have either lost money or made nothing in profit. It sounds terrible, right? This is where it gets fun. There are three solid winners, which are still alive and growing. Gingko Bioworks comes in at a near 14 bagger. ShipBob, which is a 19 bagger, but it’s probably more due to a new funding round. And then there’s Checkr, which is a 76 bagger and counting. And the best part is, they’re not done yet. Worst part, they’re not done yet and still could fail too. Overall, these three power law outliers have raised the overall portfolio to a 5X return, which is great in VC, by the way, at last check. Even though 75% of the portfolio holdings are duds so far.

Fifth and last point, how do you handle it when a company is a rocket ship? Specifically, we’ve covered position sizing and initial investment, as well as follow-ons, and what happens when a company goes to zero. Well, nothing, duh, you lose all your money. But what happens when a company actually works? Let’s say your plan is to invest in 100 companies over five years with 10k each. And let’s say halfway through, you hit the lottery. One of these companies goes full rocket ship and hits unicorn status. It goes public, and suddenly, boom, 100 bagger in your E-trade account, woohoo. But what now? You must have a plan for the right tail too. What happens when things work?

Your original plan was to invest in 100 companies, but you’re only 50 in and your one holding is worth more than twice the rest of the portfolio combined. Should you trim, sell some? Do you take all your chips off the table so you can play with house money? Or, if their prospects are positive, do you continue to hold all the shares and let it ride? What if that 100X is just the first stop on the way to 1000X? That $1 million position could be $10 million.

Look, there’s no right answer, there’s only the right answer for you. So, think through this stuff ahead of time, so you don’t let emotional decision-making creep in and that’s where the fractures occur. Perhaps you will scale out at every funding round, or maybe sell X amount if it increases past Y percent of your portfolio. But all in all, look, great problem to have.

So, quick summary on how to craft a plan, there’s 10 of these. One, start following lots of angel and VC leads. Listen to our angel startup shows on the podcast. Read Jason’s book, sign up for his workshop. Two, start reviewing deals. Be in no rush to write the first check. Wait and watch for months, and start to understand all the jargon, red flags, pitfalls, etc. Number three, decide on your annual dollar commitment, say 100k per year, whatever. Four, decide on your standard unit position size, for example, $2,000. Likewise, decide if and when you’ll deviate from the sizing and by how much. For example, half size for pre-seed, to track, or 2X for head-over-heel deals.

Number five, decide on if you will do these follow-on investments, and if so, position sizing. Six, decide on the ballpark number of deals you’ll try and do per year. Seven, decide on the full cycle commitment of 5 to 10 years, and ideally, place those funds in a segregated account. Number eight, decide on what you’ll do with the big winners, and if and when you’ll scale out or sell. Number nine, if you want to do it through retirement accounts, sign up for Alto IRA or other accounts if you’re going to use retirement funds. Number 10, just learn and have lots of fun.

Notice I didn’t include preferences for stages or sectors as those may only become apparent once you start reviewing and investing. Look, overall, y’all, I highly encourage learning about angel investing. It can be incredibly financially rewarding. But as I’ve tried to point out, there’s many other reasons to do it, with perhaps the most important one, it’s just a lot of fun. We have nearly 100,000 investors in our funds at Cambria. Many of you ask, “Meb, can I just invest alongside you and your deals, or invest in your syndicate rolling fund?” And, look, hopefully it’ll be possible one day. But being a public fund manager, that’s lots and lots and lots and lots and lots and lots and lots and lots and lots and lots of extra requirements and disclosures, such a big headache.

In the meantime, you can sign up for my email list to ensure that you’ll see the deals if and when I start sharing them. And by the way, we will have a special announcement coming soon this summer, so, do not miss out. So, stay tuned, y’all. In the meantime, get started on your own. And let me know your thoughts. Let me know your progress. And as always, feel free to reach out to me on email or Twitter. Give us a shout on the podcast, feedback@themebfabershow.com. And as always, please leave us a review. Thanks for listening, friends. And good investing.

Podcast listeners, we will post show notes to today’s conversation at mebfaber.com/podcast. If you love the show, if you hate it, shoot us feedback at themebfabershow.com. We love to read the reviews. Please review us on iTunes, and subscribe to the show anywhere good podcasts are found. Thanks for listening, friends. And good investing.