Startups Are The Asset Class Your Portfolio Is Missing

Angel investing sounds like an area of investing that is reserved for millionaires and billionaires. On top of that, it seems much too risky for regular investors. However, it turns out that if you apply the power of diversification and basic business principles, this asset class can be a great addition to your portfolio.

What is Angel Investing?

Every day in America, entrepreneurs have new ideas and are in the process of creating a product or service that they can sell to consumers. Investing in these early stage companies that have the potential for exponential growth is called Angel Investing. Typically, these companies have an idea, a product and potentially revenue. Because they are so early in their lifecycle, they are very risky investments that institutional investors will not fund. This is the niche where angel investors can fill the gap. They get the opportunity to buy a piece of the company at a low valuation. Many of these companies will fail, but those that succeed have tremendous potential to provide a large multiple on the original investment.

For example, Jim has created a new high-tech widget with the potential to capture a large share of a growing market. He started the company, secured a patent, and sold a few to friends and family using his own money.  Jim’s plan requires $1,000,000 to carry the company to cash-flow positive. He offers Angel Investors the opportunity to buy into his company at a $4,000,000 valuation.  Typically, there are multiple angel investors that each put up $50,000 or more to reach the one-million-dollar target.  In industry jargon this would be a pre-money valuation of $4,000,000 and a post-money valuation of $5,000,000 (the value of the company is increased by the amount of money raised).  If you invested $100,000 you would own 2% of the company ($100k/$5M).

If all goes well, the company grows rapidly and a year later is valued at $20,000,000. At this point, the company would likely raise funds from venture capital investors, thus diluting your 2% down to 1.5% because new shares would be issued to the venture capital investor. Another year later they get an offer to buy the company for $100,000,000. As a 1.5% owner of the company, you have grown your original $100,000 investment to $1,500,000 for a 1,500% return.

Research Findings

In 2016, The Angel Resource Institute studied 245 completed investments of early stage startups. They found that a large percentage of them fail to ever return investors capital (70%). However, they also found that the distribution of returns over the average 4.5 year hold period ranged from zero up to 30 or more times the original investment.

Obviously, it is advantageous to have stake in the company that provides greater than 30x the original return, but if we could all pick the next Google and Facebook we would have a lot more money than we do now.

Out of curiosity, I plotted the expected returns in a table and found that a diversified investment of $100,000 over the expected historical outcomes of early stage startups would receive a 2.7x multiple on the original investment after 4.5 years. For those of you who like calculating the time value of money, this is an Internal Rate of Return = 24.69%.

 

 Projected Returns from a Diversified Angel Portfolio  
Capital Invested $100,000 Expected Return
70% <1x capital
18% 1x-5x capital 45,000.0
6% 5-10x capital 45,000.0
4% 10-30x capital 80,000.0
2% >30x capital 100,000.0
Total 270,000.0
Internal Rate of Return 24.69%

 

This was a surprise to me. I invest in many real estate deals where the expected IRR is less than 20%, but often these are concentrated in one asset class and sometimes in one set of buildings in a specific city. If I can achieve a higher expected return by investing in a diversified group of startups, it seems logical that I should consider allocating a portion of my portfolio to this asset class. Plus, this performance is likely to be highly uncorrelated with your other investments which provides additional safety to your overall portfolio.

Criteria for Investing in Startups

The next logical question is to determine what type of startups to invest in. I came to the conclusion that I wanted to invest into early stage companies that have a business model I can understand, a CEO I trust, have very high growth potential, that are scalable and have a strong competitive advantage.

Business Model: Use some basic business sense when evaluating these companies. If there isn’t a market for the product or the market is way too small, they will likely not be able to rapidly grow the company. If the product does not have a path to being profitable, this is not going to be a good company in which to invest.

Founder/CEO: The leader of the company will be a critical piece of the company’s success or failure. You want a leader who can grow the company, who is truly planning to sell the company, who can court investors and has a good track record. Having a CEO you trust is a huge part of the evaluation process as the company will rise or fall based on their abilities in the early stages.

High Growth Potential: Without a high ceiling for growth, you will never have a startup that falls into the 10-30x or 30x+ buckets. According to the Angel Resource Institute, those exits greater than 5x, represented only 10% of companies, but generate 85% of the return. To be successful as an angel investor, you need to maximize your chances of having a high multiple return. A company that projects to grow at 5% per year would not fit the criteria. In addition, the valuation of the company to invest in is important because it is a lot easier to 10x a 1-million-dollar company than a 50-million-dollar company. Pay attention to the valuation of the company when you invest.

Scalable: The company also must have the ability to scale. While fast growth can grow a company from 1 to 2 million in value, it will be much harder to scale up to a 10 or 100-million-dollar business. Often the companies that are successful in scaling up are technology companies because the marginal cost of adding another user is much lower than the marginal revenue that will be achieved.

Competitive Advantage: Last, you want to find a company that has a product or software that is either protected by a patent or by some other logical barrier to entry. If your company has a great idea and proves that there is a market for it, what is to stop a big player from copying the idea and putting you out of business? Without this, you would be very hesitant to invest in a company, even if some of the other criteria are met.

Tax Advantages

There are a few tax reasons to consider investing a portion of your portfolio into a diversified portfolio of early stage companies. First, you can potentially shield up to $10m in gains or 10 times your investment from federal taxes under Section 1202 of the Internal Revenue Code. Consult your tax adviser for more information on Section 1202.

Even without the section 1202 gains rules, your returns in a startup will be treated as long-term capital gains which are taxed at a preferential rate. Also, you can hold title to your shares in a self-directed IRA which provides additional tax benefits.

How to get started

A general rule of thumb is to hold no more than 10% of your net worth in this asset class. Also, you will want to invest in a diversified portfolio of several startups and not put all your eggs into one company. With a 70% chance of failure, you do not want to concentrate all your holdings into one company.

Often the initial minimum investment is $50,000. One way around this is to create an LLC with a few friends and invest into startups as a group. This provides the ability to meet the $50k minimums while providing all of you a more diversified portfolio. For example, if 5 friends put $100k each into the LLC, you could invest in 10 different companies at $50k each with only $100k of capital required of each investor. This provides a way to gain exposure to a wider variety of companies and this LLC can be funded through your self-directed IRA

Conclusion

A diversified holding of startups can provide a non-correlated asset class to your overall portfolio. The high expected returns and tax advantages provide a reason to at least consider why startups are not a part of your current portfolio. Overall, this is an important asset class that is often overlooked by traditional investors.

Peter Amico, PhD

Partner

www.newgatecapitalpartners.com

2250 Lee Road | Winter Park, Fl. 32789 | O: 407.647.8752 Ext 103 | C: 617-501-0065

Business Sales | Angel Investing | Incubation Services

Categories:

Biotech and Medtech are two buzz word industries to be on the lookout for in the M&A space during 2020

Both of these industries have been taking off in the last decade, with an estimation that the global market for Biotech is going to surpass $775 billion within the next 4 years. These estimations coming off the backs of companies making substantial progress within the spaces of human organ growth, lab grown plants, as well as meat synthetics.

In 2017 the same market was valued around $96.4 billion, so the industry is looking at over a 7x growth within only 7 years.

Medtech companies are estimated to be valued in total around $200 billion by 2023 according to a report last year. The aging of the baby boomer generation as well as the rising prevalence of chronic diseases (6 in 10 Americans have one) are some of the key driving factors of this industry. The World Health Organization reports that by 2050 16% of the total world population will be geriatric, which means a giant demand for advancements within medical tech.

The rise of “tele-doctors” within the last 5 years is also new territory. This simple, yet effective, combination of video conferencing and mobile app technology has led to the rise of companies such as “ZocDoc”, which is currently worked over $2 Billion, providing early stage investors over a 100x return from their Series B round, and a 20x return from their Series C round.

Even companies as large as Apple have kept up with the trend in the last decade. The Apple Watch is marketed as not only a wearable for entertainment, but also because of the many health benefits that it offers alongside it. With built-in heart monitoring, moving tracking, and other features many people are are turning to this entry level medical device as a segue into the market.

 

 

One of the largest M&A acquisitions of 2019 was also directly in the BioTech/Med Tech space. Bristol Myers was acquired by Celgen for over $70 billion in early 2019, with many other $10b+ happening further in the year. This trend does not seem to be slowing down either. Forecasts for 2020 show that M&A within this space is expected to continue to increase of the next 5 years, as many of the larger BioTech/BioPharm companies are looking to acquire any new technology they can to continue to capture additional market share.

Investor interest within this space has grown exponentially since the early 2000’s, and right now there is actually a key role for Angel Investors to play within this market. Many of the larger venture firms are waiting to fund these companies until their later rounds (Series B/C), meaning that many of these MedTech firms are looking for debt raises, and Angel Investor raises to get them by in the meantime. What this means for a potential investor is that they will be able to get a much larger piece of these companies, and higher upside return, if they are able to identify prime targets early on.

This space can be hard to break into for a solo Angel Investor if you do not have the right network, but here at Newgate Capital, we screen many potential MedTech deals each year, and are always on the lookout for a great opportunity.

There is no doubt that these spaces are going to continue to thrive over the next decade, and any savvy investor should be looking to diversify a bit of their portfolio here.

Dec 2018 Newsletter

As we near the end of 2018 (my, my what a year this has been), we would like to provide a brief overview of a few of the exciting partner companies in our portfolio (in no particular order). As you can see, we are industry agnostic so our portfolio ranges from the highest of high-tech to a delicious line of Rum. We have additional companies in our portfolio as well as multiple businesses for sale that we will cover in future newsletters.We are very fortunate and grateful that a boutique firm like NewGate Capital is able to attract such quality deals.


locator x company logo

LocatorX plans to disrupt the $27 Billion GPS location services market through their partnership with Oxford University which provides exclusive rights to the University developed Solid-state Miniature Atomic Clock. Once scaled, the patented Global Resource Locator will enable real-time tracking of any asset – both indoors and outdoors – at a low per-unit cost, without the need of installing expensive beacon systems.

As the Internet of Things (IoT) continues its rapid growth, the Global Resource Locator will seamlessly integrate into any device or product to enable accurate and timely location tracking.  While the Global Resource Locator is being developed for mass production, LocatorX is creating a suite of products to improve product and tracking information which will commercialize the back-end functionality of the final product and generate near term revenue.


threatlocker
ThreatLocker has developed an application whitelisting solution that allows businesses to control exactly what is running on their systems while giving them complete visibility. The ThreatLocker solution stops users from running unknown applications (i.e. viruses, malware) without explicit permission from the I.T. department. This results in the virtual elimination of malware and cyber breaches. Unlike traditional whitelisting solutions, ThreatLocker is easy to deploy, requires little management, and easy to permit new software when it is needed. ThreatLocker is fully developed and is in the market with customers and revenue.


A passion for Caribbean culture, coffee and rum. RumJava is a line of artisan crafted rums (4 dark rums and 2 rum creams) distilled in Florida from Florida cane and other natural ingredients. The rums, infused with five Java’Mon Coffee blends, are positioned in the growing flavored rum category and they compete with premium sipping rums. RumJava was awarded 3 Gold Medals at the Miami RumFest and was the highest selling rum at Miami RumFest, UK RumFest and the London Spirits Show. Created in 2017, RumJava has sold 24,000 bottles in 8 states, the UK and the Virgin Islands and is increasingly cashflow positive.

 


secureair

SecureAire has developed and commercialized today’s most advanced air purification systems to combat the growing problem of indoor air quality. SecureAire’s patented Particle Control Technology is able to filter out critical contaminants including viruses, bacteria, mold, VOCs and dissolved gasses (CO2). SecureAire technology has been proven through several supervised pilot projects in hospitals and commercial buildings.  SecureAire is currently manufacturing and selling units for commercial and residential applications.


SuperCooler Technology

SuperCooler Technologies focuses on precision refrigeration and beverage supercooling. They hold numerous patents for chilling, storing and serving beverages. SuperCooler’s flagship product keeps liquids just below their freezing point to offer a perfectly cooled beverage with an instant slush.  A version of this product is being offered in partnership with Coca-Cola branded as Artic Coke. Two of the first Artic Coke Supercoolers in Florida have been placed in Disney Springs at the Coca-Cola Store.


Rentivity is developing the first end-to-end digital marketplace for single-family rentals. A highly automated single point of entry SaaS platform integrates all users, streamlining the entire asset lifecycle. Originated from experience, Rentivity is designed to scale while mitigating risks, improving rents, reducing vacant time on market, and controlling costs.  The Rentivity platform is fully developed, has completed testing, a pilot launch and will be fully released with live customers before year’s end.


GeoToll

GeoToll has created a mobile phone app that replaces the window stickers and other devices used for electronic toll collection. Not only easier to use than SunPass, EZ-Pass, Peach Pass, and all the other toll passes but your one GeoToll app can handle them all. GeoToll has you covered whether you are driving locally, cross country or in a rental car.

GeoToll technology has been proven through multiple pilot tests and is now entering two go-to-market launches in California. The Bay Area Toll Authority (BATA) and the LA County Metropolitan Transportation have awarded GeoToll exclusive contracts and have committed over $350k to proving customer acceptance and operational benefits.


We want to wish each and everyone of you a wonderful Holiday and a very prosperous New Year.

Possible scenario(s) of the future of various industries

Change is inevitable

I imagine some of this will not turn out quite as planned, but it’s interesting to think about, just the same.
In 1998, Kodak had 170,000 employees and sold 85% of all photo paper worldwide. Within just a few years, their business model disappeared and they went bankrupt.

What happened to Kodak will happen in a lot of industries in the next 10 years – and most people won’t see it coming. Did you think in 1998 that 3 years later you would never take pictures on film again?

Yet digital cameras were invented in 1975. The first ones only had 10,000 pixels, but followed Moore’s law. So as with all exponential technologies, it was a disappointment for a long time, before it became way superior and got mainstream in only a few short years. It will now happen with Artificial Intelligence, health, autonomous and electric cars, education, 3D printing, agriculture and jobs. Welcome to the 4th Industrial Revolution. Welcome to the Exponential Age.

Software will disrupt most traditional industries in the next 5-10 years.

Uber is just a software tool, they don’t own any cars, and are now the biggest taxi company in the world.  Airbnb is now the biggest hotel company in the world, although they don’t own any properties.

Artificial Intelligence: Computers become exponentially better in understanding the world. This year, a computer beat the best Go player in the world, 10 years earlier than expected.

In the US, young lawyers already don’t get jobs. Because of IBM Watson, you can get legal advice (so far for more or less basic stuff) within seconds, with 90% accuracy compared with 70% accuracy when done by humans.  So if you study law, stop immediately. There will be 90% less lawyers in the future, only specialists will remain.

Watson already helps nurses diagnosing cancer, 4 times more accurate than human nurses.

Facebook now has a pattern recognition software that can recognize faces better than humans. In 2030, computers will become more intelligent than humans.

Autonomous cars: In 2018 the first self-driving cars will appear for the public. Around 2020, the complete industry will start to be disrupted. You don’t want to own a car anymore. You will call a car with your phone, it will show up at your location and drive you to your destination. You will not need to park it, you only pay for the driven distance and can be productive while driving. Our kids will never get a driver’s license and will never own a car.

It will change the cities, because we will need 90-95% less cars for that. We can transform former parking spaces into parks. 1.2 million people die each year in car accidents worldwide. We now have one accident every 60,000 mi (100,000 km), with autonomous driving that will drop to one accident in 6 million mi (10 million km). That will save a million lives each year.

Most car companies will probably become bankrupt. Traditional car companies try the evolutionary approach and just build a better car, while tech companies (Tesla, Apple, Google) will do the revolutionary approach and build a computer on wheels. Many engineers from Volkswagen and Audi; are completely terrified of Tesla.

Insurance companies will have massive trouble because without accidents, the insurance will become 100x cheaper. Their car insurance business model will disappear.

Real estate will change. Because if you can work while you commute, people will move further away to live in a more beautiful neighborhood.

Electric cars will become mainstream about 2020. Cities will be less noisy because all new cars will run on electricity. Electricity will become incredibly cheap and clean: Solar production has been on an exponential curve for 30 years, but you can now see the burgeoning impact.

Last year, more solar energy was installed worldwide than fossil. Energy companies are desperately trying to limit access to the grid to prevent competition from home solar installations, but that can’t last. Technology will take care of that strategy.

With cheap electricity comes cheap and abundant water. Desalination of salt water now only needs 2kWh per cubic meter (@ 0.25 cents). We don’t have scarce water in most places, we only have scarce drinking water. Imagine what will be possible if anyone can have as much clean water as he wants, for nearly no cost.

Health: The Tricorder X price will be announced this year. There are companies who will build a medical device (called the “Tricorder” from Star Trek) that works with your phone, which takes your retina scan, your blood sample and you breath into it.nIt then analyses 54 biomarkers that will identify nearly any disease. It will be cheap, so in a few years everyone on this planet will have access to world class medical analysis, nearly for free. Goodbye, medical establishment.

3D printing: The price of the cheapest 3D printer came down from $18,000 to $400 within 10 years. In the same time, it became 100 times faster. All major shoe companies have already started 3D printing shoes.  Some spare airplane parts are already 3D printed in remote airports. The space station now has a printer that eliminates the need for the large amount of spare parts they used to have in the past.
At the end of this year, new smart phones will have 3D scanning possibilities. You can then 3D scan your feet and print your perfect shoe at home.  In China, they already 3D printed and built a complete 6-storey office building. By 2027, 10% of everything that’s being produced will be 3D printed.

Business opportunities: If you think of a niche you want to go in, ask yourself: “in the future, do you think we will have that?” and if the answer is yes, how can you make that happen sooner? If it doesn’t work with your phone, forget the idea. And any idea designed for success in the 20th century is doomed to failure in the 21st century.

Work: 70-80% of jobs will disappear in the next 20 years. There will be a lot of new jobs, but it is not clear if there will be enough new jobs in such a small time.

Agriculture: There will be a $100 agricultural robot in the future. Farmers in 3rd world countries can then become managers of their field instead of working all day on their fields.

Aeroponics will need much less water. The first Petri dish produced veal, is now available and will be cheaper than cow produced veal in 2018. Right now, 30% of all agricultural surfaces is used for cows. Imagine if we don’t need that space anymore. There are several startups who will bring insect protein to the market shortly. It contains more protein than meat. It will be labeled as “alternative protein source” (because most people still reject the idea of eating insects).

There is an app called “moodies” which can already tell what mood you are in. By 2020 there will be apps that can tell by your facial expressions, if you are lying. Imagine a political debate where it’s being displayed when they are telling the truth and when they are not.

Bitcoin may even become the default reserve currency. Of the world.

Longevity: Right now, the average life span increases by 3 months per year. Four years ago, the life span used to be 79 years, now it’s 80 years. The increase itself is increasing and by 2036, there will be more than one year increase per year. So we all might live for a long long time, probably way more than 100.

Education: The cheapest smart phones are already sold for $10 in Africa and Asia. By 2020, 70% of all humans will own a smart phone. That means, everyone has the same access to world class education.? Every child can use Khan academy for everything a child learns at school in First World countries. We have already released our software in Indonesia and will release it in Arabic, Suaheli and Chinese this Summer, because I see an enormous potential. We will give the English app for free, so that children in Africa can become fluent in English within half a year. Boom!

 (Author unknown)

Top 10 Investors’ Investment Criteria

Investor’s investment criteria in rough order of importance for all investors

Source – Harvard Business School Division of Research

  1. Enthusiasm of entrepreneur

  2. Trustworthiness of the Entrepreneur

  3. Sales potential of the product

  4. Expertise of the Entrepreneur

  5. Investors liked entrepreneur upon meeting

  6. Perceived financial reward

  7. Growth potential of the market

  8. Quality of the Product

  9. Niche Market

  10. Track record of the entrepreneur

Invest

Angel groups expose entrepreneurs to a wide set of potential investors. At NewGate Capital Partners, our structured process facilitates a relatively quick and efficient investment decision. We provide insight through ongoing coaching and mentoring from seasoned entrepreneurs and executives.

 

For more info check out this guide Angel Investing 101

Want to know more? visit us at http://www.newgatecapitalpartners.com/capital-angels/entrepreneurs/

 

For the Complete list look below:

 

Investors' Investment Criteria HBR

 

 

Investing in Startups has Increased Significantly Over Recent Years

Investment changes you should be aware of

Rock The Post’s 2013 Investor Trends Survey reveals interesting insights into the changing investment landscape and investment
attitudes among private investors today compared to 10 years ago. Upcoming regulatory changes with the JOBS Act will further
shape the investment world, allowing investors to invest in private companies for the first time in 80 years regardless of income
or net worth. The Investor Trends Survey also identifies some key characteristics of experienced angel investors ? those who
have experience investing in startups ? compared to non-angel or novice angel investors.
This special report contains a selection of the insights from Rock The Post’s 2013 Investor Trends Survey, including:

  • Investor portfolios consist of 15% more alternative investments now than 10 years ago
  • Experienced angel investors have a lower percentage of mutual funds in their portfolios than novice and non-angel investors
  • Investors are relying less on intermediaries to carry out their investments and more on direct investing methods
  • The availability of investment tools, such as online trading platforms, and investors experience with direct investing are the main reasons they are encouraged to manage their own portfolios.