(Forbes) Diversify across stocks and sectors. Diversify between asset classes. Even mix up asset managers. All so that a single blow or oversight won’t wipe out most of your wealth.
From an asset class perspective, diversifying used to be easy. You simply juggled two asset classes: bonds and stocks. Can afford to take chances? Load up on more stocks. Taking it easy before retirement? Tilt the portfolio toward bonds.
There’s even a first-grader-level formula for that: your age = the percentage of bonds in your portfolio.
But what if the two main building blocks of the portfolio have gone off the rails?
Rising inflation has marked the end of a 40-year bull market in bonds. Even investing prodigy Warren Buffett recently admitted that “bonds are not the place to be these days.”
This setup is urging a boom in so-called “alternatives.” That’s a fancy word for investing in any stuff other than bonds and stocks. It could be real estate, private companies, loans to people or businesses—or even a pair of collectible Jordans.
So today I’ll touch on one alternative investment that recently opened up to all individual investors. It’s venture capital. And billionaire investor Kevin O’Leary thinks it will be the fastest-growing asset class among individual investors.
So I spoke with Kevin about this niche asset class and how individual investors could incorporate it into their broader portfolio. Here are some highlights from our conversation.
Kevin, as someone who’s invested in hundreds of startups and now has his own company raising money through crowdfunding, could you give me your “insider” take on crowdfunded equity? Is it a passing fad, or something that will stick around?
That is an excellent question and a good way to start because equity crowdfunding began years ago when regulators saw a big problem. Companies like Google or Microsoft or any other tech behemoth… are really in the hands of a very few venture capitalists who had exclusive access to these deals.
So the regulator democratized this by allowing startups to raise funds directly from the people through crowdfunding campaigns. And obviously, many, many companies took up this opportunity, including many of my Shark Tank companies.
However, the community—if you want to call it that—came back to the regulator and said this is not enough. We need five million dollars, not one million dollars. The world has changed and five million dollars is not enough. Venture capitalists have an unfair advantage because they can offer that, we don’t.
That all changed this Monday, and I think it's a fantastic development. Crowdfunding is a perfect platform for both startups and investors—which is why I'm involved and will continue to bring my companies for funding.
Let’s talk about crowdfunded startups as an asset class. Stocks are at record highs and rising rates are squeezing up bond investors. I see that institutional investors are plowing more and more money into alternative assets for diversification and greater returns. Do you think crowdfunded startups can give individual investors similar benefits?
That’s a great point you're making because I look at it and say to myself, this is the first competitive asset class that's come out in 30 years. It’s an alternative to stocks, bonds. It’s an alternative to alternatives like private equity, venture capital, and hedge funds. I mean those other asset classes have been around for decades but this is brand new. And yes, I think it will provide diversification and outperformance benefits in the long run.
Why should anyone go to the trouble of investing in startups as opposed to simply snapping up an ETF that tracks Nasdaq?
The short answer is growth. When you’re able to harness the hyper growth of a successful startup, you can't find that in any index. You're not going to get it.
But that kind of growth, obviously, comes at a much higher risk. What percentage of the portfolio would you recommend allocating to these companies? And from a portfolio construction standpoint, how would you go about building that allocation?
I think allocating 10% of your capital to crowdfunded startups would be a great place to start. Then get a feel for the volatility, of which there's a lot. If you feel comfortable, you can ramp up the allocation, but I’d not go over 20%—ever. In that allocation, I’d have a minimum of 10 companies to diversify across sectors, products, and business models.
As an investor, I have one big concern about crowdfunded startups. It stems from the fact that a lot of early-stage companies aren’t looking just for money. They also need strategic partners. Doesn’t that mean that for a lot of companies crowdfunding is some sort of last resort funding option? In other words, aren’t individual investors betting on “leftovers”?
That's one way to look at it, but that wouldn't necessarily be correct. Here’s the problem with raising money with VC funds.
99% of the time they’ll ask for preferred shares, which will give them certain attributes to their investment that you as a founder don’t have. Then they’ll put you in some fund that has strict targets it has to meet. And in, say, 36 months, they’ll be knocking on your door to get their money back.
I mean, I don't find any of that attractive at all. So, I wouldn't even take that route from the beginning. This crowdfunding thing is not the last chance romance. It's actually a much better deal than any venture capitalists can offer. And they're going to have to adjust their models.
Now, let’s shift gears a little and talk about picking your roster. Unlike stocks, these companies are pre-money or in very early stages anyway. Could you give me a “cheat sheet” that you use to vet such early-stage companies?
Number one, does the company have a mission? I'm really amazed what happens when a company is driven by some passion for something they believe in and—most important—can communicate that very clearly.
Take M.C. Squares and how simple their story is, which is replacing billions of sticky notes that are discarded every year with a reusable alternative. It’s a very compelling argument. Everyone gets it. Their holders get it and so will potential shareholders.
That brings me to the next item on my list—the sustainability factor. That used to be a marketing play five years ago. Oh yeah, we care about the environment. That's not a marketing idea anymore. You have to have sustainability in your business model or you will not get customers, and you won't get shareholders.
Investors want to feel good about their investments. They want to feel that when they put money to work, they're not harming the earth in any way.
Third, the team and its executional skills. Do you believe they can pivot and adapt? Do you believe they understand their business model? I even prefer to invest in people who have failed before and felt the sting of failure. That motivates them to try again and not make the same mistakes.
In my case, the majority of the companies I’ve invested in are run by women. They simply mitigate risk very well, and they're just extremely good at hitting targets. I’m not biased by gender. I just like making money and I've made more money with women.
And last, I’m a big fan of the direct-to-consumer business model. I have no interest in retail anymore. The world's changed completely. Consumers want to buy directly from a company's own website. And this business model gives the highest margins a business can have.
