capital is unquestionably risk capital – to enable them to turn their dreams into realities. This book will help you find them, understand them, and, with some pluck and luck, become a successful venture capital investor or VC‐funded entrepreneur. The result could be personal wealth, job creation, and a capital contribution to our country. Simply stated, we hope this book will help you win!
Introduction
Since the financial crisis of 2008–09, the American economy has struggled to grow at just 2 %/year. Yes, there has been an extended stock bull market, but the bull must inevitably lose its vigor unless economic growth accelerates significantly.
With the stock market climbing sharply immediately following Donald Trump's election as our nation's 45th president, there are some betting that the Trump presidency will result in such an acceleration. We won't know whether such forecasts prove accurate, and to what degree, for some time. Stock market returns over the past seven or eight years admittedly look great, but that's due largely to the bounce‐back in prices following the devastating collapse of 2008–09. A look at the stock market over a more extended time frame presents a more sobering picture. Factoring in all the ups and downs, from January 1, 2000 to January 1, 2017, the S&P 500 index grew just 2.7 %/year. Add dividends paid by the S&P 500, which have averaged around 2 % annually, and you're looking at an average annual return of slightly below 5 % over that period.
Moreover, the rise in stock prices to historical highs has been helped in recent years by the near‐zero interest rate environment, which has forced investors to turn disproportionately to stocks for any hope of decent returns. Therefore, even if economic growth accelerates, let's say to a 4 % rate, the likely accompanying rise in interest rates to more normal levels should temper further prospective stock market gains.
Innovation: The Path to Wealth Creation and What Venture Capital Is All About
So how can the American Dream of wealth creation continue? The key is, and has always been, major innovation – new technology and new product development that address new needs or meet existing needs dramatically better.
The most successful major companies understand this. Today's Wall Street darlings – companies like Microsoft, Alphabet (the parent of Google), and Facebook – were yesterday's venture capital–funded startups. These companies understand that major innovation must never stop. Look at the publicized innovation efforts of Alphabet (now pursuing self‐driving cars), Tesla owner Elon Musk (racing to commercialize space travel), and the major pharmaceutical and biotech firms creating new cures for diseases that won't go away.
Automotive companies such as Volvo and BMW have established formal venture capital arms. Even marketers of mundane food, household cleaning, and personal care products, such as Unilever, are setting up venture capital arms to fund innovative startups in their fields whose growth prospects they can then nurture with dollars, distribution clout, and management know‐how.
So, a fair question from investors might be, why not just invest in the stocks of these big‐league innovators? We'd never suggest that you not invest in these companies. They've demonstrated the ability over the years to grow their businesses and stockholder value. There is one caveat, though. Their already high share prices have baked in investor expectations of continued healthy growth. Hence, you may earn a respectable return on those stocks, but don't count on breakaway gains.
The biggest wealth creation opportunity – for both entrepreneurs and the investors who back them – is through market‐changing innovation commercialized by new ventures. There are the latest winners, highly valued new ventures you've heard about – Uber, Airbnb, Instagram, Square, and many others. There are also the home runs that aren't household words. We just told you about one in the Preface that enriched many of our Batterson Venture Capital investors, a company called Cleversafe. Cleversafe's revolutionary innovations in data storage turned roughly $100 million in investments (to be clear, only about 4 % from Batterson Venture Capital) into a $1.3 billion sale to IBM. And there are some doubles and triples out there, too, though the biggest money is to be made on the home runs.
As awareness of recent venture home runs has grown, there has been a surge in innovative venture activity. It's no longer limited to Silicon Valley and Boston's Route 128. Venture capital activity is flourishing in New York, Los Angeles, the DC metro area, Austin, and anywhere where creativity, ambition, and the funds to nurture it are found.
Venture incubators and supportive angels are emerging everywhere. Cleversafe is a great example. While people often talk about the Midwest's conservatism and reliance on agriculture and heavy industry, Cleversafe's billion‐dollar+ win was created in Chicago. In fact, Inc. recently reported that Chicago (which is where our funds are based) is now second behind only New York City in the number of fast growing private companies on the Inc. 5000.
The dollar growth in venture capital investment reflects this broadened activity. Venture capital investments in 2015 totaled $59 billion, up 153 % since 2005. Importantly for our readers, for the past couple of years, investments by individuals have caught up with the dollars invested by the big institutions. The rich potential returns from venture capital used to be restricted to an exclusive club of institutions and the mega‐wealthy, but are now becoming “democratized.”
Venture capital returns historically have been handsome, averaging about 12 %/year. That's a lot better than the almost 5 % average return from the S&P 500 over the past 16 years, and almost anything beats today's near‐zero interest rates.
Some venture capital leaders have done even better. The funds we've managed have generated investor returns averaging 28 %/year over the past 30+ years. We've done that even through the dot‐com collapse of 2000 and the broad economic plunge of 2008–09.
Our secret approach in fact isn't really a secret. We've shared it openly in the past, and will share it with you in this book. It takes lots of hard work, screening hundreds and even thousands of venture opportunities to select the few that we believe could grow into billion‐dollar+ home runs. We review at least a hundred ventures for every one in which we invest. We usually get in early, while these ventures still carry low valuations, before others recognize their potential.
The exhaustive screening and due diligence pay great dividends. To be clear, we don't always get it right. But more than 35 % of our investments have delivered some positive return to investors. While that might not sound so great, that's almost double the success rate of the industry in total. (It's like baseball, where a .350 batting average can win the batting title!) And our big winners like Cleversafe (and several others, including our multibillion‐dollar exits for AOL and CyberSource) mean lots of new wealth for our investors.
Before we go further, though, let's be clear. Venture capital investment is not for the faint‐hearted. It is a high‐risk – and potentially high‐reward – opportunity. Most new ventures fail. Just 10 % of venture capital investments deliver the majority of all returns. In this book, we'll try to help you maximize your success odds and manage your risks. We don't believe that any investor should risk losing his or her proverbial shirt in venture capital.
It's a high‐risk, high‐reward potential situation for entrepreneurs, too. It's easier and lots less risky for talented, ambitious individuals to devote their talents to large, well‐capitalized enterprises and make a comfortable living. But for the most ambitious individuals (and often the most talented), many of whom don't want to live under the yoke of corporate direction and are determined to do their own great thing, that is not enough. They seek the gold ring that can be captured only by building their own market‐moving enterprise.
After they've started up by borrowing from credit cards and home equity lines and then tapping into supportive and hopefully well‐heeled family and friends, they need to find the even‐bigger funds to continue on. As startups succeed, their capital needs to realize their full potential grow sharply.
It's often said that venture successes inevitably take twice as long and require three times as many dollars as the entrepreneur expected. So he or she had better know what they're doing, and go after funds from the right