Dave Sather: The private venture lottery | Business

The allure of private ventures are similar to the mega jackpot. You get the call. “I’ve got a private investment deal. There are very few seats at the table. We want you.”

Wow! You want me on a private deal? That sounds too good to be true. It generally is.

Human psychology is attracted to exclusive things. We want to be in “The Club.” This is especially true when looking at private investments. However, because they are private, rarely is there much disclosure or track record disclosure.

Recently, Shark Tank entrepreneur Mark Cuban shed light on how well private investing worked for him. Cuban revealed that in more than a decade on the TV show, he invested nearly $20 million in more than 85 private deals. That offers a broader base of data to evaluate.

A decade later, his cumulative rate of return has been negative.

Cuban is not dumb nor is he alone in his experiences.

Between 2004 and 2014, Correlation Ventures evaluated 21,000 private venture financings. Of these, 65% lost money. However, 2.5% of the ventures delivered 10 to 20 times their investment. About 100 companies (0.5%) made 50 times their money or more—and that is where the majority of private venture returns came from.

Rarely do investors get this insight into the true performance of private investments. Everyone brags about the “killing” they made on some deal. Virtually never is there a full assessment of how a broad portfolio of decisions have worked out.

What can investors learn from this?

1. Private business ventures are very difficult and successful ones are extremely rare. Cuban’s experience, and that documented by Correlation Ventures, shows that over a very broad spectrum of industries, opportunities and time frames, most private deals are losers.
2. Don’t follow the wealthy. Just because a wealthy person allocates money in an area, does not mean it is wise for you.
3. Social media is not reality. What you see on social media is a delusional state of reality. At best, social media offers fractional insights into how a given investment performs.
4. Keep your lottery tickets very small. Mark Cuban is worth $4.7 billion, and yet only allocated $20 million to private Shark Tank investments. That is 0.425% of his net worth. Keep your lottery tickets very small relative to your net worth.
5. Understand opportunity cost. Cuban joined Shark Tank in 2011. Since then, the broad stock market increased by 300%. Not only did Cuban lose money on his private investments, but he lost the opportunity to increase his return by another 300%.
6. Losses extend beyond money. While Cuban lost cash money on his Shark Tank investments, it also consumed lots of time, his most precious resource.
7. Private investments are illiquid and complicated. Increased complexity increases carrying costs such as legal, regulatory and accounting fees. Increased complexity also exposes you to dangerous things lurking in your blind spots.
8. Entrepreneurship is a 24/7 endeavor. To be successful in an entrepreneurial endeavor, there are no 40-hour work weeks. Even if an entrepreneur works 100 hours a week, there are zero guarantees that regulation, luck or competition will allow success.
9. Loss of control. Being a passive investor in a private investment means you have given away money with zero control over what happens from that moment forward. If you are a limited partner in a private deal, you have no control over how the business is managed or when liquidity will ever be delivered.
10. Transparency. The operating details of private deals are murky and muddy. Publicly traded investments offer audited financials, immediate liquidity and simpler taxation.
11. Profitable ideas don’t always scale well. Even if you find a needle in a haystack, you may never grow beyond a local endeavor. Size is hard and expensive to achieve.
12. Humility is a must. We often see people who are very smart in one area think their intelligence will transfer into non-related areas. This is often the case in private business ventures. Know what you don’t know. Avoid areas in which you have no expertise.
13. Keep it simple. As Warren Buffett has often stated, in the discipline of investing, there are no extra points for an increased level of difficulty. Keep it as simple as possible.

Dave Sather is a Certified Financial Planner and the CEO of the Sather Financial Group, a fee-only fiduciary investment management and strategic planning firm. His column, Money Matters, publishes every other week.