Getting in on the ground floor

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A couple of weeks ago, I did an interview for Ideamensch. One of their questions was about what technology I thought would be most interesting or disruptive in the future. Here’s what I said:

I think we’re massively underestimating the importance of home 3D printing. 3D printers are where the homebrew computer club was decades ago—curiosities that geeks play with. But the color copier went from the printing shop to your home office in only a few years. So imagine what happens when everyone can print at home.

If you think that MP3s disrupted the music industry, or that streaming video killed video stores, then just wait. How will Toys-R-Us deal with us downloading and printing out children’s toys? What happens to Fedex and UPS when, instead of ordering things, we order raw materials for our printers? What happens to an auto parts store when every garage has a lathe? We’re turning supply chains into data and pushing the factory out to the edge, and that’s going to be absolutely huge.

A family friend who read this asked me how mere muggles like us could get in on these technologies early on. She’s not the first to ask me this, so I thought I’d take the time to explain it in detail. I’m not a financial advisor, but I have had dealings with investors (through the funding and acquisition of Coradiant) and early-stage incubators (like Year One Labs and FounderFuel.) So here goes; remember to ask someone smarter than me before you spend your money.

Makerbot I built last Christmas vacation

Right now, emerging tech like printing 3D objects is nascent at best—where the Homebrew Computer Club was 40 years ago, when Jobs and Wozniak were screwing together the first wood-cased Apple 1. But it’s growing fast: companies like Boston-based Formlabs are trying to launch consumer-grade devices soon. And the Thing-o-matic printer, which comes in several sizes, won awards at the mainstream Consumer Electronics Show. It was once available as a kit (like the one I built with my friend Eric Packman this Christmas) but now it comes pre-assembled, a testament to the company’s more mainstream aspirations.

The problem is that you can’t get in on the ground floor. There are four basic investment models you can adopt, each more focused (and more risky) than the former.

First: A financial advisor

First, if you’re a traditional consumer who wants to invest money, your financial advisor is putting your money into diversified funds to mitigate risk. Lower risk, lower return: like betting on red or black in the casino. But this also means you can’t reap the huge upside of a hot sector. These funds usually invest in public companies, and generally try to amortize risk across many of them, maintaining a mixture of industries, countries, and company sizes. But the companies are generally public, and as a result, less risky.

You can invest in public companies, of course. This is rather the point of the Initial Public Offering—that it’s public, and everyone can get it, but also that accountants and financial types have been through the company with a fine-toothed comb, ensuring that it’s reporting in a consistent and predictable fashion and doesn’t have skeletons in its fiscal cupboard.

Second: directed investment

A second alternative is to find a targeted investment vehicle. For example, there might be a mutual fund focused on emerging technologies. This is like betting on, say, a cluster of numbers in roulette. More risk, more reward. But even these are diversified. A mutual fund of this type might spread its investments across solar, cloud computing, 3D manufacturing and other new technologies. It’s hedging its bets—which is where the term hedge fund comes from.

So while you can use an investor-directed investment strategy (choosing where to put your RRSP or 401K, rather than having someone else allocate it based on your tolerance for risk and desire for income) you can only direct it so much: North American Emerging Technologies, or European Growth, for example.

Third: limited partnership

A third alternative is the Limited Partnership. LPs, as they’re called, are the bosses of venture capitalists. They might lend $100M to a venture firm as part of a $500M fund, and trust the VCs to find risky, but decent bets to invest in. One of those ten bets might pay off, Google-like, handsomely enough to cover the failure of the other nine; there’s a lot of debate about whether this is actually good money, or just a shell game.

Certainly, top-tier firms like Sequoia, Sierra, and NEA, as well as focused funds like IAV, deliver returns; but plenty of others don’t. Generally speaking, an LP is a pension fund or big money investor. Desjardins, the Quebec banking giant, devotes some money to VCs in this way; but it also puts plenty into boring things like insurance companies and hydro-electric dam completion bonds.

So if you have money at Desjardins, you may have money in a 3D printing company—but it’s so diluted and far away through middlemen as to be almost meaningless. Any returns from that company will be similarly diluted across more boring ones.

Fourth: angel investing

So how do you invest directly, and get in on the ground floor? Once, this was a “friends and family” deal where a few personal contacts put in tens of thousands each to get a company off the ground.

Today, if you have money to spare (the US definition of this is over $200K a year of income, or assets in excess of some amount, or an accreditation) then you are considered an “informed private investor” and can lend money to startups. In Quebec, there’s a group called Anges Québec that does this stuff; they’re the folks who backed Year One Labs for the relatively small sum of $350K ($50K per company, plus $100K of overhead; you can read more on the blog.)

Anyway, in the US there are several organizations focused on this kind of thing in a more equitable, open manner (as begets American business in general.) Much of this openness comes as a result of the reduced friction that electronic tools like mailing list bring to commerce. Some of the growth is a result of the explosion of startups encouraged by “accelerators” like YCombinator, Techstars, 500Startups, and others. In Montreal, FounderFuel is doing a good job of running this kind of program, too. (disclaimer: I’m an advisor to them.)

At the trivially low, easy end is Kickstarter, which lets you pledge money to a project (a record album, a startup, a charity) and when they meet their target, green-lights the project. This is good because it moves the riskiest part of modern business (getting customers!) up front and tests the virality of the idea (if nobody tells their friends, they won’t meet their funding target.) You’re basically voicing your support by buying something in advance, but you’re not an investor. But it does let you “test the waters” of a thing to see if it’s real, and it’s a great Litmus test for whether a thing will catch on later. There are other Kickstarter clones focused on things like university research.

A much more hands-on model is angellist, a mailing list that connects budding entrepreneurs with backers. This has introduced considerable liquidity into private equity, and it’s where early-stage companies like Formlabs get their initial funding. So why not dive right in?

The problem here is twofold:

  • First, the companies are early, unvetted, and risky (caveat emptor!) Most people won’t get their money back, which is a bad thing. You don’t know these companies, and they could fold tomorrow; they may already owe money to others, and plan to use yours to pay off those debts; the founders could have a falling out and shut the doors.
  • Second, and more insidiously, later investors who come in on subsequent investment rounds may “wash out” early investors unless those investors have additional capital to put in to preserve their percentage of investment. In the parlance of venture capital, follow-on funding is known as “dry powder”: you need to have enough dry powder in case things blow up!

It’s also worth noting that investors are pretty smart. In an era of frothy, sky-high valuations and over-hyped expectations, founders want to be valued highly. Rather than argue about what someone is worth, wily investors accept the high valuation, but pepper their investment documents with gotchas: antidillution, which makes them not get washed out when the value falls; preferences, which pay them out several times their initial investment before anyone else makes a penny (including the founders!) and so on.

Anyway, that’s the landscape of investing for mortals like us. Hopefully this gives you some things to chew on.