79. How to Achieve Institutional Terms on Venture Capital Investments with Alec Ellison

PILF 79 Alec | Diversification

 

Speculation is often the most exciting and riskiest part of a wealth-building strategy. Venture capital is a great way to potentially boost your overall portfolio returns with a small allocation to this type of speculation. We usually talk about boring (consistent) returns on real estate investments, but today we are switching gears and chasing shiny objects! Listen in as Alec Ellison, Chairman of OurCrowd US, explains how to reduce risk while investing in startups, Series A, unicorns, and much more. These are definitely more risky than our typical real estate investment, but a small and careful allocation to venture capital can have positive effects on your overall portfolio. Tune in as Alec shares his journey with Jim Pfeifer on what it’s like to pursue a proprietary public investment strategy, how to capitalize on the accelerating rate of technological change impacting companies across all industries, and learn why most startups aren’t going public as early or often as in the past.

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How to Achieve Institutional Terms on Venture Capital Investments with Alec Ellison

I’m excited to have Alec Ellison with us. He’s the Chairman of OurCrowd US business. OurCrowd is a platform that presents opportunities for investors to invest in startups, venture funds, and emerging companies. They vet the companies and deals and present them to investors. It’s a great platform. It’s one of those fun things we do with maybe a small part of a portfolio, and the rest might be the boring real estate. Alec, welcome to the show.

I’m terrific to be here. Thanks for having me.

The first question I always ask is to get a little bit about your journey and your background. How did you get to where you are? How did you get into investing in startups and then become working for a startup?

I spent my career as a technology investment banker. I started at Morgan Stanley in the mid-’80s out of college. After business school, I joined a tech M&A boutique called BroadView, knowing that I wanted to immerse myself in the technology ecosystem. I was there for several years. I was President when Jefferies bought us to be their technology investment banking business and spent several years at Jefferies.

I was first running the tech banking business, then all of TMT tech, media, telecom, and co-heading all of the banking for a while. Hanging my hat, the last several years there as a Vice Chairman of the firm and executive committee member before retiring from investment banking in 2016 after many years in the tech banking business.

I have been involved in the venture capital ecosystem as an advisor and banker since the mid-’80s. It’s when I got involved with OurCrowd. As some of your readers may know, OurCrowd is based in Israel. I had known the Founder from the mid-’90s, as we were at BroadView very active in the early days of the Israeli ecosystem, which is now a massive ecosystem and home to 10% of the world’s unicorns, which is pretty remarkable for a country of under ten million people.

I started investing on the platform. I was asked to get more involved. I joined the board for several years, and then a few years later, we are talking about the spring of ’19. I took on this executive role where I Chaired the US business and served as the firm’s Executive Committee Chair. It’s a continuation of the journey I have been on for years. What I will also add is that I have never been more excited about the technology and growth ecosystem globally.

When I started, there was a PC boom in the mid-’80s. A few of your readers may know, and most of you probably weren’t born yet, but Apple went public in ’81 and Microsoft in ’86. There have been booming buses since then. There was the internet and the so-called dot-com crash, and we had the financial crisis. More recently, we’ve had a real boom in the market and a decline in valuations but every one of these explosive booms is based on economy-changing technology. The Roaring Twenties of the 1920s, which may be a term you are familiar with, may become eclipsed by the Roaring Twenties. We believe we are entering now, as those ’20s were driven by the electrification of mechanical industries. Artificial intelligence is transforming every industry and component of digital technology.

Why artificial intelligence? Why Israel? There are so many startups in Israel. Artificial intelligence is that embedded in a lot of startups or separate startups would need artificial intelligence for other companies.

Those are two different questions, so let me address them one by one. First, Israel was labeled the Start-up Nation, which is the title of that book several years ago, where some authors looked at the ecosystem and said, “Why is this country of 7 or 8 million people, now it’s close to 10 million with very little natural resources, literally the size of New Jersey creating so many startups, particularly in areas like cybersecurity, communications, and medical devices?”

The analysis was threefold. One, pretty much every eighteen-year-old Israeli enters the Arm services because they live in a pretty bad neighborhood. Hopefully, it will get better but it’s a bad neighborhood. They get great training. There are units that have spawned repeated entrepreneurs. Number 1) Is the technical training. Number 2) Is a lack of natural resources. As Golda Meir, the late famous Prime Minister of Israel, used to say, “Moses took the Jews out of Egypt to the only place in the Middle East with no oil.”

Artificial intelligence goes back to the fifties. It's not a new term. The methodologies go back almost as far as the idea that computers actually think more and more like humans. Click To Tweet

There is some offshore natural gas now, but back in her day, that was the observation. They had this great training. They had a very educated population but you could say Switzerland has those things, a similar population, everybody goes into the Arm services, and no real natural resources except for skiing. Israel has a culture of risk-taking. That comes back a bit to the bad neighborhood. When you live in a country where you are constantly threatened existentially by your neighbors, the idea of starting a company doesn’t seem risky at all. That does pervade the ecosystem.

Once an ecosystem gets going, as we saw with Silicon Valley and Massachusetts going back to the ’50s and ’60s, it feeds on itself. It attracts risk-takers themselves. It attracts capital and all the services around it. That’s why you have that ecosystem developing that. I should add that while in the early days of OurCrowd, all the deals were coming out of Israel, and all the new companies now, only about half are coming out of Israel. Probably, a third-plus from the US and then 10%, 15% from the rest of the world, India, Southeast Asia, and Canada. We are looking a lot in the gulf now, where we have been licensed to invest in companies since the Abraham Accords. That’s the Israel part.

To your question about artificial intelligence, the term artificial intelligence goes back to the ’50s. It’s not a new term. The methodologies go back almost as far as the idea that computers think more and more like humans. When I was a young banker in the ’80s, we would call on artificial intelligence companies. Every single one of them disappeared. The reason was that the methodologies involved in artificial intelligence require lots of computing power.

These terms you hear like graphic processors and big data cloud computing, the ability for anybody in a lab, anywhere to access world-class power of computing are what have enabled these methodologies that have existed for many years to finally be applied. That’s what is started happening now. Another term is 5G. 5G communication is the power to wirelessly convey the big data that is being collected with the internet of things, which is another buzzword for you.

All these billions of devices around the world that are collecting this and communicating it wirelessly to a processor are continuing with Moore’s Law and getting more powerful. Processing speed and storage can be accessed with a link to Amazon web services or Google cloud about anywhere in the world if you’ve got a connection.

It’s this infrastructure. Again, big data and the internet of things, all these things that didn’t exist when artificial intelligence methodologies were first developed, are now allowing the promise to be a reality. As Marc Andreessen famously said in 2011, “Software eats the world.” Anytime you can digitize a process in any industry, even old boring industries like utilities. You can apply software and change it. That eats that industry.

It’s hard to name an industry that has not been transformed by technology. That same digital technology has transformed every industry and is being turbocharged with artificial intelligence. When we talk about some of our companies being artificial intelligence companies like Hailo, it’s an artificial intelligence chip company but about any tech company worth their salt is applying the components of artificial intelligence if they are going to be competitive.

The first thing I need to do is step back because we are getting into it, and this is what I want. Venture capital is what we are talking about, startups, Angels, and unicorns. Are those all the same thing? What are the terms that we are looking for our crowd as investing and these pre-IPOs? Are they all the same thing?

No, they are not. I will tone down the buzzwords a little bit because I know you and your investors are in real estate. The way you think about venture capital it’s a subsegment of the private equity world. The private equity world includes anything that’s not public. That is a world that is growing by leaps and bounds in part because the public markets are shrinking. There were barely half as many US public companies now than there were in 2000. It has been a steady decline. We thought there was going to be some dramatic expansion with the so-called SPAC phenomenon. It’s not playing out. That market is busted.

The private market is becoming more and more important compared to the public market. Unfortunately, the private market isn’t accessible to everybody. We think, dare I say, a tragedy but certainly a lost opportunity for most investors who are sitting around waiting for a great company or the next Google to go public but the reality is over 90% of companies that get actual venture capital money, never go public. They sell before they go public.

The public misses these opportunities very differently than when I started my career. When Apple and Microsoft went public, they were much earlier in their development. If you bought those things, you’ve 1,000 times your money. Google went public in ’04, it’s probably 40 times your money now, which is unbelievable but that’s the big outlier. Most companies never go public, and the companies that do go public wait until they are much longer.

PILF 79 Alec | Diversification
Diversification: We had the financial crisis, and then more recently, we’ve had a real boom in the market and a decline in valuations. But every one of these explosive booms is based on literally an economy-changing technology.

Turn into the private world, and venture capital is the term applied to the earlier stage of the private world. Everything from startups, seed investing, which is even a subset of that, and the growth stage. You think of it as seed, startup, growth, and then maturation. It’s very different than the LBO world. LBO means Leveraged Buyout, which implies that there’s leverage. There’s a lot of borrowing and debt where you take mature companies and lever them up as you do with real estate. You take a dependable set of cashflows, lever them up, and get a better equity return.

Vert little leverage in the venture and growth world. There are some but very little because there’s enough risk without taking on incremental financial risks. You’ve got technology risk, and product market fit risk. Usually, debt only comes in later stages and with small debt to a total cap or debt to a total value type of ratios compared to what you see in the real estate world.

The term venture capital also is used when there’s institutional money or high-net-worth money going into the companies. It’s a little bit different than Angel investing. Angel investing often comes at an earlier stage when individuals are serving as Angels. We, ourselves, fit into that, both of those worlds because the Angel investing term also implies that the individuals are not just investing passively in the company but are looking to get involved to add value and open doors for the companies in which they’ve invested. Hopefully, it gooses their financial return. To some extent, it provides a psychic value to individuals about getting involved with exciting companies.

A lot of these companies are in the so-called impact worlds of energy, technology, and food tech, trying to solve major global sustainability issues. In fact, probably 30% of the deals we invest in are in those areas. Broadly in the venture capital world, 20% plus of companies are seeking to address these types of sustainability or impact challenges.

How does this series A fit into that or series B? It’s very confusing to me, at least.

It’s a nomenclature that many companies go through their first investing is often called seed, which might come from Angels or a fund. These are generally hundreds of thousands of dollars of equity investments. Series A is the next stage. There is a certain amount that is involved with series A. It’s typically in the seven figures but it can vary. Series B is the next round after that, and C, D, E, F, etc.

It’s a nomenclature to capture which round of financing the company is going through. There are some guidelines that typically, series A financing doesn’t occur until a company has shown that it can generate revenue. Not necessary profits but some revenue. Series B and C is the growth stage where a company has shown that there’s product market fit, that the dogs are eating the dog food, as we say. It’s not a few trial customers. There’s a real business model. You are trying to fund the growth that is necessary.

Companies are still losing a substantial amount of money but you can look at the long-term value of the customer, the LTV, as often called. The Long-Term Value of the customers being brought in, and say, “This is worth financing because if I want to be profitable, I could slow the growth but why do that when you know that you’ve got product market fit and you are continuing to finance that growth?” Those are your growth stages, B, C, and it could be D.

Many companies never get to a so-called E round because good things are happening or they could be doing a restructuring. Things haven’t gone well, and they are having to recapitalize the company. It’s like a piece of real estate where half the tenants disappear, and you’ve got to restructure the cap structure. Sometimes, the later rounds look like that.

Many companies get acquired by the major tech companies, whether it’s semiconductors, software, you name it, before they get to those later rounds. A very few percent do go public. Again, it’s the single digits. I can remember early in my career, as I said, venture-backed companies went public, much more than they would sell. It flipped in the mid-’90s, the 50/50. Now, there are regulatory and other reasons. It’s tough to be a public company, and most companies and their investors would prefer to sell and realize an exit on their investment.

The dilution of your investment, if you are an early investor and all these rounds come in after you, is it typical that your ownership percentage gets diluted? Do you want to invest early to get better returns or is it later you get less diluted?

The private equity world includes basically anything that's not public. And that is a world growing by leaps and bounds because the public markets are shrinking. Click To Tweet

There are two types of dilution. There’s a dilution of ownership or if you don’t participate in the next round, your percentage goes down but if the share price is going up, think about being in a public company. Suppose I bought a stock at $10 a share, and they decided to do a big equity offering at $2. That doesn’t upset me. I still own my stock. It’s $10 per share. My ownership is diluted, the percent I owe.

However, in venture deals, we pride ourselves that we are offering individual investors institutional-type terms. I don’t want to get into all the complexities around common stock, preferred stock, and different types of preferred stocks but the latter with all those protections are what we mean when we say institutional terms. We invest institutionally alongside very well-known venture firms, often alongside strategics, meaning corporations. We are providing those types of terms and protections. There’s an old saying, “You named the price. I will name the terms.” It’s more important to have the ability to name the terms of a deal because that’s where the protections come in, in case things don’t go well, for example.

The idea of being able to invest as an individual in institutional terms is very much a key to the value proposition that we offer. I should also add we are not only looking at 50 years plus of deals before we do a single deal. We are investing ourselves at the general partner level on every deal. It’s not just vetted curated deals. We are putting our own money where our mouth is, so to speak. Many of our individuals like myself invest on our own accounts and platform individual deals or in funds. We know what’s going on in the kitchen, we decided to eat it anyway while we are also serving it out to the patrons in the main dining room.

That gives confidence. That is something that we look at when we are doing the normal real estate stuff, the GPs are in a deal that makes them feel a lot more comfortable. We are mostly real estate, when we look at a real estate deal, the first thing we do is vet the operator, look at the market, then look at the deal. That’s how we do it. How do you vet the company on your platform? What due diligence do you do because you invest in your money and the company’s money and vetting deals for us, which is huge? What procedures do you have there? How do that work?

What you said was interesting because it echoed my real estate professor in business school. He always talked about people’s property deals. That was the whole framework for the class. That’s exactly what you said. A little different than location and location. That’s part of the property side of things. The reality is a piece of real property is much less complicated than a company.

First of all, there’s something you can look at, feel, and touch. You can’t look, feel, and touch computer code. That’s pretty much anything we do, even if it’s a piece of hardware like a semiconductor. The value is the code. It’s the algorithm or the process. You have to ask yourself, “Are they doing this better than somebody else? Is this accounting software better than somebody else’s accounting software? Is Google or Microsoft going to leapfrog them? Hopefully, they will buy them.”

You’ve got these five biggest market cap companies in the US that may be on the planet are all tech companies. It’s Apple, Amazon, Microsoft, Meta for what we know as Facebook, and Google. They all started several years, it’s rather remarkable. They were all first-time entrepreneurs, all five of them rather remarkable, which gets to one of the things we vet.

We vet the people but if you only invest in serial entrepreneurs, you wouldn’t have done Microsoft, Google, Apple, Amazon or Facebook. We start with the people. That’s where I was heading on that, and you are looking for tremendous competence. It’s nice when they have a successful entrepreneurial record but you want to see success in the different roles in ventures they’ve played.

It has a lot of judgment involved. Reference checking is absolutely critical. You’ve got to find that type of perseverance. It’s very different than a piece of property where you are going to make sure that you are dealing with high-integrity individuals who were involved but if you’ve got a great piece of beachfront property with all the tenants locked in, and the promoter is not adding that much value, it might not matter.

If you’ve got a lousy executive starting the company, you got to stay away. We will walk away from so many things because we are not comfortable. You are not saying they are bad low, integrity people. You are just not saying that they are standouts, that these are winners. That’s number 1. Number 2) You talk about property. The property analog is, what are the problem that they are trying to address and the proposed solution? It’s best if that problem is understood by the market and there aren’t real solutions. If there are other solutions out there, you’ve got to make the case for why you have the better solution or mouse trap.

One big difference between technology and growth companies versus real estate is you don’t have the competitive advantage of location. That gas station at a great corner is still going to do a lot of business. The location has almost no relevance around the globe. You can have the best startup in the world, and it can be in Eastern Europe, Australia, the US, Canada or Israel. By the way, this is one of the reasons that Israel was able with undesirable locations to compete effectively. If you’ve got the best algorithm and best problem to a solution, and you can get that message out, then you are going to have great company. That’s again number two, people’s property.

PILF 79 Alec | Diversification
Diversification: This infrastructure, big data, internet, and all these things that didn’t exist when artificial intelligence methodologies were first developed is now allowing the promise to be a reality.

You then talk about deals. Deals are critical. For us, that’s price and terms. As I said, the terms component, protections, and understanding of what happens if things go wrong are absolutely critical. In addition to those three analogs to people property deals, I would add the following. Who else is in the deal? Who were the co-investors in the deal? That can be a form of validation. Do you have any strategic investors? Meaning corporate investors might be clients who therefore serve as a source of revenue, and they have a stake in the company’s success. A little bit different than the real estate world. That’s co-investors, other firms, credibility, and corporates.

The key thing to look at is the competition. Every piece of real estate has a different location. There is competition but it’s not global competition. It’s, by definition, a location-based community, city, and regional competition at most. There’s a tremendous amount of time focused to understand the competition.

This is the hardest area of diligence because there are often in the early stages, and there are competitors you’ve never heard of. They are in stealth mode. You don’t know that somebody else is addressing the same issue. We look in the rear-view mirror with hindsight at the great successes like Facebook. They weren’t the first people to do what they were doing. Do you remember a company called GeoCities? Is that name ring a bell?

Yeah.

They were doing the same thing and didn’t do it well. There are all kinds of companies you never heard of that disappeared. I could go with so many stories of companies because you are dealing with algorithms, and the best mouse trap wins, can win globally even, which makes for huge economic rans and potential profits.

It also means that you can have an easy 0 if you are not 1 or 2 in the market. It’s like what Jack Welch used to say at GE. He wants to be 1 or 2 in every market he’s in or he’s not in there. That is true in so many of the technology areas because they also rans, just don’t have a role. They disappear. Have you ever heard of a company called Digital Research? Does that ring a bell at all?

Vaguely, also.

I’m impressed. Many people never heard of it. They were number two to Microsoft in the ’80s with DOS. They ended up getting sold for very little. The founder died in a bar room brawl. They were this close to being Microsoft. Think of it on a curve as you’ve got people way up here and down here, and then would disappear. That competitive dynamic in the analysis is a fifth area that is somewhat different than the real estate analysis.

We can look at all of that. We bring things forth to or investment committee. Frankly, 9 out of 10 things that come over the trends that we look at, we quickly dismiss. Often, they are jumping too early. They are an idea, a thought, or a concept. They haven’t thought about how they are going to go to market if they even are successful in developing what they are. It’s that 1 in 10 that get into our diligence process, and then about 1 in 5 of those, we will get into our investment committee funnel and get funded.

As I said, our model is we are investing at the general partner level on each deal, then and only then do we put it on our global platform and allow people around the world to invest. I mean it when I say around the world. In 2021, we had investors from 64 different countries write checks to invest in companies or funds on our platform.

That’s how you vet and figure out how you want to invest in it. As an investor, how do I figure out? I go to a website, there are 50 companies on there. They are all vetted by you. You are already investing in them. How does an investor like me figure out, “I’m going to do this or not this one?”

One big difference between technology and growth companies versus real estate is you don't have the competitive advantage of location. Click To Tweet

We never have 50 companies. We tend to try to limit it to 20 or 25. It’s still a lot but it’s fewer. We also have funds. We entered the fund business a couple of years ago because we have this question with people saying, “I can’t figure this out.” We’ve got people who love to figure it out. They are semi-retired or retired. They want to get involved with the companies. They enjoy it.

They want to go long on areas they know. “I’m a former software engineer. I want to invest in software or I’m a doctor. I want to invest in med tech,” but plenty of people say, “I can’t figure it out,” so we created funds. Our flagship fund is called OC50, which stands for OurCrowd50, and it’s the next 50 deals we do irrespective of geography, segment, and stage. It might be the C round of a company we invested in a few years ago, and now we are up to the C round. That goes 2% of the fund into that. It might be our first round, then we are fine. It gives this segment and the stage diversification that is rather unique.

That’s the easiest way to get exposure to the category and be diversified automatically. If you are going to invest deal by deal, which I do. I’m invested in 40-plus different companies. If you are going to invest individually, you want to invest in numerous companies because you want that same diversification but you have to create it yourself rather than with one purchase of an interest in a fund.

Those are the ways to think about it. We try to make our site very searchable for people who want to look at segments, themes or sustainability. You could say, “I want to look at everything that’s ESG related.” You will see the ESG deals. “I want to look at things that are AI, Artificial Intelligence related.” You will get that. We have all kinds of tools on that front. We have lots of tools to teach you about venture capital, tutorials, and the like.

If you simply want the simplest way, that’s how probably a third of our investors buy a fun product, the most popular being OC50. The other types of fund products we have are thematic. For example, we have a cybersecurity fund on the platform. That’s got a lot of interest because people understand these threats around the world are only getting worse.

We have a food tech company that we launched. Given the recognition of protein substitution because sustainability is a big driver. Who’s reading this that hasn’t tried some type of alternative product in the dairy world, whether it’s almond milk, coconut milk or oat milk? We have a company called Ripple, which is vegetable based. It has as much protein as milk, as opposed to nut-based milk. We are all living that. In fact, a lot of our deals that resonate the most are these things that have the sense of I can try it. It’s hard for me to understand an artificial intelligence chip but I can understand a dairy alternative.

I need Ripple. I like the dairy and meat alternatives. Those are the ones I’m always looking forward to because, as you said, I can understand it, and it seems like something that is common.

We were in Beyond Meat before it went public. One of the few companies that went public. When we would talk about that, when it was like, “You can call it what you want, ‘Veggie burger.’” You can say it’s a different alternative. You got to taste it first. To me, when we had our Global Investor Summit in Israel, shortly before it went public, we called it beyond meat gridlock because we had free burgers at a kiosk, and we gave out several thousand. It showed that people liked it. It’s simple but taste matters on food tech.

What is the typical investor allocation to this type of investment? As I said, in real estate, we like the boring stuff. We don’t want anything exciting. Part of the reason I’m in it is that it’s super fun. Do you know what the typical allocation is? Is it 1%, 5% or 10% of your portfolios that go into this stuff?

It’s usually mid-single digits because it’s risky. There’s no question about it. In a way, the more money you have, the higher of percentage you can allocate and feel comfortable. In fact, what’s happening in the consumer ultra-high net worth world of this so-called democratization of venture investing trend that I alluded to up front, which was enabled by regulatory changes, which is when OurCrowd came into being, is mirroring what happened in the institutional world.

If you go back 40-plus years, the great endowments of this country, Yale, Harvard, MIT, Stanford, and Princeton, are still the five big endowments. There was this classic 60/40 mix between equity and fixed income. There was no real estate generally in these portfolios except university-owned real estate. Some of it was valuable, and some weren’t.

PILF 79 Alec | Diversification
Diversification: The private market is becoming more important than the public market. And unfortunately, the public-private market isn’t accessible to everybody.

There was this guy named David Swensen who passed away. If anybody falls Financial press, his passing was a major news item. He was the Chief Investment Officer at Yale University. He had a very simple insight in the mid-’80s, which is that the endowments have permanent capital. It has been here 100 years ago. It should be in 100 years. Therefore, I can think long-term and illiquid. I can start looking elsewhere.

He started investing in LBO, private equity, and then venture capital. He bidding the office. The returns at Yale, look it up anywhere, have outpaced every one of its rivals on almost any twenty-year period for many years. It fundamentally changed. Institutional investing changed. It changed the university system in this country. David’s friends probably have had more impact on higher education than any individual because of the resources that were able to be developed as endowment started investing in this fashion and getting superior returns far above the classic 60/40 equity fixed income split.

Again, you will find that the endowment is worth their salt, which is doing this now. In fact, at the top endowments, the percentage of venture capital alone is 20% to 25%. Public equity is single-digit. You and I can’t think in terms of 100 years. I would like to think that one day I will have the wealth where I can think in terms of 3 or 4 generations down but that’s generally not the case. There’s a small part of the population that can do that way.

The way to think about your allocation is a function of how long-term and illiquid you can think. What can you spare to be capital gain long-term oriented? It’s not twenty-something percent like a university. Generally, for most people, it’s a single-digit percentage. Another key way to think about it is, “In which part of my investing portfolio do I have this?” Counter-intuitively, if you are able to, a very logical place is a retirement fund because that’s where you should be thinking long-term. The average retirement fund holding is 27 years. It’s a very logical place for your most long-term oriented investing.

People think of it as their nest egg, and they shouldn’t be risky with it. It’s almost the opposite. They should be thinking, “This is where more of their risky long-term capital gain-oriented investing should be.” We made it not just in the US but in other countries where people can invest in OurCrowd through retirement accounts so that they can have that long-term type of orientation.

That makes me feel good because the bulk of speculation stuff is in my self-directed IRA.

That’s exactly the way to think of it.

You talked a little bit about the exit is either, maybe if they go public or get bought out. More get bought out. What does the typical exit, and how long is the typical investment?

The vast majority get bought out. In the mid-’90s, it was maybe 50/50 venture-backed companies go public, and the other half get bought. The small-cap public market system has been ripped apart by regulation and other changes, whether it’s decimalization, which took away the trading margin or Sarbanes-Oxley, which added all this regulation. I’ve met CEOs of great companies as bankers and investors who have no interest in being public.

It’s the vast majority that gets sold. When does that exit happen, whether it’s M&A or sold? It’s typically a 6 to-9-year period from the first investment. That’s why we have some people who say, “That’s too long for me to wait. I want to invest later state. I’m going to invest in those individual companies on the platform that is in their C, D, and E round or we have one product, which is a follow-on product, which only invests in companies that we’ve already invested in and now investing in a second time.” By definition, it’s positive self-selection in its later stage.

Typically, there is a greater return with greater risk. Investing early can, in fact, be where you get the greatest return. One of the reasons OC50 is popular is because it provides that stage diversification, not segment diversification. You are getting some mid and late stage, not just early stage. The short answer to your question is from initial funding until liquidity is something 6 to 9 years.

If you've got the best algorithm, you've got the best problem to solve, and you can get that message out. You're going to have a great company. Click To Tweet

Typical returns, is it all or nothing? Meaning, half of them go to zero, and half of them go to the moon? I imagine somewhere in the middle.

A third, maybe give or take, we will go to zero. You’ve got those in the middle, and then those are the 5, 10, or even bigger multiples on invested capital. One of the reasons that a lot of people like to invest in funds or on our platform, you can form your own diversified fund. In fact, we tell people, “We can’t stop you from investing in one company but that’s not the way to think about it. You need to be diversified because one investment might be a zero. It could also be a ten-bagger.” The range of returns is much more disparate than in areas like real estate. That’s why it’s so critical to be diversified. Those of you who are familiar with public markets know that there are varied returns but the turns are even more varied in the private or venture markets.

The current economic conditions, meaning all of the uncertainty, the interest rates, inflation, the war in Europe, all of this stuff going on, how does that affect startups and the companies that you might be investing in?

I have been through numerous cycles since the mid-’80s. The first thing is always to look at the backdrop of what’s happening technologically, which I described, which is the continued component of software eating the world that is turbocharged with artificial intelligence methodologies. With that said, valuations clearly got ahead of themselves in late 2021, with multiples at historic highs.

Those multiples have now moved back into the public market, and they work their way back into the private markets as well. By definition, now is a better evaluation environment than months ago. We were sitting here in August of 2022, and multiples in many segments are half or even less of what they were at the peak of the market, November and December 2021, and January of 2022.

Those of us like yourself or readers who invested back then say, “I’ve lost half my money.” Frankly, you may have lost half your money. That’s why it’s so critical to be investing in a company that’s growing very fast. We have a lot of companies now that are pricing rounds at the same price as their last round, even though they were 2 or 3 times the size they were then.

Here’s an analog to the public market comes in like a lot of investors in the public market do dollar cost averaging. They find good companies and keep investing in them, not trying to time and not thinking about price. Similarly, if you are invested in the A or B round of a company and that round in hindsight was overpriced, by all means, take advantage of the next round or the multiple of revenue, for example, is much lower, and you are effectively dollar cost averaging down your investment.

Sometimes people aren’t disciplined to do that. They are like, “I’m all upset that I invested in something, and it’s doubled but the price is still the same,” or worse. Investors’ clinical discipline would lead you to what I said, and you should say, “I like this company. It’s performing and growing well. I’m now getting my shares at a lower multiple. I should put more capital into it.”

That’s why these institutional terms I talked about are so important because one of the key institutional terms is the right to invest in the next round. The worst thing is those of you who are reading to be Angel investing with your cousin’s company, buying common equity, and maybe there’s some institutional money, and things don’t go so well in that startup or that growth stage company. You get jammed down and pushed down the cap structure with the new money, and you don’t have the right to participate. Those rights are very critical.

How does an investor like me get to know those terms?

We publish them on the site. The deal terms are all there. The most important one is preferred. I’m going to give you a little tutorial. It means your preferred stock is ahead of the common stock. What that means simply is let’s say a company has a valuation of $50 million and the venture capital has come in, and they invest $10 million in their preferred stock.

PILF 79 Alec | Diversification
Diversification: It’s almost more important to have the ability to name the terms of a deal because that’s where the protections come in.

If things don’t go well and the company sells for $15 million, that $10 million of preferred gets their $10 million out first, and the rest of that $5 million of the sale price goes to every other investor. That’s why it’s so important. It’s better than in some ways in the public market where you have common stock, where you don’t have that but that preference is important while you want to be in the top stack of the capital structure.

It’s similar to real estate. You may have bank debt that is senior to the sub-debt, and then below that, you’ve got the equity holders, and the value of the building went from $100 million to $50 million. The bank is going to take everything if you’ve got $50 million or more of debt. The equity guys are washed out. Maybe you throw them a tip so they don’t sue you. That’s what happens in the restructuring of a company or a building to pay off some money but the bank gets it.

The preferred is like the bank, and that’s where you want to be but in the venture, preferred is almost always convertible into common if things go well. That’s the key. You are getting the equity upside of the potential return. You said, “Why do companies give convertible preferred to venture investors like ourselves and others with whom we invest?” The reason is that’s what you must do to attract and have people take this risk or put their capital at risk.

It’s often a misconception that venture capitalists are going in there side-by-side with the entrepreneur. They are generally not. They are senior to the entrepreneur in liquidation, and yet they are side-by-side of things going well. This is risky stuff. These terms evolved over time. When I first got into this market in the ’80s, I was like, “This doesn’t seem right.” It makes sense because the entrepreneur has sweat equity. That has real value but someone who’s putting out real capital should be more senior in the cap structure.

You talked about Beyond Meat, can you talk about what are some other big successes on the platform? On the other side, if I invest in 100 companies on the platform, how many of those are going to zero?

In venture, in general, a third of the companies, give or take will often go to zero. Our ratio is better than that but I’m giving you a number. I’ve had some of the partners in the best venture funds around. I’m a higher percentage because they take more risks and don’t care about the company’s going to zero. They care about the 10, 20, and 30Xs.

Think about that, you are going to lose one time your money in a venture. You can make 5, 10, 15, or 20 times. A lot of venture capitalist philosophy is to take great risks. I have individual investors I talked to on our platform. One comes to mind immediately. I won’t name him. He says, “I don’t think people want to see something that’s not looking for 10X. I used your platform for my high-risk swing for the fence’s money.” That’s his perspective. We have other investors with different.

That’s a key theme of our platform. We want to empower investors to invest how they want, whether by segment, geography, stage or with different risk profiles. We have investors who think that way. We have some investors who say, “I want to do impact investing or I want to do late stage.” That’s why that percentage prediction component, the second question, I throw out a number but it’s very much a range.

The first part of the question is about the big successes besides Beyond Meat. I point to companies you might not have heard of, Wave, a Canadian accounting software company, interestingly, was brought to us by one of our investors. We look at our global crowd as not a source of capital but as a source of companies. People will bring companies to us. Sometimes we will give them a piece of the economics if we liked something that they brought. That was a company H&R Block for $500 million. Lemonade is disrupting the insurance business. It was a great success. The public stock did go public.

We got out at a pretty high price. The stock has had its challenges since then but it was a great return for us. Those are some of them. Another company, the scooter business that we sold to Uber. We got Uber stock before it went public. It was a great success for us. We have a number of companies in the portfolio that are now valued at 10X or more from what we initially invested in them.

That’s interesting to see who the companies are and where they go. That’s awesome. Can you talk a little bit about minimum investment? Some platforms have investments you can get in for hundreds of dollars and some for thousands of dollars. Can you talk about your minimums and how that works?

There is a greater return with greater risk. So investing early can be where you get the greatest return. Click To Tweet

First of all, our platform is only for accredited investors. I suspect some of your readers are not accredited investors. The guidelines for what a credit investor is hasn’t changed. It loosened up a little bit. It relates to having either $1 million of investible assets total, outside your home or $200,000 of income. If you are a financial services professional, those rules don’t apply. You are considered okay to be an accredited investor. That sets us apart. There are reasons we did that.

From a regulatory standpoint, the minimum investment in an individual company is $10,000 unless you are making a commitment to invest in multiple companies, and then that minimum is $5,000. The minimum investment in one of our funds, such as OC50, where it’s 1 size, 1 investment, gets you diversified instantly. The minimum is $50,000.

It’s significantly higher than some of the other platforms out there. It’s one of the reasons we believe that we are the biggest platform in the world, with close to $2 billion invested. One of the reasons we did that is, as I mentioned, for regulatory reasons but also our investors are often a source of value to our companies. We like having investors who are a little higher up the socioeconomic pyramid because they tend to have the networks that can help our companies the most too which again is not meant to be disparaging. We would love to see the accredited investor rules liberalize.

The last SEC chairman during the Trump administration was pushing for more liberalization, such as the expansion of financial service professionals. There were a lot of talks then. It has been silenced on letting engineers invest in tech companies. Don’t tell them because you are a young engineer or maybe an immigrant engineer that you don’t know enough to invest as compared to somebody who happened to inherit a few million dollars. Why should she or he invest? Those of you who are aware of this issue, please lobby your respective congressmen and women that accredited investor limitations should be liberalized.

I completely agree with that. I cannot stand the accredited investors’ status because it’s based on your wallet, not on your knowledge. It makes me crazy but that’s whole another conversation.

It’s a very political conversation.

The last question I always ask is, what is a great podcast that you listen to?

I’m going to sound trite but I love a lot of the Tim Ferriss podcasts. He enjoys the benefit of having a broad listener base, who is able to bring on more and more interesting, varied, accomplished individuals who can provide perspectives on so many different areas. I’m not a huge podcast listener but that’s the one I’ve listened to the most.

If readers want to get in touch with you or to get to know more about OurCrowd, what’s the best way to do that?

I would suggest two things. First, go to www.OurCrowd.com. You can register on the platform in about 60 seconds, asking yourself a few questions about yourself, and you will start seeing deal flow but I will invite you to send me an email if you would like. I will direct you to someone who can assist. It’s [email protected]. Our whole platform is designed to be very low friction, easy to use, and enable people to invest. We have people who invested who never talked to an individual or had any contact with one of our individuals on staff and our investor relations centers. One of my brothers did that.

If you see something you like and you want to start the process, there are four documents you need that’s your bank account, license, passport, etc. Literally, we’ve got the process down where the friction is so low. It’s under 10 minutes, sometimes under 5 minutes, to make that first investment. That’s what we are about. We are about empowerment. We are not about sending crazy documents around but we do follow the regulations to the tee. We are very proud of our ability to bring in investors around the world because we’ve taken the effort, cost, and resources to be approved to handle investors in so many different countries.

PILF 79 Alec | Diversification
Diversification: You need to be diversified because one investment might be a zero. The range of returns is much more disparate than in areas like real estate. That’s why it’s so critical to be diversified.

I can agree with that. I’m on the platform. I invested in so many companies, and it is very easy. It is easier than real estate syndication.

We have a great mobile app, so go to the App Store and download OurCrowd. You can walk around on your phone. Once you make some investments, you get updates on the companies. You will get the quarterly update on how the company is doing but companies are putting out press releases of new things they are doing. You are seeing new deals in real-time on the app. I spend much more time on the app personally than I do on my laptop.

Thank you so much for being our guest. This was not our normal topic but it was fascinating to me. I’m interested in it. I appreciate your time, and this was a great episode for our community.

It’s my pleasure. Thanks for inviting me. We will look forward to seeing you all on the site.

I enjoyed that conversation with Alec. It’s one of these things, as I said, many times in the show, we generally like to do the boring real estate stuff. That’s where I get cashflow and to live my life but the fun part for me is the speculation when I’m investing in these startups that may go to the moon or may go nowhere. I was excited about this. It’s a little bit out of the norm for our show but it was nice to have Alec come on from OurCrowd. I’m an investor there. I’m in a couple of other platforms too but OurCrowd, I liked the way they vet the deals. That’s nice.

As he said, they invest in their own deals. He’s in 40 deals on his own but then OurCrowd also invest in all these deals, and they do the vetting. They are going to be better at that than I am. It gives you a little bit more confidence when you are looking at these startups because I don’t know anything about the technology. I look at it and say, “That sounds interesting. Some experts have vetted it. Maybe I will give it a shot.” That’s what I’m doing a small percentage of my portfolio, 5% to 10% in some of the speculative stuff.

I found it also comforting that he explained the difference between venture capital startup series A and all the others, which I hear those terms all the time. I have no idea what they are. The only one I understood was unicorn because that’s the one that doesn’t exist, and if you find it, there you go. It was nice to get a little bit of level setting on what all of those terms meant.

It’s also interesting, and I’ve heard this before, that a lot of these startups aren’t going public anymore. They are selling to somebody else. Google or 1 of those 5 companies he mentioned ends up buying a lot of these. You are not maybe getting the huge multiples that you were in the past with these companies going public but you are still getting 5X, 10X returns on some of these, hopefully.

That’s one of the most impactful things that Alec said, “You can only lose one time, your money.” These aren’t on merging, and you are not using leverage. On these deals, you can lose all of your money and probably will on quite a few of these but it only takes one 10X deal to make up for 9 that goes to 0. That’s not the ratio you want. I don’t know what the ratio you will get is, but if a couple of years ago, 5, 10, 20X, it’s going to make up for those losses.

As far as the fund, I liked the fund idea because, as he said, that’s diversification immediately. Not only by industry probably but also by stage, whether their series A, series F, a venture or a startup, I liked that. Although in my case, I have so much fun looking through and trying to pick the exact right company and companies that I’m interested in that I haven’t invested in the fund.

This is a case of the smartest thing to do is probably put your money in that fund because you will probably get pretty good returns but the fun thing to do is search through and find these companies that are interesting to you. Those are the companies I end up investing in. I’m not built for the fund because that would put me back in the boring real estate category.

For this stuff, I’m hoping to make a bunch of money but I’m also looking to have a little bit of fun and invest in things that are interesting to me. I feel like I get both with that. I don’t always make the best financial decisions but on this part, it feels like having a little fun is okay. That’s what I’m doing. I hope you enjoyed it. We will have him on again in the future to catch up but that’s it for us. We will see you next time in the Left Field.

 

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About Alec Ellison

PILF 79 Alec | DiversificationAlec Ellison serves as Chairman of OurCrowd’s US business, a role he took on after serving nearly 3 years on OurCrowd’s Advisory Board. He joined OurCrowd after a nearly 30-year career in investment banking focused on the technology sector. Alec was formerly a Vice Chairman of Jefferies LLC, the longtime head of the firm’s Technology Investment Banking Group, and a member of the firm’s Executive Committee. He joined Jefferies as part of the firm’s 2003 acquisition of Broadview International, where he was President. He began his investment banking career at Morgan Stanley. After retiring from Jefferies, he founded Outvest Capital to pursue a proprietary public investing strategy capitalizing on how the accelerating rate of technological change impacts companies across all industries. Alec has been deeply involved in the Israeli technology scene since 1996. He is a South Carolina native, resides in Connecticut, and holds a BA from Yale (summa cum laude) and an MBA with High Distinction from the Harvard Business School.

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