The huge-return possibilities of private company investing… where are we in the investment cycle?… how you can be wrong a lot, yet still generate big returns
When’s the last time you sunk $5,000 into an investment and it turned into $180,000?
That’s a gain of 35X.
It’s also roughly what private investing specialist, Cody Shirk, has enjoyed with one of his recent, private deals (I suspect the amount invested was somewhat larger than $5K).
More on that in a bit…
First, to make sure we’re all on the same page, nearly two weeks ago, we featured an interview with Cody here in the Digest.
We did this because the long-time barriers to being a private investor have been removed. As recently as just a few years ago, this world was reserved only for the wealthy. No longer. Today, even regular investors can access the private markets.
Frankly, this is huge, because private investments offer the potential for vastly greater returns than just about anything you’d see in the public markets. The 35-bagger just mentioned is one such example.
So, who is Cody and why should we listen to his views on the private investing world?
He’s a 35-year-old private deal investor, who came from meager beginnings. Yet, today, he’s a successful entrepreneur and accomplished private investor.
Here he is, in his own words, on his career path:
I’m not wealthy. I grew up in a trailer, so I didn’t come from money at all.
I became a firefighter in Santa Monica and made surprisingly good money for a blue-collar worker. I wanted to put my money to work, so I decided to learn investing. I did the whole newsletter world and read all the books.
But with stocks, the takeaway seemed to be “I can probably get rich by the time I’m 50 or 60.” And that’s a great route to go, but I’m more impatient. I like to attack things.
So, I started diving into the whole private equity world.
It turned out to be a wise move…
Cody has now done deals all over the world, and has a growing list of 10X winners to his name. Best of all, they didn’t require decades to develop. The roughly 35X-winner from above took less than a year.
Given the positive feedback we received about our interview with Cody, we decided to feature him again in today’s Digest. This is easy, as there was a great deal of valuable content that I wanted to include in our issue two weeks ago, but that Digest was already nearly twice our usual length, so it didn’t make the cut.
Today, let’s fix that.
If you missed our first Digest with Cody, you can review it by clicking here. In short, we covered the regulatory changes that now allow private investing for you and me… we discussed the main draw of this asset class – which is the potential for stratospheric, life-changing returns… and we walked through some practical action steps for getting started.
Today, let’s add to this by asking an important question…
For private-market-newbies, is now actually a good time to begin?
After all, the S&P is at an all-time high, valuations are stretched well above normal, we’re seeing the highest inflation numbers in years, and we’re getting mixed signals on the economic reopening.
If the economy and the public stock markets roll over, what will that mean for private investments?
Today, let’s find out.
We’ll also revisit the return potential here, illustrating how just one winner can be a gamechanger.
***The private deal market is red hot right now…is that a warning sign?
I’ll begin by pointing out that today’s private deal market is on fire.
Cody has had some investments this past year that have exited in less than six months.
If you’re unfamiliar with the lingo, “exited” refers to an exit from the private market. The exit usually comes courtesy of a buyout from another company, or an IPO.
In either of those cases, an exit prompts a liquidity event – you can think of this as the payday for early investors.
For Cody to have generated 10X-20X returns in less than six months is astonishing. It’s not the usual. Again, it’s a sign of a hot market.
That’s where we’ll pick up with the interview.
Jeff: So, we’re in this red-hot market. But there are life cycles to everything – all asset classes.
For a new investor who’s just getting involved right now, is there a risk that we’re at the tail-end of what’s been a surging market at its cycle-peak, and it’s now about to head downhill?
Basically, is this terrible timing?
Cody: That’s such a good question. And I think that’s everyone’s question right now.
What happened with COVID? The world shut down – are we going to have this big hangover?
What’s going on with this ridiculous amount of fiat money printing going on? I mean, there are so many questions right now.
That said, I personally believe that private markets are the best place to allocate capital right now. I’d say the safest place is probably just in gold and silver, but the best place right now is in private equity.
I’ll explain it…
The valuations of a private company don’t ever occur until there’s a price around, meaning a company raises money at a certain valuation, or there’s a liquidity event.
If a company is not raising money and they’re not liquid, the value of the company is in the eye of the beholder. In other words, just because a company is operating, if they’re not public and they’re not traded daily, you don’t really know its value.
I think this makes private companies a great place for money, because private companies that are successfully generating revenue can remain private until they choose it’s a good time to exit. And when they choose to exit, they will exit at that period of time’s valuation in that market.
In the meantime, your cash is attached to a company that’s growing and developing.
If you’re holding onto cash right now, that money isn’t building a company. Your cash isn’t generating revenue, it’s just sitting there. So, I believe your cash should be sitting in a private company.
Jeff: The flip side of the argument is, “well, that private company could go under.”
Cody: Absolutely. And as we’ve talked about, some will. That’s why it’s important to spread a reasonable amount of your dollars over many deals.
But as we also talked about, when you hit a homerun investment, the returns can be like nothing you’d ever get from a public company.
Plus, one thing we haven’t discussed are the tax advantages. For a long-term hold period, there are all kinds of tax incentives that come along with that. There are also tax incentives based on how specific companies are registered along with the amount of money they raise.
For example, if a company raises less than $50 million and they exit, those profits are tax free. So, there’s all kinds of interesting loopholes and ways to navigate the private markets.
Jeff: Any thoughts on inflation and private investing?
Cody: The big question right now, or fear, is inflation. I’m nervous for inflation if I’m holding cash, but I’m not nervous for inflation if I’m invested in a company that’s doing great business.
If a business has customers, is generating revenue, and is continuing to do that in an upward trend, I would rather have my money invested there than any other place, because any other place is just a gamble to me right now.
Jeff: I would say that’s especially true if the private company has pricing power and is able to raise its prices, passing along higher inflation to customers.
Cody: Exactly. So, it’s almost like the best way to, I don’t want to say hedge, but just track the market without actually being directly exposed to fluctuating prices.
Jeff: So, many investors fear inflation today, but there’s also the fear that that the public stock market is overdue for a crash – and this time, a lingering bear market that sticks around far longer than what we saw last year.
If that happens, would there be a similar crash in the private markets?
Cody: If you have money in a private company right now, it is going to be a little bit risky because the expectation is that your investment should be acquired or going public.
So, in order for a company to get acquired or go public, typically we should be in a bull market. If we do have a market crash, these companies that should be acquired or go public probably will not.
Instead, they’ll need to operate privately for a while, which could mean they will need to go out and raise more money from private investors, which could mean a down round. By that, I mean they’re raising money at a lower valuation, which means previous investors kind of get screwed.
Now, that’s from the eyes of an investor who currently has their money in private investments. If you’re new to this market and just getting started, this is actually a very interesting time.
In fact, it’s an exciting time for me because I have not made many private investments over the past year. That’s because companies are overvalued, in my opinion.
You have these stocks, Tesla, or whatever, that are so overpriced that they have tons of money. So, they can go out and acquire smaller, private companies. And that raises the market value of these private companies.
We’re seeing these inflated valuations. That’s not to say there aren’t great opportunities out there right now, but that is to say that, hey, when we do have a correction, when we do have some “back to reality” valuations, there will be some incredible deals.
Jeff: I would guess that a tougher market environment may also lead to more demand for equity financing, which would be good for private company investors.
Cody: Absolutely. If a private company can borrow money, it’s going to do that instead of giveaway equity in its company.
Well, when we have a bear market, those companies that have borrowed cheaply are going to have a really hard time continuing that. They’re going to have to take money from investors.
Most likely, they’ll have to do this by lowering the value of their company, which provides a better opportunity for investors.
So, for anybody looking into the private market space, this is a great opportunity to learn and get a wish-list going. Decide what you really want to invest in and wait for those opportunities when valuations come back down.
Jeff: It sounds like I hear you saying you’d actually be excited about a pullback or a crash.
Cody: Oh yeah, I can’t wait.
***The life-changing return potential of private investing
Before we wrap up today, let’s revisit the main feature that gets people excited about investing in private companies – the money.
Cody’s roughly 35X return referenced at the top of this Digest comes from a small medicinal psychedelics company named, MindMed.
Cody wasn’t exactly sure of his return, but he ballparked it at 30X-to-40X. I split the difference at 35X for convenience.
Now, one of the concerns of investors eyeing the private markets is the risk of a company failing – which would mean a complete loss of investment capital.
That’s not just a concern, it will happen. That’s the nature of this asset class.
But look at the power of one 35X return, along with a reasonable projection of a portfolio of private investing returns.
Say you invest in 50 private companies. You’ll put in $1,000 each.
Let’s say that a full 30 of these companies go out of business…a complete destruction of capital. You put in $1,000 but get $0 back. That’s on 60% of your investments.
Let’s then assume that five of these companies go nowhere. They close up shop, but they’re able to return your $1,000. So, you get a 0% gain.
The next five companies give us good public market returns – gains of 50%.
Then we have four gains of 100%… three gains of 200%, one 400% gain, one 1,000% gain, and then our 35-bagger.
What’s the overall portfolio return?
Remember, a full 70% of our invested companies either lost all money or returned nothing…not a dime.
The total portfolio return is 39%.
Now, just for fun, what if we replace one 100% loser with another 35-bagger?
The portfolio-return shoots to 135%…even though, in this case, a full 68% of our investments either destroyed our capital or returned nothing.
That’s the power of one big private investment winner.
If you’re looking to dip your toe in the water, our earlier Digest with Cody covered some action steps. I encourage you to take a look.
Wrapping up, we’ll keep tracking the condition of the private markets with Cody’s help and will report back here in the Digest.
Have a good evening,
Jeff Remsburg
