Doing What You're Doing, You'll Never Get Rich Investing
If you've ever wondered why there are billionaire investors out there, living it up on 200-foot yachts and helicopter-access-only private islands, jetting from home to home in airborne limousines and sipping cocktails, while you're slaving away at your 9-to-5 job only to see your IRA make single-digit returns, let me explain to you how things really work.
I'm not going to throw out a bunch of numbers and terms that only somebody with a business degree would understand.
Instead, I'm going to tell you a quick story about an idea that becomes the next greatest thing in consumer products, and let you experience the difference between how the billionaires invest and how you invest.
It All Starts With a Spark
A young software engineer (let's call him Sam) gets an idea for a fun new mobile app.
It's called Gliphar, and it's the newest, coolest way for young people to communicate. Instead of using letters to spell out words, it lets users communicate ideas using strings of simple icons, just like the kind used in text messaging on your smartphone.
These strings of icons are called “gliphs,” and the possibility of what you can say is only limited by your imagination.
Sam writes the code and submits an early version for distribution to Apple's App Store so consumers can try it out and provide feedback.
As anticipated, everyone over 25 thinks it's utterly useless and a waste of time, but the target audience — teenagers — immediately takes to it.
Realizing they can rapidly communicate with their friends in code their parents have no prayer of deciphering, users flock to the app at a geometric rate, going from 100 users to 1,000, to 10,000, to 100,000 in just days.
Gliphar gives rise to a whole new language, but it's also got bugs.
It cannot handle the volume of users it's attracting, and as a result, it is constantly crashing. It's glitchy. It's clunky. Some of the icons the app uses to compose gliphs are the intellectual property of other companies or individuals, so Sam needs to come up with his own set of characters or risk being sued.
Sam quickly puts out some updates, attempting to fix these glitches, but soon realizes he needs infrastructure and employees to continue to refine and build the product.
For that, however, Sam needs something he doesn't have: money.
Sam manages to scrape together some cash from his friends and family, which allows him to quit his job and work on Gliphar full time.
In exchange, he gives up 10% of his shares to this initial seed round of investors.
Within a month, the app is in its second, improved version, but with a user count well past 1 million, additional improvements need to be made immediately or the whole operation could come to a screeching halt.
Never Fear, Your Financing Is Here
A small private-equity investment firm, Neu Venture Capital, contacts Sam and offers up $250,000 in exchange for 5% of the company's stock.
The company is still private, and it's not even a company yet, so incorporation documents are quickly drawn up so the enterprise that was just one guy and some code can become a legal entity capable of taking on formally structured financing.
Gliphar, Inc. is born.
That $250,000 is then used to hire a few additional programmers, rent office space, and get dedicated servers to handle all the traffic Gliphar is generating.
The investment pays off.
Within two months, Gliphar's third version is introduced. With a brand-new, proprietary set of icons and much more efficient, streamlined coding, the app is faster, more functional, and more fun than ever.
Membership continues to expand rapidly. By month four, there are over 5 million users. But now a new problem arises: the app is burning through money but bringing none in to offset those costs.
As much traffic as it generates, it produces zero revenue, so the only way to keep it growing is to raise more money.
The Second Round Comes Around
Middleman Management meets with Sam, and a deal is quickly sealed.
In exchange for 10% of the company stock, Middleman Management agrees to give Gliphar $5 million for the purposes of expanding operations, hiring new staff, and, most importantly, beginning the process of monetizing the application.
On paper, Gliphar is now valued at $50 million. Sam, who still owns 75% of the company, now has a theoretical net worth of $37.5 million.
This second round of financing turns Gliphar into a bona fide company.
It now has a large office, with more than two-dozen full-time employees; it's renting an entire data center to handle its huge volume of traffic; and it's also got a whole team dedicated to commercializing the product.
In the sixth month of operation, as the app crosses the 10 million-user mark, the company starts to serve ads, and for the first time ever, the money starts flowing in.
But it's still not enough. The company takes in $1 million in its first month of monetization but spends more than three times that on overhead — which includes advertising its own services.
An old problem comes back to haunt Sam: The growth has reached a point where all of the expansion efforts simply cannot keep up.
Once again, the app, and Gliphar, Inc., is at risk. It needs more money. Much more money. But with 25 million users already signed on and more flowing in, help is not far away.
Welcome to the Big Leagues
Just as the 30 millionth user signs up, Titan Capital Management and Sam sit down for a friendly lunch.
Titan CM picks up the check, and in exchange for $50 million, it walks away with 10% of the company.
On paper, this seven-month-old enterprise is now worth half a billion, and Sam, a guy who had been working out of his basement office just half a year earlier, has a net worth of $325 million.
Gliphar takes on new employees, putting an emphasis on marketing and product development. It builds its own data center, spending millions but also alleviating the pressure of recurring overhead.
For the next several months, growth continues at a steady pace. The 50 million-user milestone is hit at month 10. At month 12, it's at 75 million users.
At month 15, 120 million users.
Revenue grows, too, but it still can't keep up with expenses. For every dollar the company takes in, it spends two dollars to maintain growth.
Finally, inevitably, the decision is made to make the ultimate step, the holy grail of financings: The company decides to go public.
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Ringing the Bell
Two years after Gliphar signed its first user, Sam rings the opening bell as Gliphar, Inc. debuts on the Nasdaq under the symbol GPHR.
With more than 200 million users sending over a two billion gliphs per day, the company is that year's big tech IPO story.
The stock debuts at $10, and with more than a billion shares outstanding, the company's valuation is now north of $10 billion.
Sam, who has had to give up more of his stock to the initial public offering (IPO), as well as to the underwriters who took the company public, and to his own employees, now only owns 30% of the company... but that's enough to make him a multi-billionaire.
In return for all the paperwork, Gliphar, Inc. now has more than a billion dollars in cash in its treasury to deal with the mounting influx of users and the associated expenses.
After the first week of trading, shares are up to $15.
After the first month, Gliphar, Inc. is trading for $20.
Everything looks great for all parties, until finally, reality sets in.
According to rules governing IPOs, there is a six-month restriction on trading for any insiders holding company stock prior to the IPO.
Six months and one day after Sam rings the opening bell, the insiders start unloading their stock for some much-anticipated gain, and things begin to go south.
The share price stagnates at $20 and then slowly begins to meander downwards.
Fundamentally, the company is doing better than ever, creating new users, making more revenue; it's even approaching that magical point of inflection that defines every corporate journey: profitability.
But the hype just isn't what it once was, and with Neu Venture Capital, Middleman Management, and Titan Capital Management now selling, it's becoming a buyer’s market.
Shares shrink back down to $12 before finally stabilizing.
Sam is a multibillionaire. His early investors are sitting on eight- and nine-figure gains. His faithful friends and family members are rich enough to retire and leave inheritances big enough for their kids to never work.
But that's where the fairy tale ends.
Those who bought the stock on the open market, just as the hype hit an all-time high, come out with holes in their wallets.
For the sake of brevity, this story is, of course, an oversimplification of a somewhat complicated process... But nevertheless, both the general principle and the outcome are accurate.
Where Are You in This Story?
So... back to my original question: What is the difference between you and the guy in the private jet sipping the cocktail, waiting to land at some exotic location to do exotic things with exotic people?
Well, the guy in the jet is one of the managers who worked for any one of the three investment houses that financed Gliphar in its early days; or he was one of the Sam's friends who coughed up a couple thousand bucks for 1% or 2% of the company, back before anybody had ever heard of Gliphar.
The retail investors, people who bought the stock the moment it hit Wall Street on the day of its IPO, well, at most they doubled their money from $10 on opening day to $20 at its peak before the insider selling began.
If you're 99.9% of the people out there who invest as a means of supplementing your income, then that's where you are in the equation.
In short, you're late to the party.
And remember, in this model, a clean double is a best-case scenario for the retail market.
Sadly, most retail investors don't buy in at the lowest of the low, and they almost always miss the peak exit point.
Meaning many could have lost up to 40% of their investment on a deal that made multimillionaires and billionaires out of those who got in at the venture stage.
It's Not All Hopeless
If you think this is unfair or that investing is a matter of luck, positioning, or who your friends and family are, then you're not wrong.
But just because you're not wrong doesn't mean it matters. Luck and positioning and friends and family determine much of what happens to us in life, from birth onwards.
Today, however, there are opportunities available to get into venture-stage investments without having to be an insider.
It's a method few know about and even fewer take advantage of.
If you choose to exploit this method, you will find yourself trading alongside professional investors, even some of the very same fund managers that in our imaginary scenario would have financed Gliphar, Inc. through its development stages.
Only this isn't an imaginary scenario, and you don't need a special license or a special title or to win the lottery of life by being related to the next big tech tycoon to be involved.
In fact, if you know how to use an online brokerage account like TD Ameritrade or E-Trade, you can do all this without having to leave your home.
Fortune favors the bold,
Coming to us from an already impressive career as an independent trader and private investor, Alex's specialty is in the often misunderstood but highly profitable development-stage microcap sector. Focusing on young, aggressive, innovative biotech and technology firms from the U.S. and Canada, Alex has built a track record most Wall Street hedge funders would envy. Alex contributes his thoughts and insights regularly to Wealth Daily. To learn more about Alex, click here.
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