Start-ups are risky by nature, the upside however, is potentially life-changing…

We have written previously about the art of the private deal. In that post we alluded to a very successful friend of ours who we also interviewed for our readers. This gentleman, who focuses among other things on start-ups in the technology sector, has had quite a few homeruns.

At the time of the interview we discussed an investment we were making in a social media company targeting the music industry. The information was a little too “specific” for the company’s attorneys, so we were asked to remove the bulk of that particular missive, at least until such time that the company’s application exited the beta phase. That time is almost upon us, so we will shortly be free to discuss more detail.

Thus far we are very happy investors, and management have been executing beyond our expectations. The first capital raise has been completed. A high-profile Internet/technology law firm has come on board (and taken a piece of the seed round), and it’s looking like the next round will happen at a multiple of the seed round valuation.

How I Do It

I cannot, nor do I intend to be, an expert in every sector.

However, I’ve managed to do very well investing in private companies by doing a few simple things very systematically:

1. Identify and invest in major trends. We discussed this in the post on attempting to predict prosperity;
2. Only invest in sound management;
3. When the above two are in place we like to invest alongside trusted and successful lead investors. This gives us a “trifecta”;
4. Limit our exposure on each investment so as not to take a substantial loss on any one particular company if we are proven wrong. This can happen even where our macro-analysis may be spot on.

I discussed the major theme of an open source world before, so I won’t rehash those thoughts in this post. Let me point out however that the Internet sector of the technology space affords us (as investors) and entrepreneurs incredible leverage. We can participate in a low start-up cost business sector where it is entirely possible to go from a valuation of a few hundred thousand or less, to hundreds of millions in short order.

I’ve have been working on a deal in this space for the last six months or so. I’ve not discussed it in these pages because, frankly, I didn’t want to jeopardize what I were trying to accomplish before reaching an agreement with my partners. Last week we reached that agreement, and we are very excited to be investing alongside some very savvy and successful “founders”, while at the same time investing in proven, exceptionally talented entrepreneurs.

By agreeing to take a significant slice of the seed equity, we get to buy into a newly conceived “incubator” at a very attractive valuation. The venture just happens to be financed and run by the very same group that we invested within the music industry-targeted social media company we alluded to previously. This is basically their personal “skunk works,” where the “wunderkind” will create and bring to market apps specifically targeting the mobile space.

We’ve had some great success in the past by negotiating for larger slices of equity (larger than we would take if we were acting on our own), and just like buying in bulk at Costco, we get more attractive valuations, warrants or some such similar incentives by taking these larger positions.

Running A Successful Business Incubator

Why an incubator? Incubators allow for diversification into the specific sector that they are focused on, in this case the mobile apps space allow for a pooling of talent and resources which enable higher rates of success than their stand-alone counterparts. In short, the risk/reward is significantly tilted in our favour by participating in an incubator.

The incubator we are seeding has 4 separate projects currently in varying stages of completion. Each of these projects we might talk about in future posts where appropriate, but we believe that on aggregate the incubator will be able to spin these out at between $5M – $25M apiece, providing multiples on our investment capital, with multiple swings at the plate.

I’m excited to write on, but I desperately need to go take a run and sweat out all the overindulgence of the past few days.

– Chris

“We’re living at a time when attention is the new currency. Those who insert themselves into as many channels as possible look set to capture the most value.” – Pete Cashmore, Founder of mashable.com