Startups: The Buffet Factor

Legendary investor Warren Buffet famously avoids investing in startups and IPOs (Initial Public Offerings.) That is because said investments violate one of his fundamental rules. The rule is that a company under consideration must demonstrate a 10-year average of 15% ROE-Return on Equity.) Startups, almost by definition, can’t meet that standard.

Having said that, the Buffet Factor can still come in to play when evaluating a startup. Here are excerpts from an OurCrowd blog post describing how Buffet’s investment rules can be applied to startups.

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[EXCERPTS from an OurCrowd Blog post]
Startup ventures typically have little or no income, making many of Buffett’s models for evaluating the intrinsic value of a company extremely hard to calculate. Furthermore, startups don’t have track records that can be studied to understand their stability. The result is that startup investors that seek to invest using Buffett’s principles, a.k.a Buffettologists, must rely on some of Buffett’s more qualitative parameters when assessing an early-stage company.

Outlined below are three Warren Buffett-inspired investment tips to help you identify promising startup investment opportunities.
1) Invest in a great team
Investing in serial entrepreneurs is a way to help identify potentially successful startups. According to a study published in the Harvard Business Review, experienced entrepreneurs (failed entrepreneurs included), have a much higher predicted success rate then first time entrepreneurs.
When you invest in a startup, you invest in the company’s management. Finding a company with responsible, experienced leaders meets the Buffett standard for investing in a great team.

2) Invest in what you know
Warren Buffett is known for investing in companies with simple businesses models. Companies like The Coca-Cola Co, Wal-Mart Stores, Inc. and Exxon Mobil Corporation are all great examples of these easy to understand companies from the Buffett portfolio.
This basic Buffett investment strategy has been applied to angel investing and has even been statistically proven to improve ROI in startup investing. The Kauffman Report, which was the largest research report on angel investing, found that investment multiples were twice as high when angels invested in industries that they were familiar with. Investing in companies with simple business models means that it is easy to understand how they will make money, which leads us to our next tip.

3) Find companies with recurring revenue
One measurable metric that Buffett requires of all his investments is recurring annual revenue and clear earnings predictability. One sure way for a company to generate recurring revenue is by selling a product that addresses a huge market with perpetual demand.
Today’s startup/tech equivalent would be software as a service (SaaS) technologies that usually charge their customers based on a monthly subscription fee.
Monthly recurring revenue (MRR) is a great way to show potential investors a consistent source of revenue as opposed to relying on large individual sales. As a startup investor, look for companies that can present solid (and simple) business plans that provide clear earnings predictability for the future.
source: https://blog.ourcrowd.com/3-warren-buffett-inspired-tips-for-investing-in-promising-startups/
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TIP: OurCrowd is a company specializing in VC (Venture Capital)-level investment opportunities, so employ your critical skills when reading the things on offer on their Web site.

Here is a little background on the company, taken, again, from their Web site.

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About OurCrowd
OurCrowd was started in 2013, driven by the idea that the business of building startups grows bigger and better when the global 'crowd' gains access to VC-level investment opportunities.
Today, OurCrowd is a leading equity crowdfunding platform for investing in global startups, led by serial entrepreneur Jon Medved and run by a team of seasoned investment professionals. Offering unprecedented access to startup investing, individual investors through OurCrowd are fueling innovations that change the way people work, travel, shop, heal, and conduct business. OurCrowd investors participate in these opportunities alongside VCs and institutional co-investors, at the same terms.
source: https://www.ourcrowd.com/
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Jean Steinhardt served as Librarian, Aramco Services, Engineering Division, for 13 years. He now heads Jean Steinhardt Consulting LLC, producing the same high quality research that he performed for Aramco.

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