September 10, 2002

The Roads Less Traveled

Planning to travel the alternative investments hig

Stocks too commonplace? Mutual funds not quite the ticket? Bonds just not quite what you had in mind for that client with unique requirements and ample assets? So you're looking at hedge funds, maybe, or venture capital, or even angel investing. If these are areas in which you're not particularly well-versed, or if you feel your client needs a bit of background on something you'd like her to consider, we've got some suggestions for reading material that should help.

If hedge funds are your thing (or your client wants them), you can get a brief but thorough education on the good, the bad, and the ugly with Hedge Funds: The Courtesans of Capitalism, by Peter Temple (John Wiley & Sons, 2001). As befits its slightly racy title implications, this is written in a style that seems to be a cross between textbook and gossip column. This chatty yet educational book offers insights into exactly what hedge funds are, how they're designed to work, how they originated, and how to judge whether to venture into their sometimes turbulent waters (remember Long Term Capital Management?).

In comparing hedge funds to courtesans, Temple is not quite so far off as you might think. Many of his parallels are not only amusing but accurate . He points out that hedge funds are exotic and somewhat risky (think Mata Hari), with limited availability, not quite respectable (falsification of performance figures by some high-profile managers have quite a lot to do with this), and offering the potential for good through their managers' often noteworthy penchant for philanthropy (remember Belle Watling giving Melanie Wilkes money for charity in Gone with the Wind?) while at the same time embodying risk. Or, as Temple puts it, "Whether supporting military and political leaders, comforting kings and princes, spying by passing secrets acquired during pillow talk, or bringing a scandal in their wake and toppling governments, courtesans have often played a pivotal role in history. Hedge funds have broken currencies, bankrupted economies, and threatened to destabilize the financial system." Hedge fund managers, he points out through many fascinating anecdotes, can make the hedge fund business more or less risky, interesting, philanthropic, profitable, or comfortable based on their own personalities.

Although hedge funds may seem arcane to many, this book explains even complex concepts in such a way as to offer the least fund-savvy reader a sound grasp of what hedge funds are all about. It does this in an entertaining fashion, sandwiching in financial concepts among snippets of personal information about fund managers, and the differences in style between the originator of hedge funds (Alfred Winslow Jones) and such fund luminaries (or former luminaries) as George Soros, John Meriwether, and numerous others. It also dishes the dirt on how and why various hedge funds failed. He argues that such failures were due largely to the fact that the funds failed to live up to the hedge in their names.

Something Ventured

If venture capital is where you're headed, you might want to try Venture Capital: The Definitive Guide for Entrepreneurs, Investors, and Practitioners, by Joel Cardis, Sam Kirschner, Stan Richelson, Jason Kirschner, and Hildy Richelson (John Wiley & Sons, 2001). This book breaks down the process of seeking (or offering) venture capital into a series of small. manageable steps. Whether you seek to get or place venture capital, you will have a good idea of the process, from where to look and how to value a company, to what is expected of a venture capitalist.

You'll see the kinds of things that venture capitalists look for (or should look for) in a business and in the owner/founder: a host of factors that perhaps even include failing at a startup before (after all, experience is a great teacher). You'll meet David Henry, whose company runs inner-city day care centers and has grown into a multimillion-dollar operation because of Henry's devotion to his business and his knowledge of the market, the need for his product, and the people who work for him.

You'll learn about proprietary technology, and how to judge whether yours (or your prospective investment's) is really safe from the competition. What is the burn rate for the company under consideration? How do you calculate that? You'll find out. A whole chapter on writing a business plan will give you insights, regardless of what side of the transaction you're on, into what's important when seeking or considering funding. And you'll learn what to watch for on both sides of the table. Exhaustive appendices covering a range of issue from due diligence to preferred stock purchase round out the book. Overall, Venture Capital will give you or your client a good head start on examining this form of alternative investment.

Getting in Deeper

If your true interest is venture capital, then try Venture Capital Due Diligence, by Justin J. Camp (John Wiley & Sons, 2002), which will guide you through the research process necessary before you make a decision on committing capital.

If you're not familiar with all the areas of due diligence in this arena, a look at the table of contents will get you started. But each chapter is a wealth of information. Intangibles, intellectual property protection and development, research into management and business opportunities, and the legal and financial ins and outs of venture capital investing are all covered . The chapter on management due diligence offers insights on what personality types are best for individual positions , such as CEO, CFO, chief technical officer, head of business development, or head of marketing.

Here, too, Camp argues, previous start-up failures are not necessarily negatives. He quotes Jennifer Gill Roberts of Sevin Rosen Funds as saying, "Scar tissue is good." Other VC firms agree. "Sequoia enjoys nurturing . . . the experienced entrepreneur who failed miserably the first time out and wants to show the world that the defeat was a fluke," says Douglas Leone of Sequoia Capital . Such high motivation, these experts say, can make the difference.

If you've decided to go ahead and take the plunge, there are other issues to consider. Should you seek full participation or capped participation? Will a merger or acquisition be treated as a deemed liquidation? What are the debt repayment terms? How is antidilution protection determined? Camp provides answers to such complex questions, and presents more mundane matters such as a discussion of how well the business plan is presented. While appearances aren't everything, points out a venture capital company partner, if the plan is not presented in a professional manner it calls into question how organized or professional the presenter is.

You'll come away from Camp's book with a much clearer understanding of the process and a better appreciation for the work involved in preparing to invest in an entrepreneur's company.

Touched by an Angel

Attracting Capital from Angels: How Their Moneyaeand Their ExperienceaeCan Help You Build a Successful Company, by Brian E. Hill and Dee Power (John Wiley & Sons, 2002) offers another education for those interested in investing in a more direct way than the market offers.

Whether it's the mechanics of finding angel investors understanding the differences between angel investing and venture capital investing, or, as an angel, how to find a business to invest in, there is a wealth of information here. Real-life examples, too, offer insights into various aspects of the process. One of the more entertaining of these is about the golf entrepreneur.

A golf addict came up with a training aid to improve his golf game, and decided to form a company to market it. He went after the "ideal angel," pitching his business plan (a very professional business plan, says the book) to potential angels between holes on the golf course. Hill and Power quote this story: "When the entrepreneur first showed us the technology, one of us, an avid golfer, got up from the chair and exclaimed, 'Wow, this is so cool. How does it work? I can't wait to try it.' The other, a non-golfer, stayed still and said, 'I don't get it.'"

"You'll have to decide for yourself," the authors continue, "whether these angels were doing what all successful business people do from time to time, rely on gut instinct, the emotional reaction to a product, or were merely falling into the trap of performing 'duh diligence' on their investments."

Advice sections throughout the book from angels, entrepreneurs, and venture capitalists serve to highlight potential hazards along the way, and reinforce the power of using common sense in evaluating potential investments.

Whether you're educating yourself or your clients about alternatives to conventional investments, there's a lot of homework to do. These books will help you do it, and offer you places to go to continue that education.

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