If Warren Buffett Invested in Startups

By Wayne Mulligan, on Friday, November 1, 2013

Investing can give you whiplash.

One day it seems like you know exactly what you’re doing. The next day you turn on CNBC and some “talking head” is preaching about how wrong you are.

In the late 90’s, you were “missing out” if you weren’t investing in dot-com companies.

In 2001, you wouldn’t be caught dead with one in your portfolio.

And now, with the outrageous success of consumer technology companies such as Google and Facebook, the pendulum has swung all the way back: Tech, bio-tech, mobile – many of us are clamoring for more.

As an investor, what should you do? Try to predict trends? Follow them?

Too bad there’s not a better roadmap; a less “ADD-like” method of investing.

Actually, there is. And we can find the clues to uncovering it by looking at two verysuccessful investors – from very opposite ends of the investing spectrum.

Mr. Value

“Value is destroyed, not created, by any business that loses money over its lifetime.”

This quote was pulled from an interview Warren Buffett gave back in 2001. He was discussing his rationale for avoiding money-losing dot-coms during the late 90’s – a time when it seemed like everybody else on the planet was pouring money into them.

Buffett’s position on avoiding technology stocks led many to dub him – and his investing framework – as “outdated.” Remember, at that time, professional and amateur investors alike were making fortunes in the market. And it seemed that guys like Buffett – who were basically sitting on the sidelines – were missing out.

Needless to say, Warren did just fine. He’s still one of the Top 3 Richest men in the world, still investing in companies like Coca-Cola, and still beating the market.

Does that mean Warren was right and everyone else was wrong? The answer isn’t so cut-and-dried…

Tech Investors Have Done Well Too

Let’s take a look at a technology investor who was around both before and after the dot-com bubble. He’s done very, very well for himself. His name is Fred Wilson.

Fred is the co-founder and managing partner at one of the most successful early-stage venture capital firms. It’s called Union Square Ventures.  He’s invested in many successful start-ups including comScore (now public), Geocities (acquired for $5 billion), Twitter (about to go public), Tumblr (acquired for $1 billion), and the list goes on and on.

He tends to look at companies and investments a bit differently than Buffett. For example, things like current profits (or lack thereof) don’t necessarily concern him.

In fact, he wrote a post on his blog last weekend summing up his thinking regarding how he sees businesses and investments over the long term »

In his article, Fred talks about publicly-traded companies that are currently losing money – but still commanding multi-billion dollar market caps.

Fred argues that these losses are intentional; that the company’s managers could turn losses into profits at any time. All they’d have to do is invest less in future growth.

Start-ups are essentially doing the same thing. They’re not “losing money;” they’re making an investment in their future.

Does this mean Fred is right?  Is the road to riches paved with profitless tech companies?

What Should You Do?

These are clearly two very different schools of thought when it comes to investing.

But instead of looking at what makes them different, let’s look at some of the things they have in common:

1.Long-term Thinkers:  Both Buffett and Wilson take a long-term view of their investments. Buffett is clearly unmoved by the pundits on CNBC. He’s been investing exactly the same way for decades, and been through multiple market cycles. The internet start-up trend didn’t phase him at all; he was playing a long, stable hand.

Same with Fred. After the dot-com meltdown, many “tech investors” suddenly had zero interest in the sector. Fred believed in the power of technology and its ability to change the world… maybe not right away, but certainly over time. He kept right on investing in new companies – and he’s continued to do well.

2.Invest in What You Know:  Buffett has often said that he doesn’t avoid tech stocks because he thinks they’re inherently “risky;” he thinks they’re risky for him because he doesn’t know enough about the tech sector. What he knows about is insurance, consumer goods and finance – which  explains his investments in companies like Coca-Cola, Goldman Sachs and Geico.

Fred, on the other hand, has been an early-stage technology investor his entire career. And before he was a VC, Fred attended MIT where he studied Mechanical Engineering. Technology is in his DNA – it’s what he knows, which explains why this is where he invests.

3.Frameworks:  These two investors don’t throw darts at the wall to pick their investments. They create an investing framework – a filter. By putting a potential investment through their filter, they can determine its merit.

Buffett’s framework, for example, involves looking for companies in specific industries, trading at prices that denote “value.” Wilson’s involves getting into certain types of technology companies very early – companies that can gain “network effects,” for example, where the value of a product increases as more and more people use it. Think Facebook, or Twitter, or social games.

Without a stable framework, it’s doubtful that either investor would be as successful as they are today.

Given the recent excitement around technology companies, equity crowdfunding, etc., it seems that investing in start-ups is once again back in vogue.

But if you jump into equity crowdfunding because it’s “trendy,” you might lose the confidence to stick around when the waters get choppy. Keep in mind: sailing through choppy waters is one of the hallmarks of both Buffett and Wilson. They play the long-hand – and it’s led to wealth creation.

So if you’re thinking about investing in early-stage companies, do it by following both Buffett and Wilson. Think in terms of years, not months. Stick to industries you know or can understand. And have a framework that you can apply consistently!

We try to help you develop a personal framework in our report: The 10 Crowdfunding Commandments »

If you haven’t already read it, we recommend you get started today!

Best Regards,
Wayne Mulligan
Wayne Mulligan


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Tags: Equity Crowdfunding Crowdfunding Education Early-stage Early-stage Investing Warren Buffett Fred Wilson

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