Lateral Capital Management, LLC

Why Is Lateral Capital Here?

When the Pillsbury Company was sold to General Mills in 2001, Pillsbury CEO John Lilly decided not to return to “CEO-ing.” After working on 50 businesses in 25 countries over 25 years, it became clear that what was really exciting in business – the process of bringing new products and services to market – was a real struggle for big companies. With this came the decision to move from the Manager/Leader corporate life to being an Investor/Advisor working with other like-minded individuals. Over time, this has evolved into a simple Mission; an expression of “Why” we are here:

We will prove that
investing in Early Stage companies

can be consistently profitable

and contribute to the common good.

When we first started to make Early Stage investments, we thought there must be a “proven process.” Or at least a database which would show what works and what doesn’t. We learned two things.

First,there is no “book” which explains exactly how to be a successful Early Stage investor.. Rather, we learned that most investors believe in one of several “schools of thought” about how to invest successfully. These models are what most investors hear about in the media, so they seem very logical:

  • The Investing Genius School – This approach says that there are a few expert investors who are so good, that they can consistently pick winning technologies, companies or business segments. These people are the heroes of the investing world. They have no identifiable process for picking winners. But they always seem to “know.” We have yet to meet this person.
  • The Category Expert School –Think back to Dustin Hoffman in The Graduate: The word for the future was … Plastics! This school says that there are only a small number of high potential categories and that if you focus all your investing there, you will win disproportionately. Everyone will remember one or more of these “can’t miss” categories: Online education, craft brewing and our current favorite, crypto currencies!
  • The “Spray and Pray” School – This approach says that if you invest in everything, you are bound to have one or two big hits. We have been told that this is the approach which funds like 500 Startups use: They invest in 499 fairly random startups, then “discover” Facebook.
  • The Entrepreneur as Genius School – If Mark Zuckerberg or Jeff Bezos or someone equally famous invests in it, it must be great! After all, they’ve done so well in the past that even when they get behind Fisker or Segway (both now bankrupt), we tend to be impressed.
  • The Country Club School – This is the School that Bernie Madoff made famous. It says that the really great deals are all “secret” and that if you just know the right people from the club or your class in college, you too can own a piece of the “next big thing.” Many country club investors also succumb to FOBLO. These are people who invest principally because of the Fear of Being Left OWe know many investors who work this way – sometimes following the herd right off a cliff.

After looking around the country, we could find no one who had “cracked the code” of Early Stage investing. In fact, none of these “schools” seemed to work for anyone on a consistent, sustainable basis.

Second, we learned that very little research has been run on what investment strategies work and which don’t.. There is no national database of Angel investments. None of the big research companies like Preqin or CB Insights covers the Early Stage market in depth or in its entirety. Fortunately, the Angel Capital Association, the Kaufmann Institute and two professors at the University of Willamette had done several pieces of very revealing research. Here’s what we learned from them:

  1. Investors making “one-off” investments in Early Stage companies typically fail..
  • This is because half or more Early Stage investments fail to return their capital.
  • This leads to a negative impression of Early Stage investing as an asset class.
  1. Research suggests that with multiple investments, Early Stage can be quite successful..
  • Three Willamette University/Angel Resource Institute/HALO studies supported by the Kauffman Foundation analyzed 745 Early Stage/Angel investments in the U.S. and U.K. from 1995 to 2016.
  • Research suggests that Early Stage investing can be quite compelling with return multiples of 2.2 to 2.6X over 3.5 to 4.5 years.
1 Source: “Returns to Angel Investors in Groups”
2 Source: “Siding with the Angels”
3 Source: “Tracking Angel Returns 2016 (2017 Update)” Tracking Angel Returns 2016.
4 Forecasts are inherently uncertain and subject to change. Actual results may vary.
  • Key learning is that Early Stage has to be treated as an asset class, not as “one-off” investments. Investors would never invest in just one NYSE stock. Why only one Early Stage company?
  • Within this research, we learned that numbers are your friends; that the chances of success on average improve as the number of your investments increases. Analysis of the Willamette/Kauffman 2007 U.S. data suggests that:

–     Investing in 12 companies predicts a 75% chance of achieving a 2.6X average return.

–     Investing in 24 companies predicts a 90% chance of achieving a 2.6X average return.

–     Investing in 40 companies predicts a 95% chance of achieving a 2.6X average return.

  1. There are very few organized Early Stage funds::
  • Early Stage investments are hard to find and diligence.
  • Early Stage funds typically invest small amounts of capital – so “fund sponsors” can’t earn significant fees.
  • Where there are no fees, there are no funds!

It should be noted that none of this research is airtight. The total base is only about 750 companies. It comes from multiple sources and there is likely to be some survivor bias in the reports. But we had to start somewhere and this is the best starting place we could find.

Our secret plan – So as we began investing in an organized way, we decided we would have to learn by doing as opposed to “studying” various markets and methods. There was simply not much to learn from. We also decided that we had to be open to making lots of mistakes; that it would be impossible to “pick only winners.” Finally, we decided to chart our own course in terms of how to approach the market – to keep investing until we learned enough to settle on a strategy which would be sustainable and repeatable.

We decided that investing in new companies should be thought of as a type of farming. Most Early Stage investors look for the perfect seed – the world’s greatest ideas. That’s not us. Rather, we think of ourselves not as seed hunters, but as walking through a greenhouse. As we walk along, we decided not to invest until the seed has a few leaves on it and the start of a root system. In this sense, we think of ourselves as looking to find the right seedlings – companies with a finished product and at least one customer – which we can help to grow.

What we bring to the greenhouse is an ability to assess and then improve the quality of the company’s soil. Once we invest, we look for ways to help companies find the right people, strategies and customers – resources the seedling will need to develop deep roots and thrive. This is based on the notion that even if the seedling turns out to be something of a weed, great soil can sometimes make it grow strong and, yes, even beautiful! Sometimes, the seedling simply won’t grow where it is. But if the soil is good, it’s possible to quickly “pivot”; to replant it in another part of the greenhouse.

    From this, it should be clear we are not looking to be “heroic” investors. We are not looking for the next Facebook, Google or LinkedIn. Rather, we are only looking to be “above average” Early Stage investors. By that, we mean we want to consistently over deliver the “average” return for investors in Early Stage companies: Above 2.6X our money. Truthfully, that kind of average return would be terrific and our mission would be fulfilled!

“You don’t need to be an expert in order to achieve satisfactory investment returns. But if you aren’t, you must recognize your limitations and follow a course certain to work reasonably well. Keep things simple and don’t swing for the fences.”

Warren Buffet