Episode 165 – How to Invest in the Private Market With Leif Hartwig

Have you ever been curious about the hidden opportunities that lie beyond Wall Street’s reach, but not sure where to find them? This informational episode about investing in private markets will provide context, and a very useful resource to help you do just that.

In this episode of The Agent of Wealth Podcast, host Marc Bautis is joined by Leif Hartwig, Founder and CEO of WealthVP, a subscription-based platform that matches private investors with high-quality companies seeking funding. Leif draws on over 30 years of experience in the software startups and financial service industries.

In this episode, you will learn:

• How companies are getting funded through private investments.
• The difference between private investments and venture capital investments.
• What makes a private company investible.
• The risks associated with private investing.
• How companies can use WealthVP, an investor community that matches high-quality private companies for investment.
• And more!

Resources:

wealthvp.com | [email protected] | Bautis Financial: 8 Hillside Ave, Suite LL1 Montclair, New Jersey 07042 (862) 205-5000 | Schedule an Introductory Call

Welcome back to The Agent of Wealth Podcast, this is your host Marc Bautis. Today I’m joined by guest Leif Hartwig. Leif is the Founder and CEO of WealthVP, a subscription-based platform that matches private investors with high-quality companies seeking funding. Leif draws on over 30 years of experience in the software startups and financial service industries. 

Leif, welcome to the show.

Hey Marc, thanks for having me.

I’m excited to discuss private investments today, exploring both perspectives: that of the investors seeking opportunities and the companies actively seeking funding. In the past, private investments were not widely understood or accessible to many. However, the market has since exploded with growth. I’m curious to know, how did you become involved in private investments?

How Companies Get Funded Through Private Investments

I’ve been involved in the investment world for most of my career, as an investment advisor on the public side – which is the top of the market – and by forming my own companies, growing and raising money, eventually seeking investment.

So, as I learned about those markets, and over time became a serial entrepreneur, I discovered this huge marketplace. As you correctly said, these marketplaces have not changed in finding investments for 50-plus years. This two-and-a-half-trillion dollar marketplace for private companies, just in the United States, is all word of mouth and networking. Can you believe that?

I know, it’s crazy. So, why are we seeing more exposure recently? Is it because there is more accessibility, or is it because people are looking for other avenues to build wealth?

Growth in the Marketplace

Well, we’re talking about a two-sided marketplace. There’s the investors, they’ve been working with venture capital funds, which everybody’s heard of. What most people don’t understand is, the venture capital industry only funds about 1% of private companies. So who funds the rest? It’s investors – like those in your audience – that does.

Yet, they don’t have access to the deal flow that they would like to see. In fact, most private investing happens through your network. Hearing about an opportunity from a friend, colleague or family member. But, in those cases, how do you vet the company? 

So, from the investor side, there was a need. And private companies have a need, too – about 90% of all private companies go under because of lack of capital. They can’t find it, or they don’t know how to pitch.

The markets have grown so substantially that, just from a company standpoint, we saw maybe 50 unicorns (private companies worth $1 billion dollars) in 2015. Today, there are over 1,200 unicorns. There were over 5 million new startups last year. I don’t know if that’s because of the pandemic, but this marketplace has just exploded.

The Difference Between Private and Venture Capital Investments

I think that investors are tired of venture capital investments, because they charge something called two-in-20. The venture company takes 20% on the backside of deals, and they also take 2% per year. Over a 10-year period of time, that’s 40%. 

So investors really want to invest directly, and I saw that the industry was ripe for digitization. 

Of course, the public markets have been digitized well, and the bottom part of the market – crowdfunding – is readily available. So my focus is on this middle marketplace.

So, how does the platform work?

How Companies Can Use WealthVP

To give everybody a visual, WealthVP is like match.com meets Shark Tank. So, we have companies that we would say are on the match.com side, seeking investors. Then, there are the investors on the Shark Tank side. The people who join the platform are not just individuals, we have a whole community. They can connect with each other, join angel groups in specific marketplaces, or aggregate together on syndicate deals.

My idea originally was, if someone was willing to pay 50 bucks a month for a date, would they pay 50 bucks a month to meet an investor?

Oh, yeah. It’s a great idea. 

So, because we only take a monthly recurring revenue from companies, it was important for us to stay outside of the SEC rules. We are not a broker dealer, we just do matching. Because of that, we can’t vet, but we can qualify. 

These are the three qualifications that put a company in the upper 5% of investible private companies:

1. They’re in revenues. They really have a product that’s being sold – it’s not just an idea.
2. They have an 18-month burn rate. Most investors don’t want to risk their money in a way that it’s depleted before it’s profitable. So, we’ve found that the rule of thumb is 18 months burn rate, or of your expenses given your performance. So, to qualify, they must raise at least that.
3. They have experienced management. That could mean that those involved have had an exit in the past, or that they’ve come from the industry in which they have experience. That attracts investors. attracting that experience. 

So those three qualifications we use on our platform.

So let’s say a company passes those qualifications and gets onto the platform. Are the private companies investible individually, or packaged up into a fund?

The investments are individual to the company. 

When a company comes onto the platform, we provide them a lot of service. In this modern day of software, it’s rare that you’ll find old world meets new world. But, with Wealth VP, not only will they get the platform and be able to connect with the community of investors, but they’ll also get a concierge service.

We’ll also go over their pitch deck. 99% of all pitch decks we see need help. And, by the way, that’s the gift that keeps on giving. Because not only will they be raising money on our platform, but they can use that pitch deck in all situations. It’s a quality product that they can continue to put forward.

They also will be on a virtual pitch event with dozens of highly qualified investors.

Diversification in Private Investing

Now, going back to the investor side. If you’re investing in, say, public markets, there’s this concept of diversification. Diversification could mean a lot of different things, but what does that look like on the private investment side? 

In the past, I was really steeped in portfolio diversification. As an investment advisor, if you came to me, you’d know your alpha, beta, sharp, brake. 

Because I’m a huge believer in diversification, I think that if you’re going to make an investment in private markets, you should consider picking up more than one. It could be 20, 10 or five. What the grouping looks like will depend on the investor’s area of expertise. 

We have a number of investors that invest in only three or five companies, but in the industry that they know.

If you don’t come from an investment background, you should invest in some number of companies to diversify your risk. Venture capital companies have what’s called a five, three, two. Five companies go under ten, three break even, and two knock the cover off the ball. I’d say your success rate will be similar on our platform.

That’s like the Peter Lynch method of investing, invest in what you know

Exactly.

Is there a secondary market for private investments?

Right now, there is not. And remember, none of the buying and selling happens on the platform. We match the investors up with the individual, and they take it from there. 

However, I think you’re asking a great, broader question about the private market. In the middle markets. They’ve exploded so much that we’re seeing a great effort made by many companies out there, to have secondary markets in the private markets.

Because in the past, you would find investors would get into a company and then they would say, gee, we’d like to get out. The company’s doing well, but there’s not a liquidity event that’s happened yet. And so we are finding that there are groups out there that are forming secondary markets, being able to sell what you’ve said, a secondary market. And we see some very large companies in the exchanges trying to figure out an exchange for private companies.

That’s not something that we do, but it is something that’s growing and developing in the middle market. And I think over the next three to five years, we’re going to see more work in that area, where people can have a liquidity or an exit event separate from the private company exit event.

Going back to the business side, and where the company’s looking for financing or capital, can you take us through, and I know you mentioned the three criteria and one of them is that a company has revenue. And actually has a product, or a service, or something where it’s generating revenue. But can you take us through the typical stages that a company goes through, from idea to when it starts raising money, and the different stages of raising money, and who typically gets involved in each of those stages?

Yes, thanks. I think it’s a really misunderstood part of, how do you … And I’m going to come from the company standpoint, but as I mentioning this, this will be great for your investors too out there. Because they can understand what a company goes through.

When you first come up with an idea, that probably most of us out there have had this fantastic idea of, how do we want to build a company? And we could make a billion dollars by doing this. So you go through the thought process, then you develop the product in your mind, and maybe you develop a prototype of that.

During that time, you’re probably working your day job and developing this thing until you get to a point where you say, wow, it’s time to fish or cut bait. I’ve either got to do this or not, but I don’t have the money to do it.

So that’s called, right now that’s called pre-seed stage. It used to be called seed. And everything’s kind of moved up a notch, and replaced the upper tiers. So the pre-seed series round is what we call friends and family. And that’s really what you need to be doing, is going out to people you know within their network, and raising whatever that minimum amount is to get to the product that you have a real product that can be saleable.

So it’s typically pre-revenue, and that’s called pre-seed. How much you need to raise just depends on, do you need a lot more people? Do you need a lab, do you need facility, do you need some sort of manufacturing goods and services? So it could vary from maybe as little as a hundred thousand dollars, to maybe a million dollars. Somewhere in that range is typically the pre-seed.

The next stage up is that you’re now in revenues, and now you’re a seed-stage company. The seed is the old series A, which is the next level up. And we’re seeing an average of about $5 million raised in that area. So it could be anywhere from maybe a couple million dollars. Again, noticing your 18-month, the burn rate, that’s how you figure it out, up to maybe several million dollars that’s in that phase.

One question, is the seed round, are the companies still doing typically a convertible note at that point? Because they don’t really, there’s protection for both the company and the investor. Because I think that’s one thing you see, people see Shark Tank and they see, all right, it’s a straight equity investment, but the reality is a lot of times you don’t get to that phase until further down the road.

Yes, we see the most predominant type of security as a convertible note, or a safe note. They’re called a lot of different things. And what that is, the company is saying, we really don’t know what the value of our company is. We think it’s worth this, but what we’ll do is, we’ll have you invest money in us in a note that has an interest rate that’s typically a little lower. And that note will convert into the stock into the next round. When you have, really, people that know the values.

The next round they’ll get, let’s say the company’s worth now $20 million, and this new investor is going to come in with $5 million. And it could be a venture fund, and they really know the values. But right now we’re saying, we really don’t know the value. So that, what you’re buying, will convert into the next round, and will give you a discount on the next round.

So you were in earlier, took more risk, we’re going to give you a 20% discount on that next price. Which is pretty fair, right? So if they valued the company, the new one at $20 million, your note converts into a $16 million pre-funding valuation.

And most investors would say, yeah, I like that. And in the meantime, I get interest while I wait. Also, a note. In a liquidation preference in the company, if something were happen or go under, the debt holders get their money before the equity holders would get preferred or common stock. So yes, that’s typically done in a convertible note.

Is that cap that you were talking about, whether it’s the 20 million, 16 million, is that in the convertible note? Or is there something in the convertible note that says you will get a 20% discount on whatever the next round is?

The price of the stock is not in the convertible note. Companies really don’t know what that’s going to be worth. However, what you see in a number of notes is they will give a maximum cap that you will get in. For instance, the convertible note will say, I’ll give you a 20% discount on the next offering, or we’ll cap the company of what you can get in at $10 million.

So even if the next round is 20 million, you’re still getting in at 10?

Yeah, they’ll either get the lower of the two. So in this case, instead of 16 million, you would convert into 10 million and pretty much have a double, at least hypothetically right off the bat. So some of these notes come with that cap, others don’t. But I would say most do at the C-level

And at the C-level are they getting into the VC companies, or is this a place where your platform comes in and provides a market?

So really, this is a step out. You’re now trying to find people with greater amounts of money, unless your network has that. But most don’t. What we found is that this is a really difficult level, and it’s where companies either succeed or fail.

They need to find money, but let’s say that you were raising a million dollars in this next seed round. And you set your limit at $10,000 minimum. If everybody came in at that, you’d have a hundred people you’d have to sell. And even BlackRock only gets a 30% close rate. So let’s say you could do as well as 10% of all the people you pitch comes in, you have to pitch a thousand people. It’s almost impossible.

So you need to set your limits higher, maybe at the 25, 50, a hundred thousand dollar limit. And then you need to seek out those organizations, or those networks that have those types of investors. And those types of investors typically have to have 10, 25, $50 million of assets under management to be able to afford a hundred thousand dollar investment.

So you truly need to seek out, at that level. Hire investors so you could still work with your network, but what I found, you get what you ask for. So if you ask for $10,000, that’s what you’re going to get. If you ask for 50 or a hundred, that’s who you start attracting into this new investment world. And to some of your companies out there, that sounds like a lot of money. But it’s really, in the scheme of things with our investors, it’s relatively a low amount for an investor to come in.

Okay, so let’s say they do go through that seed round, and then that company’s still continuing to grow. What’s next, typically after that?

That’s an A round. And then you go from A, B, C, D on out. The A rounds are typically now at $10 million, average amount, 10 to $15 million, but they want to see now more revenues. They want to reduce their risk. And so if you are a SaaS company, software as a service company, they’re looking for maybe $5 million in annual recurring revenues. When you get to 10 million, that’s when you become very interesting to most every venture company.

But still, it’s a really low rounds. And even though that 15 million sounds like a lot of money, truly when you have these multi-billion dollar VCs, it’s a relatively low amount for them. We’re finding family offices, and some of you and your audience haven’t heard that term before. But basically at some guy or gal that exited their company with a lot of money, and now they’ve decided they’re going to use this money as their business for investing.

And so the family office then will look for these private investments, both in real estate and in private companies, and they will start selecting those. We think that our platform is better, faster, less expensive. Instead of having to build an organization and paying hundreds of thousands of dollars and a lot of time and effort, you can go to our platform and get deals, and have concierge services, and see pitch events and do all that.

In this series, A rounds is what family offices and ultra-high net worth people are valuing our platform because of the ease of use and the deals that they see. And then the companies also like the fact that they can get a hundred thousand dollar minimum investment versus having to go out on their own. And typically, these companies are just brilliant at what they do, but it’s typically not raising money.

Right. I know from the investor side, everyone’s interested or eager to hear about what is the liquidity event, and when they can get their money back. I think typically you hear about the company could get acquired, or the company goes public. What are some of the trends you’re seeing now on both of those stages? In terms of where does it fall in the life cycle of the company? Are companies getting acquired later and later? Are they going public later and later, or is it just as it’s always been?

I talk about the three ways in which you can get an exit, and now with the secondary markets perhaps having, that’s a fourth way. The least likelihood is to go public. It’s very arduous, and many of the CEOs that I’ve had as friends that have gone public said, we wish we wouldn’t have done it. It’s just tough ,and you got to be shareholder-focused. And so we’re seeing less and less companies go public. In fact, we’re seeing delisting from the exchanges. But that is an option.

The next option would be, you’re going to be acquired by a large corporation. And we saw companies like Slack, and LinkedIn, and a lot of these that really made it big. They were acquired by Salesforce or Microsoft. What these corporations won’t do is, they’re not going to come out with a competing product at a low level where your revenues are low, because you haven’t proven the market.

But they will buy you. Once you’ve proven that marketplace, and they believe they can scale you up. And so they would rather pay you a lot of money than do it themselves and add employees, capital, and risk. Being purchased by a corporation in your market area is a great alternative.

And then when you get to the later levels and you want to exit B and C levels of the series raises, now you have venture capital and private equity, and I’ll tell you the difference between them in just a minute. So they would purchase your company and come in. And in the private equity, differently than … Venture capital just invests in companies that have a 10 to 50 times potential return. Private equity likes to see mature companies. And when they invest in you, they’ll actually help you with executives and team people that can help you grow. But their return expectations may be three times or five times, because it’s more of a safety play where they can grow versus a venture play that’s very high risk.

Those would be the three areas. And then what we mentioned earlier in our conversation, that secondary markets are becoming available. So a liquidity event, the founder might say, hey, the company’s really growing. I love it. I really don’t want to have a liquidity event. I’m going to keep it private. And in that case, the secondary market that’s being developed, I think, will be more and more popular for those initial founding investors to get out.

Yeah, makes sense. From the investor side, I think one of the things I see is people, they’re hesitant taking that first step of investing in a private company. For probably a lot of different reasons. But how does the platform, or how can you suggest that they can become more comfortable with doing it?

So, we have a variety of investors – those that have never invested in a private company to those that do it often. Before I founded WealthVP, I hired a coach who helped me nail down my values: Character, integrity, family, faith. And so, I think as an initial investor, it’s all about trust. And it’s all about understanding that they’re finding a quality deal that gives them the greatest probability of success. We’ve designed our company not just to match people, but to actually have conversations, to get other people involved in deals, to have quantifiable information.

For instance, we have data and deal rooms on our platform that you can not only see their proformas, their decks, their executive summaries, their cap tables, but also any other articles that maybe they’ve had published on themselves, so that investors can do a deep due diligence dive and check out the facts.

And so the hesitancy I think comes from people where there’s a fear of the unknown. Of a past situation they might have had, and they project that into this new deal. We try to provide as much information as we can without recommending the deal.

We are there to help them look, and understand, and compare different deals. And really leave it up to them to do that. But we also have experts that are related to our platform as well, that can provide additional information that we can’t provide. So there may be due diligence companies, there could be companies that help with analyzing share values and all those things that we won’t do. Because we are not the recommendation people, we are the matching people.

So in summary, what reduces fear to those initial investors, or the hesitancy? I think it’s not having enough information and not knowing. However, everybody in your audience needs to know these are high-risk investments, and they can lose all their money. And we make that clear to everybody. But what we’re trying to do is increase the probability of success by doing your homework.

How to Find Private Real Estate Investing Opportunities

Earlier, you mentioned real estate. Are there different types of asset classes that you have on the platform?

Yeah, we’re industry agnostic on the company side. On the WealthVP website, we have dropdown menus for the industry categories – EdTech, MedTech, cannabis, crypto, EV, etc. 

Recently, we were asked by our family offices to include real estate. And so I had one of my old friends that worked with a company called Green Street, that on the public side provided more data and more reliable than anyone else out there. And they would analyze REITs and sell those to Goldman or a Merrill Lynch.

So he’s come to work for us, and we’ve identified three additional categories that are just real estate. And what we found is that our investors wanted some tax-advantage deals. For instance, if you have a property that you’ve sold, you’ve got 180 days to put that money back into another real estate property, called a 10-31 exchange. And you can avoid the capital gains taxes, and defer that sometime in the future. So that’s one category.

Another category, it will be opportunity zones. Which, not only can you do that deferral, but … The rules are pretty complex, but if you hold it for certain periods of time, you can actually eliminate some taxes on the earlier deals by getting into these opportunity zones.

The third category is what we call non-taxable deals that just would be growth deals, but they don’t have the deferral. But we all know that real estate has additional tax advantages just on its own. So those would be the three categories that we’re just now developing on our platform with those matching features.

Great. Well, we’re just about out of time. Leif, I’d like to thank you for being on the show today. You provided some great information on private investing from both the investor and the company side. How best can people find out more about you, or learn more about Wealth VP?

Our website is wealthvp.com, VP is short for Wealth Venture Partners. Your listeners can reach me directly at [email protected]. I’d love to answer any questions that people might have, or get you set up on the platform.

Great, we’ll link to all of that in the show notes. Thanks again, Leif. And thank you everyone for tuning into today’s episode. Don’t forget to follow The Agent of Wealth on the platform you listen from and leave us a review of the show. We are currently accepting new clients, if you’d like to schedule a 1-on-1 consultation with our advisors, please do so below.