In the pro shop of a Florida golf course, I was introduced to a man who, I was told, was worth more than $100 million. I was there to try to entice him to invest in a Reg. D offering I was then representing — as it happens, a fund of venture capital funds. It was September 2000 — post peak, but only just — from today's vantage point, a completely different world.
That is to say, the animal spirits were still burning for tech. So much so, that the VC guys were raising record amounts from investors — and not just the traditional participants in such funds, institutional investors, but from wealthy individuals.
So, there I stood, somewhat in awe, shaking hands with $100 million. I was to learn, in hushed reverential asides from the financial advisor who had brokered our introduction, that the mogul had made considerable sums of money in real estate, that he owned the golf course on which we were meeting and that he owned buildings in midtown Manhattan.
He is not what I expected. To me he appeared almost medicated — all but expressionless, with a painfully slow speaking pattern. But it was quickly apparent why he was Mr. $100 Million. He spoke unusually bluntly (“Who are you?” he asked me, even before his financial advisor could introduce me.) His questions rolled out in a slow, methodical stream that drilled down to the essentials.
Although he was out of his element (real estate), he quickly showed an innate ability to cut to the core of our offering. At one point, unbelievably, he noticed an error in our private-placement memorandum — something about the fund's timetable for liquidation. The embarrassment staggered my partners for a moment, but Mr. Hundred Mill never missed a beat.
The questions continued to spill forth. To me: “What do you do, exactly? What's your fee?” Then, turning to my business partners, the guys who put together the offering, he said, “What are the expenses with the underlying VC managers? With you, the general partner? Tell me about the lockup? When the capital is returned to me, does that incur a cap gain or is it legally a return of initial capital?” Never wasting a word or a syllable, he continued to speak in declarative sentences. (only interupted when his granddaughter passed through the room.)
I fell silent as my partners did their thing, touting the merits of the deal, the quality of the underlying managers. They spoke of the individual styles of the several VC managers and how those styles complemented each other, about how this — right now — was a unique time in history for technological advances and an auspicious time to invest.
This was my cue to pull out marketing materials showing the internal return rates for each of the underlying VC managers, who, no kidding, were some of the most established in the business. Their historical returns were astonishing. The returns for all of the managers, net of fees, were truly mouth-watering.
“Okay,” interrupted our quarry. “I'm satisfied with that part of it.” Then, he apparently got to what he really seemed to want to know: “Are you predicting a 40 percent IRR [internal rate of return]?” A smile crossed his lips; I turned to see if his granddaughter had toddled back in. She hadn't.
Compared to his earlier demeanor, this smiling and expression of interest, was what must pass for excitement with him. And a realization came over me: Discussing prospective returns can transform even the most sober, disciplined investor into a drunk teenager on spring break (metaphorically speaking).
He ended up putting in several million — not, he said, because he needed the money. “Because it's fun to be right. I just like to be right,” he said. In thinking about it later, I never bought that explanation. There was some real cachet to being able to get a piece of those VC managers in those days.
But given the state of the VC market right now, I know that he couldn't have been pleased to have been so wrong, horribly wrong (although I must admit that I do not know how that particular fund of funds has performed). I think that even the most savvy client can become intoxicated by the potential profits from a red-hot sector. Of course, you knew that. For me, the lesson was clear: Don't just point to the risk factors page in the private placement memorandum, make them copy it. That way, if things don't go right, you'll stand a better chance of avoiding arbitration.
Aldo Blackthorn is the pen name of a New York-based writer.