Stay in your circle of competence
Famous investors often talk about the importance of investing in companies whose products you understand. Peter Lynch waxes lyrical on this in his very readable book One Up on Wall Street, and Warren Buffett trots out his ‘I only invest in things I understand’ humblebrag all the time.
A few years ago I was offered a chance to invest in a new educational company that would provide teacher education online. I’ve been a teacher most of my life, as well as a teacher trainer and manager of teachers, so I felt this was right up my alley.
I also knew most of the people involved, who were all respected, hard-working, competent, professional teachers.
They sent me a prospectus and everything looked good. The company would pay a dividend, buy back shares, and hopefully be purchased by a larger entity.
A 20% dividend? Being part of an exciting new company doing good work? The possibility of a profitable exit? Sign me up 🙂
I invested $12,000 in the new company, giving me a 2% ownership stake, and it launched.
Doubts grew slowly. I wasn’t impressed with the website. Things seemed to be moving slower than I had anticipated. All the founders and members of the team had day jobs. There seemed to be large technical challenges. Attracting paying customers seemed to be more difficult than anticipated.
The first dividend was missed. Communications from the team slowed down, and then pretty much stopped. Emails went unanswered. About once a year I would send an email asking for an update, which would normally be answered but not always with specifics.
The company pivoted, moving away from mass online instruction to a more bespoke, online seminar model (much less profitable and more time-intensive) that didn’t require most of the initial tech investment.
Mentally I wrote off my investment and apologized to my wife, whose money I had also used for my chance of startup glory.
To date I have not received any return on my investment and I doubt I ever will.
Lessons Learned?
Well, I learned that it is not enough to understand the product and know the people involved. You also need a good idea of the market.
The founders, great people though they are, were clearly out of their depth in hindsight. Too many teachers, not enough financial types.
If something sounds too good to be true, it probably is (20% annual dividend… hah!).
Angel investing works by investing in 100 companies and hoping that one or two of them make enough money to make up for the money you lost on the other 98-99. Those odds make investing in one company a losing proposition.
Just to be clear, I don’t blame anyone for this (except maybe myself). The founders put in much more money, time, and effort than I did and continue to try to make the company work.
I learned some very valuable lessons about competence and diversification, and the loss, while not small, is not going to hurt us or even inconvenience us. It could have been a lot worse!
How about you? Any investing war stories? Would you have gone for this investment (or a similar one in your field?
Ouch – but yeah, there are so many red flags here that I would have been running for the hills.
20% dividend – yes, huge red flag. Using such castle-in-the-sky fantasy numbers for the financials means the entire business proposal is sketchy at best (‘if it sounds too good to be true…..’ as you say).
More to the point, a) offering a 20% dividend and b) being able to withdraw 50% of the investment, c) only 18 months after launch makes no sense. When the most attractive dividend-paying stocks worth investing in are offering dividend yields of 3-5% no proper start-up would offer quadruple the dividend unless they had no intention of returning any money at all to begin with. Why would any start-up company want to commit to paying out so much? Why do they need to offer such a huge return? Start-up companies require cash – and they always require more cash than they think. If they pay out huge amounts in dividends then run out of cash…they need more investors, which either requires you to invest more in a struggling start-up, or others invest, which dilutes your equity. If they had offered, say, a 5-8% dividend, that’d be at least plausible.
Secondly, I’m not sure of the timing of when you got involved, but my next question would have been to query the time frame: All shareholder funds received in end-June, site launches in end-September? Three months isn’t even remotely plausible: launching a commercial website takes anywhere from 9 to 18 months depending on the complexity, security etc. But perhaps the team was working on the site already…in which case you should have been able to see a working demo. If not….big red flag.
It’s understandable that you felt a bit more secure because you knew some of the people involved, but unfortunately, that’s how the majority of scams work: Nobody would fork over $10K to a stranger, but if it’s someone you know, they wouldn’t screw you over, right?
And scammers know that people will usually find it too awkward / uncomfortable to make a big fuss: in general, people are nice and don’t want to make a scene. So at first you’re patient. You’re polite. The more time that goes by, the worse things seem to be going, but the more time that passes, the harder you find it is to speak up.
Perhaps you still don’t think it’s an outright scam, just incompetence. In which case you probably aren’t going to sue. Honestly speaking, I think it was probably a scam, but either way: Do you still see or meet any of the people involved? If so – I would ask them – politely but firmly – about your money every single time. They still owe you your money or at the very least an explanation – and it should be more uncomfortable for them than you. Don’t feel bad about it. And the amounts they may (or may not) have invested is irrelevant to *you*.
Although this is why they say it’s not a good idea to go into business with friends…
I personally would not have invested in this, mainly because I’m old and cynical, too much bile in my system so I generally have a poor opinion of the majority of my fellow men <g>
Well, I wouldn’t invest *now* 😉
I’m not too bothered. It was a mistake, but I learned a lot from it.
I made a much bigger mistake investing in a ‘trend’ hedge fund a few years ago. That still makes me sad…
Ouch – but yeah, a 20% dividend is a huge red flag. Maybe it wasn’t an outright scam (although I think it was), but using such castle-in-the-sky fantasy numbers for the financials means the entire business proposal is sketchy at best.
Why offer a 20% dividend? There’s no need to offer such a dividend – something in the 5-8% range would been completely fine: more attractive than alternatives, given the low-interest rate environment, while keeping funds in the company. Start-ups need cash. Always. Running out of cash means either you have to invest more in a struggling startup, or others invest, diluting your equity. The only reason to offer a 20% dividend is if they had no intention of returning a penny.
I’m not sure of the timing of when you got involved, but my second question would have been to query the time frame: All shareholder funds received in end-June, site launches in end-September? Three months is fantasy-land stuff. Launching a proper, commercial website takes anywhere from 9 to 18 months depending on the complexity, security etc. Perhaps the team was working on site already…in which case you would have been able to see working demos or prototypes. If not….big red flag.
It’s understandable that you felt a bit more secure because you knew some of the people involved (but that’s why most scams are targeting people the scammers know – nobody would fork over $12K to a stranger, but if it’s someone you know, they wouldn’t screw you over, right?) But did you meet with the management team? The developers? That the people involved in the company all had day jobs is a HUGE red flag. Especially given the compressed time frame.
Do you still see or meet them regularly? If so – I would ask them about your money every time you meet them. It should be infinitely more awkward for them than it is for you. If you’re convinced it wasn’t a scam, just incompetence, then probably no need to sue, but they still owe you your money or at the very least an explanation, or you should be making it very uncomfortable for them, and making sure they’re not scamming over others. The amounts they may (or may not) have invested is irrelevant, what is relevant to *you* is the money *you* invested.
I personally would not have invested in this, mainly because I’m old and cynical, too much bile in my system LOL.
I’ve bought two stocks that I count as failures. One was recommended by a friend, but I forget where I learned about the other one. I knew they were risky investments up front, and in both cases the money came from the “I can afford to lose this money” basket (I had already maxed out retirement investments). The losses were balanced out by better performance of other investments. They helped prove for me that it’s very difficult to find the next Apple. Now that I’m older, I’d stick with mutual funds.