We lost our head & invested $50k in a startup

No, we’re not really crazy. But this is out of character for us.

I typically hew pretty close to the JL Collins  and the Bogleheads approach to investing: choose a few low-cost Vanguard funds (no bonds for me, thanks), or the lowest cost funds I can find within our 403(b)s and 457(b)s. I now avoid investing in individual stocks (although dividend fund investing is something I’m planning on looking into down the road – see dividend mantra) because I’ve gotten burned (I’m looking at you, Yandex…). I do vary a bit from the pack, in that I’m heavily invested in healthcare mutual funds and not just VTSAX and its brethren.

But back to the story. We recently veered from this reasonable (and dead simple) approach because we were offered the opportunity to invest in a friend’s startup company.

Without revealing much about the company at this time, let it suffice to say we did our due diligence and feel very good about dropping $50k in the private stock offering.

Now let’s be clear, there are only two outcomes:

1. We get a big multiplier on our money in 5-7 years (10x on the low end, perhaps as high as 50x on the high end)
2. We lose it all

There’s no in-between. Either they make it or don’t. And we put 15% ($50,000) of our pre-tax retirement funds into this company in order to buy about 1% of private common stock (no preferred stock was offered). It’s a bit scary.

So what if we lose it? We scrimp a little more, we hustle a little more, and we keep cranking. I will probably drink a little extra Scotch the night that we find out our stock certificates are worthless.

So what if we get the big payout? I’ll probably drink a little extra Scotch that night, too, except it won’t be the cheap shit (friends don’t let friends drink Johnny Walker Red).

After that, if the multiplier is closer to 50 than to 10, then it’s early retirement immediately. Otherwise, we have taken a giant leap in our retirement profile (a nice big catch up to make up for my wanton spending years).

But you’re probably still thinking that we’re idiots for investing so much in a risky enterprise.

Let me tell you why we feel so comfortable.

1. Virtually no competition. The only competition are people who charge big bucks to do consulting, which gives one recommendation for improvement based upon a single snapshot in time.
2. This product gives continuous feedback to a healthcare sector that is prone to high cost, volatility, and a rapidly-changing competitive landscape.
3. Relatively low cost and high benefits to the end user – and high profits for the company.
4. SaaS (software as a service) model – recurring revenue, year over year.
5. High benefit to cost ratio – the customers pay a realtively small amount (in the grand scheme of things) and get a lot back in terms of savings and/or better personnel management.
6. Constantly improving product – more features added with no additional charge to the company.
7. Supported by nearly $1 million in federal grants for improving the product…while the product is still in relative infancy.
8. Amazing management and development team – CEO has taken multiple companies to buyout, and the developers are sharp statisticians who know what they are doing.
9. The CEO has taken no pay thus far – only has stock (and a lot of it).

They think they can get to buyout in 5-7 years. They are already beating their conservative projected numbers for the calendar year. If they have their product in just 500 locations, We’ll probably see about 3-4 million dollars roll back to us.

Was this a good idea?

Man, I sure as hell hope so. It’s a risk we had to take. These opportunities don’t come along often. I’ll be sad if we completely lose the money, but I’d be even sadder if we missed out if (when) they hit it big.

“When” – but there are no guarantees. We know that.

How did we invest retirement funds in private stock?

Now, I alluded earlier that we bought these stocks with IRA funds. That’s only partially true. We rolled over IRAs into a checkbook-controlled 401k solo trust plan so that we can invest in alternatives – privately traded stock, real estate, etc. If you haven’t considered this, I highly recommend it.

I’ll be posting a companion piece on how to start a 401k solo trust with checkbook control – this is great because you get a Roth Solo 401k and a Solo 401k pre-tax, which are great ways to put money away from your side gigs (These are better than checkbook-control IRAs for many reasons, among them the fact that you can put up to $18,000 per year into the 401k instead of $5,500 as with IRAs…and the true top end is actually north of $50k, but we’ll talk about that later). This is not your typical 401k solo that you set up with TD Ameritrade.

So getting back to the how, once the 401k solo trust was set up, and bank accounts established for the 401ks, we just had our financial institution wire transfer the money, and voila! We are the proud owners of a piece of paper that could very well be worthless in five years.

We don’t think it will be.

But I’ve got the Scotch handy in either case.

Have you taken a gamble off the beaten path? What will you be drinking?