The champagne was flowing.
Music filled the air.
Beautiful people were dancing, lounging, and having the time of their lives…
That’s the image I had in my head when I wrote a check for what turned out to be the worst investment of my life.
Dim Lights, Big City
I was never much for going to nightclubs, but when you grow up in New York City, eventually you find yourself in a hotspot or two.
And I have to admit, there’s something seductive about finding yourself with a player from the New York Knicks sitting to your left, a group of models sitting to your right.
But the real energy in the room – the real power player – belongs to the nightclub owners. When the owners walk in, everyone gets up to shake their hand and kiss their cheek.
So when I was offered the chance to become a partner in a local New York nightclub, I decided to take a look.
Is “Local” a Good Investment Filter?
Earlier this week, my partner Matt wrote a post for Crowdability about Local vs. Non-local investing.
Like Matt, until equity crowdfunding came along, I had never invested in a private company outside of New York City.
In fact, a handful of my investments were very local – for example, my childhood friend’s restaurant down the street from where we grew up, and a cool new retail store a few blocks from where I live in midtown Manhattan.
And then there was the nightclub.
Boots on the Ground
My criteria for making local investments weren’t as rigorous as my criteria for investing in technology start-ups. My reasoning was simple – perhaps too simple: since I could be “boots on the ground,” see the operations up close, and offer my two cents as needed in person, I’d reduce some risk.
When I did due diligence on the nightclub opportunity, these were the basic elements I looked at:
Management Team
The club was going to be run by a group of experienced operators. They had owned and operated several bars throughout the city.
I gave the team the thumbs up.
Location, Location, Location
My Rule Number #2 for vetting a local business? Location.
This club was going to be based in New York City, in a “hip” neighborhood known for nightlife.
The location passed my test.
”If You Like the Store, Chances Are You’ll Love the Stock”
That’s a quote from legendary stock picker Peter Lynch.
The gist is, if you find yourself frequently shopping at a specific store, it might be worth buying stock in the store’s owner.
As I mentioned, I was never much for going to nightclubs. But I liked the atmosphere the operators had created in their previous establishments. If I were making the effort to go to a nightclub, I’d want to visit something they set up.
That was it. I considered my due diligence done.
The Velvet Rope
I took out my checkbook and made the investment.
Was I excited to receive my promised dividend check in a few months? Sure. But I was even more excited about the prospect of jumping to the front of the line outside the club, being ushered past the velvet rope, and handing out free drinks to all my friends.
In retrospect, not a good sign.
Too bad I didn’t apply some of the investment filters Crowdability talks about in its 10 Crowd Commandments report.
“Risk Comes From Not Knowing What You’re Doing”
Before my nightclub investment experience, I viewed local investing to be inherently less risky than investing in tech start-ups.
But as Warren Buffett says, “Risk comes from not knowing what you’re doing.” And boy, as it turns out, my partners and I had no clue what we were doing.
First and foremost, I made a mistake on the team – not because they weren’t great people or managers, but because they didn’t have relevant experience. As it turns out, running a bar is dramatically different than running a nightclub. Had the managers operated a club before, they would’ve known that!
And “location, location, location”? Almost irrelevant. For clubs, it’s all about the quality of the crowd. If there’s a “hot” crowd, people will travel to the end of the earth.
What about “If you like the store, chances are you’ll love the stock”? The “store” looked like a bar, not a club. Wrong vibe!
Belly Up
My theory about local businesses being less risky fell flat on its rear-end. Less than twelve months after we opened our doors, the club went out of business.
A business might be in your backyard – but that doesn’t mean you’ll understand it better than a business that’s on the other side of the world.
Perversely, an investment being so local might give you a false sense of security.
Crowdfunding Advantages
I still look at plenty of ideas and investment opportunities in my own backyard – I just make sure I do the same level of due diligence on them as I do on my other investments. (By the way, I keep a picture of the nightclub on my desk to remind me of my mistakes!)
Nowadays I’m thinking more about equity crowdfunding opportunities than local opportunities. And some of the advantages are pretty striking:
1. Geographical Diversification – With equity crowdfunding, I’m able to invest in businesses from all over the country… or as Matt pointed out earlier this week, from all over the world.
2. Low “Cost of Entry” – Historically, making “angel” investments in local businesses required check sizes of at least $10,000, and often much more.
With equity crowdfunding, I could conceivably make ten investments with that same $10,000. And with early-stage investing, more diversification is a good thing.
3. Specialization – It might seem like conflicting advice to talk about specialization and diversification in the same breath, but with equity crowdfunding, you can have both.
Given the number of crowdfunding opportunities, and the relatively low cost of entry of each one, you can specialize in investments from a certain sector – for example, biotech, social media companies, or B2B software – and then invest in a diverse portfolio of companies from within that sector.
Early-stage investing is risky – whether you’re doing it locally, or online through equity crowdfunding. But it sure is exciting that some of the risks can be mitigated through equity crowdfunding.
Share Your Story
Have you ever invested in a local company or a private company?
Did you make money or lose money?
We’d love to hear about it.
Send an email to [email protected] — we’d love to hear about your experiences investing in anything from local businesses to private start-ups.
Tell us how you discovered the investment, what your process was like for vetting it, and the ups & downs of owning a private company.
We hope to feature your stories in a future issue!
