Keep the Venture Capital Moving

Ford v Ferrari featuring Christian Bale and Matt Damon, was, simply put, incredible.

The racing scenes in this movie demonstrated the shared reason why successful drivers win races, and why successful investors make money.

Here are some hints. It’s not technology. Nor the brightest smile. Nor the best college degree. Nor even the best hair (although studies show that can go help in life).

The core reason why the world’s greatest race drivers win is because regardless of the environmental and technological dynamics, they’re able to maintain a higher average speed than the rest of the drivers on the track until they achieve a superior overall time.

A critical aspect to achieving superior times is ensuring the car’s engine achieves optimum levels of revolutions per minute (RPM). The optimal RPM unleashes the motor’s power which achieves maximum acceleration within the respective time. This was observed in Ford vs Ferrari many times where Matt Damon’s character, Carroll Shelby, was thinking out-loud regarding the exact moments for Christian Bale’s character, Ken Miles, to downshift and brake into a turn. He would make the comment, “Wait for it…wait for it…wait for it…NOW!” This is because Shelby, being a very accomplished racer himself, knew that braking too soon lowers the average speed (and consequently, RPM’s) of the car.

In simple terms, the most successful race car drivers leverage the principle of velocity.

So as exhilarating as it was to watch the race scenes in Ford vs Ferrari, it was equally pleasing to observe one of the most critical principles of successful investing (velocity) play-out in a completely different profession; racing.

The topic of velocity leads us to Capital Cycle Rate (CCR), which is the investor’s version of RPM – and it’s what we consider the single most important metric for any investor to keep in mind, minus return of capital.

Capital Cycle Rate (CCR): The Single Most Important Venture Investing Metric You’ve Never Heard About

Thankfully we have a real-life case study that demonstrates the power of CCR for an investor. We’ll briefly walk through this case study using the SAR method (Situation, Action, Result) to explain CCR.

SITUATION:

“Acme Capital” (AC) is small proprietary trading department of a larger private equity fund. Their approach is fairly straightforward. They trade US-listed equities and options.

Recently they hired a new trader with a bright future and impressive background. This trader is a swing trader; meaning, instead of trying to gain from intra-day (minor) moves in equity pricing, he focuses on longer term trades (several days to weeks) with the strategy of catching larger “rips” (i.e. profits).

It’s important to note that a common trade for a day trader is 1-2% whereas a swing trader’s common gain is approximately 8%.

“Acme Capital” embrace’s and encourage traders to bring their own philosophies and employ them using the firm’s capital; as long as they meet three criterion:

• The trader’s philosophy is mutually-profitable
• The trader remains receptive to performance coaching
• The philosophy is consistent with AC’s corporate values and strategic priorities

During a live coaching session, AC noticed that the trader had a winning trade that suddenly changed direction and turned into a loser. The trader was asked why he didn’t exit the position once a reasonable percentage of his profit had been retraced.

His perspective was that he expected the trade to appreciate even more than it had, and wasn’t going to exit the position until it met his pre-defined entry/exit parameters.

ACTION:

The trader himself exclaimed that he wanted to improve his performance, so AC completed a comprehensive review of the losing trade.

What was discovered was that the trader violated the principle of Capital Cycle Rate.

He didn’t fully appreciate the fact that a 1% gain per day is far superior to an 8% gain every 14 days. For this particular trade, he was originally up 5% after only 3 days, but because he was expecting 12%, he held onto the trade until it became a loser.

To illustrate the impact the CCR principle makes, let’s run the numbers on a simple example.

Assuming a $100,000 trading capital per trade, the 1% trader is yielding $1,000 per day. At approximately 20 trading days per month, that’s $20,000 for the month. For simplicity sake, let’s ignore the fact that virtually no traders have a 100% success, and even really good traders are lucky to achieve a 60% success rate.

Now the swing trader with a 10 day holding period is yielding 8%, or $16,000 per month. This is a full $4,000 less than the day trader. That adds up to $48,000 per year in lost gains.

Now interestingly enough, this example IS NOT including what would happen if the trader re-deployed the capital gains from the successful trades along with the $100,000 capital, thus magnifying the superiority of a strategy that respects the CCR.

It’s also not factoring into the equation that a day trader can make multiple trades per day with the same capital while the swing trader has to let his money sit in the trade.

This is not to say that swing trading isn’t a good strategy – and it’s not to say that it’s inferior to a day-trading strategy. The point here is to emphasize that to ignore the CCR principle for ANY strategy isn’t ideal. Why?

Because all the swing trader has to do to turn this trade from a winner to a loser is “book” the profits once the stock reverses to a certain threshold. Many traders set this at 40%, meaning if the stock reverses, the trader will exit the position once he’s lost 40% of his profit – and then he either (a) gets back into the same stock at a more favorable setup or (b) recycles the capital in an even better trade.

In other words, the trader was wasting time, and because he was wasting time, he lost opportunity cost. And because he was being too rigid in what he wanted the stock to do, he watched it lose money.

RESULT:

The outcome of not respecting CCR is that capital is left “in the wind” too long, thus reducing the opportunity to multiply it. This is also a big problem with real estate.

For example, investors in the US will buy a rental property in a hot real estate market that yields 8% per year, while the real estate flipper is doubling his capital every year during that hot market. This just doesn’t make sense, because a wise investor can leverage both strategies and come out way ahead.

When it comes to investing, a bird in the hand is always worth more than two in the bush; especially when systemic risk is taken into consideration.

This is what happens when CCR gets ignored, and it’s also equally risky with startup investing as well.

Many venture capitalists have fallen prey to investing in a startup that offers no exit strategy for 3, 5, or even 10 years, thus keeping the investors capital tied-up this whole time. Some startups, including the crowdfunding ones, offer virtually no exit strategy beyond a hope and a prayer of eventual acquisition and/or IPO.

It’s important to note that there are ancillary benefits to making startups pay dividends from day one and or providing an exit strategy that starts progressively taking effect after year 1, with perhaps the largest being accountability for the startup. This is because many Founders seek capital instead of driving sales; and that’s a venture to avoid.

Now granted, there are several huge success stories of venture capital firms that got in on Facebook and Upwork and stayed with it from day one, and now those investments are worth an insane return.

However, this doesn’t negate the importance of being a CCR conscious investor, because it would guide him in ensuring that he doesn’t tie-up all of his capital in long-term investments with a slow cycle rate. Instead he would look for a blend of both fast and slow CCR’s, so that way he’s not missing out on the next Facebook nor is he betting the farm on a venture with a 98% chance of failure.

So back to the trader case study. He was eventually asked the question, “Yonnie, what do you think is better. A trading strategy that yields 1-2% per day while risking only .5% or a strategy that yields 8% every 10 days that risks 5%?” This question led to a breakthrough for the trader; which took the form of an even deeper appreciation of the CCR principle. He was also asked, “Does a trade have to hit exactly what you want it to in order for it to be successful? What’s the ultimate measure of a trade’s success?” Yonnie smiled.

Remember, just 1% per day is doubling your capital on an annualized basis – and even more so if you recycle the profits.

Keep the venture capital moving at a good velocity, and your capital will grow beyond what you ever thought possible.

Blessings.