Earlier in this book, we told you that, over the long haul, returns on venture capital investment industry‐wide have averaged about 12%. We also mentioned that more recently, over roughly the past 20 years, the venture capital industry average return has been an even more robust 19.7%, according to the Thomson Reuters Venture Capital Research Index, which is designed to replicate the venture capital industry as a whole. We're not aware of any such scientific index available earlier, so the longer‐term rough estimate is just that, an informal estimate.

We also shared with you long‐term returns for the S&P 500, which averaged slightly below 5% annually for the period from January 1, 2000 to January 1, 2017. To keep the playing field as fairly balanced as possible, just as we cited the more recent, more robust venture capital returns, we looked for a different time period that would result in better S&P 500 returns. We found that over a longer, 30‐year period (which included the more‐bullish late 1980s and 1990s), the S&P 500 returned an average of 9.9%/year.

While the venture capital returns still look better, one would expect that comparison given venture capital's greater inherent riskiness. The 9.9% return rate for the S&P 500 looks pretty good as well. So, why not just stick with the S&P 500 for the really long haul and not try to outsmart the market?

That's all well and good if that's really what you do. While the specific timing of your investments and ultimate withdrawals could either help or hurt you, chances are you'll come out okay. However, the reality is that the average investor does try to outsmart the market, and moves in and out of stocks inefficiently, too often buying high and selling low and incurring all those trading charges along the way.

But let's assume you're smarter than the average individual investor. You're not one of those impatient types who follow the herd, buying too often when things are high and then selling when they're low. We'll further assume that, since you're investing your time to read this book, you've studied other aspects of the market as well. We therefore assume you know that a recognized gold standard in investment expertise is Warren Buffett, and perhaps you've committed to following Buffett's rules of investment.

We share your admiration for Warren Buffett. He has achieved annualized returns for his investors over the past 50+ years averaging above 20%. While we've told you that Len's firms' venture capital investments have achieved returns over 30+ years averaging 28%/year, neither of us claims to be nearly as smart as Warren Buffett.

Let's look at “Buffett's Real Rules” and then compare how Len's venture capital investment approach compares to those principles. You'll see that they are surprisingly similar. The reason Len has been able to beat the Oracle of Omaha reflects the very nature of venture capital investment versus Buffett's traditional stock market investing. Let's explore both and compare.

“Buffett's Real Rules”

This compilation of Buffett's investment principles synthesizes observations from a number of sources, most notably Alice Schroeder's The Snowball: Warren Buffett and the Business of Life (probably the most comprehensive biography written on Buffett), Business Insider, and even AARP The Magazine. (They have some very thoughtful financial pieces given the strong interest of many 50+ readers.) Because this is a synthesis, the words won't match these sources' exact articulations, but we're comfortable that the essence has been faithfully retained.

1. Buy at low‐to‐fair prices. Don't overpay.

Buffett has always sought out attractive intrinsic value that exceeds the price paid. As he and his key long‐term partner, Charlie Munger, have pointed out repeatedly, price and value are not the same. “Price is what you pay; value is what you get” (Letter to Berkshire Hathaway shareholders, 2008).

Buffett also cautions not to be fooled by “that Cinderella feeling” you get from what appear to be great returns due simply to irrationally inflated valuations. “Continuing to speculate in companies that have gigantic valuations relative to the cash they are likely to generate in the future will likely bring on pumpkins and mice” (Letter to Berkshire Hathaway shareholders, 2000).

His early gains were due largely to his ability to see intrinsic value where others did not. That sometimes included simply recognizing the value of a company's cash and other liquid asset holdings. As his wealth grew, that recognition focused increasingly on recognizing the substantial cash flows that could be generated by companies he acquired in such unglamorous categories as insurance and railroads.

2. Invest in companies with vigilant leadership.

Buffett has always placed tremendous importance on the investment target company's senior‐most leadership, their detailed understanding of their business, and their focus on risk management and control. He believes in investing in companies whose cash generation “can be reinvested by good management in a business they know and which has a unique position” (Business Insider).

3. Invest in business you understand.

Some might even articulate this principle, at least in Buffett's mind, as to “embrace the boring” (AARP The Magazine). Buffett sees risk in part as pursuing business you don't understand. This is why historically he has avoided the tech sector, which he admits to not understanding, though some of Buffett's younger lieutenants are now channeling his Berkshire Hathaway dollars into the tech sector as well.

4. Invest in companies with solid long‐term prospects. Buy and hold.

Buffett looks for companies with consistent, positively trending earnings over at least the past ten years, and suggests that a 30‐year horizon be your window to the future. He has therefore avoided explicitly since the 1990s businesses that he feels are likely to be impacted substantively by the Internet, given his self‐professed lack of understanding.

5. Don't shy away from revolutionary investments. Just be sure you understand them.

According to Bloomberg, Buffett has $15 billion invested in solar and wind energy. He may have avoided tech stocks, at least until recently, due to a lack of understanding of that sector, but where he can understand the market and its basis for interest, and he has faith in the management, he is willing to commit to his and the management's vision.

This was the thinking behind Berkshire Hathaway's 2008 investment in GE. In explaining that investment, Mr. Buffett expressed confidence in GE's strong management leadership and brand equity in the renewable energy industry, and especially in wind energy and the turbine business. Those are businesses where Buffett's financial acumen enables clear understanding of the fundamentals of heavy capital investment followed by a likely long stream of predictable operating cash flow.

6. Look for companies with top brands and the ability to “control” prices.

He understands that brands have greater value than “just selling stuff.” “It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price” (Letter to Berkshire Hathaway shareholders, 1989). American Express, Coca‐Cola, and Wrigley are three companies whose shares he has bought aggressively due to the strength of their iconic brands.

7. Always be liquid. Have a source of low‐cost money ready to invest.

This is why Buffett early on focused so much on insurance companies and banks. They provided a ready source of investment cash so he had the flexibility to pounce on good opportunities and did not need to rely on leverage through debt, which he has always hated. He “pledged to always run Berkshire with more than ample cash…. When forced to choose, I will not trade even a night's sleep for the chance of extra profits” (Letter to Berkshire Hathaway shareholders, 2008). This is why a related principle for Buffett was never to pay a dividend.

8. Be very selective. You don't have to move on every opportunity.

“The stock market is a no‐called‐strike game. You don't have to swing at everything—you can wait for your pitch” (The Tao of Warren Buffett via Business Insider).

9. Keep doing the above in good times and in bad.

“We've usually made our best purchases when apprehensions about some macro event were at their peak. Fear is the foe of the faddist, but the friend of the fundamentalist” (Letter to Berkshire Hathaway shareholders, 1994).

10. Minimize your mistakes, and learn from the ones you make.

Earlier, when he had far lesser reserves, Buffett was more risk averse and more focused on being sure he could sell what turned out to be a bad deal at a fair price to avoid (or at least minimize) losses. His mantra during those earlier days was, “Rule No. 1: Never lose money. Rule No. 2: Don't forget Rule No. 1” (The Tao of Warren Buffett via Business Insider).

How Len's Venture Capital Investment Principles Are Similar

You're probably wondering now how the venture capital investment principles Len and his team have learned and followed over the years could be similar to “Buffett's Real Rules.” After all, the Oracle of Omaha buys insurance companies, railroads, soda pop, and chewing gum while Len's team pursues categories, like the digital tech sector and biotechnology, that Buffett historically has avoided. Let's go back through Buffett's rules one at a time and compare.

1. Buy at low‐to‐fair prices. Don't overpay.

While we stated earlier that in the case of the biggest home runs, like AOL, the initial investment price paid doesn't matter much, there aren't many AOLs. The singles and doubles are greater in number, and for them the price paid does matter. Also, even most investment home runs aren't the tape‐measure grand‐slams that AOL was, so price paid can matter at least somewhat. Moreover, for all the deals that don't succeed, the prices paid can help moderate the inevitable losses.

Importantly as well, Len's team has always avoided the “Cinderellas,” those ventures that have already been bid up in price to what we consider excessive levels. The best examples are the unicorns. Who knows, maybe Uber will eventually generate the cash flows justifying its current $66 billion valuation and beyond, but we both believe that's way too risky. That would require virtually everything to go right for them. We wouldn't bet on that, and we don't want our investors to feel like they've bought “pumpkins and mice,” to continue the Cinderella analogy.

2. Invest in companies with vigilant leadership.

We couldn't agree more with Mr. Buffett on this one. Our team places huge importance on a venture's management, its ownership commitment, and its operating capabilities. Vision and technology alone are not enough. Even the early stage companies we invest in need operating skill, disciplined execution, and financial control. The jockey can be just as important as the horse!

3. Invest in business you understand.

Again we are on the same page. Len's teams over the years have always focused on high tech and hard science—in industries including digital products and services, cloud computing and big data, media and telecom, and biomedical and drug discovery—because those are sectors the team understands. It's great that they are broad sectors with the potential to produce and capitalize on disruptive technologies, reach a large and addressable market, and provide significant commercial opportunities, but it's equally essential that the team understands them so it can assess the opportunities more knowledgeably. Our VCapital team includes seasoned executives from industry sectors we focus on.

4. Invest in companies with solid long‐term prospects. Buy and hold.

This is at the core of venture capital. We invest for the long‐term. We're not looking for short‐term trading opportunities or flipping positions simply because valuations rise. We may not plan on Buffett's 20‐ or 30‐year horizons, and we admittedly invest with the aim of an exit within a reasonable timeframe. But those timeframes are generally 5 to 10 years—sometimes shorter, sometimes longer—when the venture is finally ready to exit via IPO or a larger company's acquisition or merger.

5. Don't shy away from revolutionary investments. Just be sure you understand them.

This, too, is the very essence of venture capital investment. We aggressively seek revolutionary investments. We subscribe to PayPal and Palantir co‐founder Peter Thiel's strategy of investing only in ideas and companies that appear to have home run potential.

Thiel's philosophy, which we share, is to consider, “What important truth do you see that very few people agree with you on?” We concur with him that if you see it first and others do not yet see it, you can start a company and build a monopoly position before others can get too close to your heels. That's what revolutionary investment is about. For Buffett, that has meant seemingly surprising affinity to solar and wind energy. For Len's teams, it has meant nanotechnology, disruptive advances in data storage, and uniquely new approaches to cancer treatment.

6. Look for companies with top brands and the ability to “control” prices.

This rule admittedly is a tougher one for us to claim comparability with Warren Buffett on. We don't invest in leading established brands like Buffett has done with American Express, the Washington Post, GE, Coca‐Cola, and Wrigley. But our practices still do hold some similarity with Buffett's. We seek products and technologies with the sorts of preemptive marketplace insulation that will permit them to capture and hold leadership positions and set the kind of pricing that enables rich margins and lucrative profit potential.

7. Always be liquid. Have a source of low‐cost money ready to invest.

Like Buffett, we strive to have cash available, or investors ready to entrust additional amounts to us quickly, to pounce on outstanding investment opportunities as quickly as the marketplace demands. Also like the Oracle of Omaha, we don't borrow to enable such liquidity.

Nevertheless, it is much more difficult for us than for Warren Buffett to achieve and ensure such advantageous liquidity and flexibility. Our investments do not pay dividends, and we do not own positions that generate cash flow for us like Buffett enjoys from his operating companies, especially his insurance companies. Moreover, venture capital funds intentionally stop raising new funds and making new investments at a point, as part of their charter is to liquidate their investments and return all those resulting monies to investors at the end of a predetermined period, hopefully returning a substantial multiple of the amount investors provided in the first place.

8. Be very selective. You don't have to move on every opportunity.

We couldn't agree more with Mr. Buffett on this rule. We are inundated with potential deals, and generally act on perhaps one out of a hundred. A key to Len's funds' consistently outstanding performance over 30+ years has been discriminating deal selection. His teams don't do a lot of deals. We move only on those we believe have home run potential.

Our team's philosophy has always been, if we miss what turns out to be a great deal, c'est la vie. We are not motivated by FOMO—Fear of Missing Out. We are motivated far more by determination to minimize losing deals, though, of course, like any venture capital investor, we have our fair share. Fortunately, our fair share of losing deals (historically 63%) is much lower than industry averages of 80–85%.

9. Keep doing the above in good times and in bad.

Again we are in lockstep with Mr. Buffett. We do not let macroeconomic cycles get in our way. Like Buffett, we are in it for the long run, not trying to time the market.

Of course, we do try to live by the mantra “buy low, sell high.” However, the ventures that we pursue tend to be at such early stages that their valuations when we invest are not impacted much by broader market valuations. Further, since our investments typically percolate for 5–10 years before an exit, we don't pretend to have any idea of where the stock market and other measures will be in 5–10 years.

When our portfolio ventures are ready to exit, IPO prices can of course be impacted by near‐term stock market froth or doldrums as well as by recent exits for comparable ventures. That might delay an exit opportunity for a little while in hopes of a more favorable market environment. Hopefully, even then the IPO price is such a substantial multiple of the initial investment that our investors are delighted.

Moreover, our strategic tendency to focus on Midwestern ventures, for which exits through acquisition by established businesses have some likelihood, also tends to insulate our portfolio ventures somewhat from short‐term market gyrations even as they are ready to exit. This is because the price realized from acquisitions by established businesses tends to be driven more by the exiting venture's intrinsic long‐term value than by the immediate state of the stock market.

10. Minimize your mistakes, and learn from the ones you make.

That's one more principle where we feel strong concurrence with the Oracle of Omaha. We discussed earlier the importance of discriminating deal selection—rigorous screening and due diligence. Better to miss some big winners than to lose our investors' money on too many losing deals. A key to minimizing mistakes in venture capital investment is to avoid FOMO mentality. It's also essential to learn from the mistakes you do make. Experience is vital in venture capital investment, just as it is in conventional equity investment or in most professional fields.

When you need surgery, you want to go to the seasoned pro who has done the same operation dozens, if not hundreds, of times. Actual data support that principle. In fact, the data show that use of a doctor who focuses on the particular type of surgery you need, versus going to a more general surgeon who's done many of your particular surgery but also many of lots of other types of surgery as well, indeed correlates with greater surgical success and fewer complications. This is why our sole focus is on venture capital. We don't dabble in other forms of private equity or real estate investment.

Unfortunately, venture capital investment experience is sometimes gained by losing a lot of money, which is not surprising in a field where on average 80–85% of deals wind up losing. It is estimated that it takes around $15 million in losses to train a successful professional VC investor. So, just as those delighted Berkshire Hathaway shareholders owe their good fortune to Warren Buffett's now‐60+ years of experience, you can improve your venture capital investment success odds by relying on seasoned pros and staying away from less experienced VCs.

Why Venture Capital Returns Can Beat Even Warren Buffett

At this point, you may be asking the question, if the principles of successful venture capital investment are so similar to Buffett's rules, why should one expect the effective VC to be able to go beyond matching Buffett's performance and to beat his results? The answer is based on the very essence of venture capital investment.

One simple reason the effective VC should be reasonably expected to have a shot at beating Buffett long‐term is that venture capital investment is inherently a high‐risk/high‐reward endeavor. The superior returns possible through venture capital, on average, appropriately offset the inherent risk.

Over 30+ years, Len's teams' investments have lost 63% of the time, which is lots better than the industry average of 80–85% but a much greater ratio of losses than for Warren Buffett. However, smart venture capital investment presents the opportunity for a percentage of deals to deliver returns of greater than 10× the initial investment and sometimes even 40× or 50× the initial investment. While Mr. Buffett's performance over 60+ years has been extraordinary, the kinds of returns we can achieve periodically in venture capital (i.e., 10× to all the way up to 40–50× initial investment within 5 to 10 years) realistically are impossible when you're investing in mature businesses like GEICO, American Express, railroads such as Union Pacific and Norfolk Southern, or everyday consumer products giants like Coca‐Cola, Wrigley, and Kraft Heinz.

Buffett's investments in mature industries are tailored to deliver more consistent and predictable returns. He looks to buy consistently strong performers when their stock, or maybe the whole stock market, is temporarily out of favor, and then to hold those investment positions for the long‐term, magnifying potential returns as well as their reliability. While he does invest in highly innovative and even revolutionary areas like solar and wind power, even such investments tend to be through mature vehicles like GE.

That is fundamentally different from venture capital's focus on startups and early stage businesses, before they reach the public trading markets and whose very reason for being is to capitalize on new technologies and often new markets. Remember the chart from the previous chapter that characterized risk and potential return by venture stage, from startup through expansion and later pre‐IPO stages? Return potential can be viewed in a similar way in comparing the risks and potential rewards of investing in venture capital versus investing in mature publicly traded companies. (See Figure 5.1.)

This is why experienced, strategically optimized, prudently managed venture capital investment can beat even the returns generated so brilliantly over the past half‐century by the Oracle of Omaha.