It's OPM. Banks don't have any money. They lend OPM. Brokerage Firms rarely risk their money; they rely on OPM to trade the Market. Venture Capitalists, Hedge Fund Managers, Pension Funds and Insurance Companies are constantly searching for more OPM. Governments rely upon OPM to run the country. So what's OPM? It's Other People's Money.
Understanding OPM is the Key to Raising Risk Capital
The suppliers of OPM expect to be rewarded for their money. That reward is a combination of acceptable risk and profit. Often these investors don't fully understand the Risk/Reward Ratio of their investment. To have any chance of succeeding over time, they should reduce investment proposals to a simple Risk/Reward ratio to determine their willingness to risk their money.
American Banks borrow money from their depositors and leverage it with tax dollars. The Depositors believe there is very little risk in loaning money to an American Bank and since 1934, no American bank depositor has lost their money in a bank failure, thanks to the American taxpayer.
Losing At the Bank
However, what bank depositors fail to realize is their 3% interest rate reward is inadequate to allow them to breakeven over time. They are taxed on their interest income at about 40%, thus their after tax income is about 1.8%. The current inflation rate is about 6%. Bank savings depositors are steadily losing money every year. To break even against inflation on a taxable investment requires a 10% interest rate. Thus, their Risk/Reward ratio is certain loss over time against a 0.03 annual reward. That's a Risk/Reward ratio of 100/0.03 over time. You would probably do far better in Las Vegas or Atlantic City!
Losing in the Stock Markets
Brokerage Firm clients supply the money (OPM) to play the Stock Market. The public company failure rate on the volatile end (Over-the-Counter and Over-the-Counter Bulletin Board) of the U.S. Public Market is over 98%. To breakeven, the client needs to sell their stock at a share price 98 times their investment. And that figure doesn't factor in taxes and inflation. It's rare that shareholders sell when the share price doubles. Thus, their Risk/Reward ratio is 98% odds of loss over time against a twofold potential reward. The Risk/Reward ration is about 98/2.
At the conservative end of the U.S. stock market (the New York Stock Exchange), most share prices have traded within a narrow range of about 20%, for the past couple of years. Thus, the OPM investor's Risk/Reward ratio is even over the past few years against a 0.02 reward. The shareholders reward isn't justified by the fact that the inflation rate is 6% and capital gains taxes of 23%. The Risk/Reward ratio is about 1/0.005
Why Most Venture Capitalists Fail
Venture Capitalists speculate with OPM. They wrongly believe that out of seven very high-risk investments, they will make money if two speculations are profitable, three financings breakeven and three speculations are losers. They fail to understand the odds against them, when only one startup company in one hundred will succeed. The odds are strongly against their making a consistent profit. So assuming a fivefold return on their two winners, their Risk/Reward ratio is 99% loss over time against a 1.43 potential reward. The Risk/Reward ration is 99/1.43. My proof of this is that any comparative review of American Venture Capital Directories shows that there is a steady attrition of these firms over time. Venture Capitalists regularly lose money because the Risk/Reward ratio is strongly against them. They are failing to do the simplest arithmetic which should be the cornerstone of their investing philosophy. I can assure you that it is the cornerstone of Beowulf Investments.
Hedge Funds use OPM to speculate in derivatives, which are high-risk financial instruments. The recent failure of a growing number of Hedge Funds underscores the high-risk nature of their speculations. Insurance companies use actuaries to ensure a mathematical bias in the favor of the company. Pension funds often take too many risks or are badly structured. The U.S. Social Security Program is a textbook example of a mathematically impossible retirement plan.
Beowulf Investments Approach to OPM
Our working rule that is the company(s) in which we invest must be publicly traded in the United States. The reason is that this gives Beowulf Investments access to OPM. We can sell our shares to the public.
We are significantly different than other private placement merchant banks. We will only sell sufficient shares to recover our risk capital. We are willing to defer profits for years, since we can't lose our money and see the sale of the public company in a M&A as the best way to maximize our profits. Our risk is zero. Our reward is about sixty-fold our initial investment. It's a winning bet. The Risk Reward Ratio is 0/66.
The VCP Program goes further. It advises the investors supplying the OPM to follow our example. Sell some of their shares to recover their risk capital and keep the balance until the public company is sold, which will maximize their profit. The GVIC (Global Village Investment Club) & ISI (International Stock Investors Newsletter) investment risk is zero after sixty days. Their potential profit at the time of the M&A acquisition is about twenty-two fold. The Risk Reward Ratio is 0/22. As for the last buyers of a VCP stock, our discount benefits program should save them the cost of their 100-share investment every year. After the first year, their Risk Reward Ratio should be 0/2.
To my way of thinking, the ONLY wise gamble is a Risk/Reward ratio where the reward is greater than the risk, the greater the better. Too many entrepreneurs and business owners think that the folks with OPM should accept a negative Risk/Reward ratio. In fact, too many people with money failed to take statistics and probability courses in college.
The OPM winners are the people who always want the number on the right of the Risk/Reward ratio to be far larger than the number on the left of the Risk/Reward ratio. If you are going to design an investment to attract OPM, you should ensure that the Reward is a multiple of the risk. There's still no guarantee that the folks with OPM will win. However, the odds will be greatly in their favor.
To contact the author: Visit the Beowulf Investments website: [http://home.earthlink.net/~beowulfinvestments/] Or, visit the Global Village Investment Club Website: [http://home.earthlink.net/~beowulfinvestments/globalvillageinvestmentclubwelcome/]
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He has been the Managing Director of Beowulf Investments [http://home.earthlink.net/~beowulfinvestments/] since 1981 and is the Executive Director of the Global Village Investment Club [http://home.earthlink.net/~beowulfinvestments/globalvillageinvestmentclubwelcome/]