Invest in the Netflix of the Classroom

By Andy Gordon, Co-Founder, First Stage Investor

We live in the greatest country in the world. I firmly believe that. But one place we fall short in is education. In doing so, we’re letting our children down. We’re letting our teachers down. And, by not doing everything in our power to give our kids a better education, we’re letting our country down.

As a nation, we’ve fallen behind Europe and Asia in science, math and other test scores. I believe it’s our duty, as parents and citizens, to act now. It’s vitally important that the private sector attack this problem with the urgency it deserves.

From Bill Nye the Science Guy to Netflix for Schools

When my son was 10 (he’s 36 now), he watched Bill Nye the Science Guy. I caught a peek every now and then. It wasn’t bad. But it wasn’t done for schools. It was done because the networks were required by law to show 3.5 hours of educational television a week. 

But what was considered “educational” became more open-ended. The networks realized the less educational these shows were, the more viewers they attracted. 

So, here we are. We live in an era of screen time. And schools don’t have decent video content. The best content is more than two decades old. Yet schools are spending more and more on digital learning. It’s now a $10 billion-per-year industry.

There’s a gaping hole when it comes to educational videos. Nobody is producing engaging, high-quality content. Other companies in this space merely aggregate old content for schools. So when Dr. Jeff Vinokur saw that schools were using VHS tapes from the 1990s, he knew he could make a difference.

A Genius Idea

Generation Genius is bringing Hollywood’s high production standards and entertainment to classrooms. It has produced 36 12-minute science videos so far for grades three through five. By the beginning of the upcoming school year, it plans to produce another 36 science videos for kindergarten through grade two. The following year, it will produce science videos for grades six through eight for the fall 2020 school year. Then it will begin producing non-science videos (first math and then English).

Real Traction

There’s a real need for original Hollywood-quality educational videos, but is there a real market? (Lesson to those new to startup investing: They’re not the same thing.) The early returns say YES…

Generation Genius introduced its first set of videos last March (minus the lesson plans, teacher’s guides, discussion, etc.). From March to March, it’s made more than $600,000 in revenue. And that’s with sales not taking off until August, after the summer break and when all the accessory materials became available along with the video.

That’s pretty good, and it will get a lot better when more schools pick up the bill. That should happen when Generation Genius’ next set of videos (for K through 2) become available. Elementary schools should be much more willing buyers (for the $495 yearly school price) than individual teachers (who would pay $95 a year).

Right now, 80% of buyers are teachers and 20% are schools. Once the next set of videos are ready for the fall 2019 school year, I expect that will eventually reverse.

Three More Reasons

Here are three more factors that I believe make this company an exceptionally attractive investment opportunity…

1. Founders. Founder and CEO Dr. Jeff Vinokur’s list of accomplishments belie his young age of 28. He’s a science guy (with a Ph.D. in biochemistry) and an entertainer (with stops on NBC’s Today, ABC’s The View and a stage show that has toured coast to coast). He’s part Hollywood (consulting for Netflix and Fox) and part entrepreneur (putting $360,000 of his own money into Generation Genius). Generation Genius co-founder and President Eric Rollman is the former president of Marvel Television and Animation and former president of Fox Family Productions. Disney bought Fox Family and Marvel for a combined $7 billion. It’s been a long time since I’ve seen a pair of founders so well-suited for success. 
2. Profit Margins. The company is a few months away from consistently breaking even. And profit margins (along with sales) will go up from there. As the company adds content, school pricing will increase from $495 to $995 (when K through 2 content is added) to $1,495 down the road (when math and English are added).
3. Feedback. It’s been overwhelmingly positive, according to Dr. Jeff. For this reason, he’s expecting a good renewal rate this September, when users will have to renew for the new school year. He expects at least a 70% renewal rate, with teachers renewing at a lower rate and schools renewing at a higher rate.

Cashing Out

Ed tech companies that do well often make attractive buyout candidates. Lynda.com was sold for $1.5 billion. Renaissance Learning for $1.1 billion. And Blackboard for $1.6 billion. 

Generation Genius has a long way to go to establish itself as a dominant educational entertainment company. But right now it’s in a space with no real competitors. And its video products are priced to sell. You’d be doing yourselves, your children and the country a big favor by investing. (And you’d better hurry. It’s raised more than $750,000 so far. And it’s allowed to raise only $1.07 million.)

How to Invest

Generation Genius is raising up to $1.07 million on StartEngine. If you don’t already have a StartEngine account, you can sign up for one here. Once you’re logged in to StartEngine, go to the Generation Genius deal page. Now click the green “Invest Now” button. Enter the amount you want to invest, and proceed through the required steps. Be sure your investment is confirmed, then you’re good to go.

Risks

This opportunity, like all early-stage investments, is risky. Early-stage investments often fail. Generation Genius might need to raise another round of funding in a year or two, if not sooner. If it executes well, this shouldn’t be a problem. But that’s a risk worth considering when investing in early-stage companies.

The investment you’re making is NOT liquid. Expect to hold your position for five to 10 years. An earlier exit is always possible but should not be expected. All that said, I believe Generation Genius offers an attractive risk-reward ratio. ■

Big Pharma Is Scared of Cannabis

Why Big Pharma Is Terrified of Cannabis

By Adam Sharp, Co-Founder, First Stage Investor

Pharmaceutical companies today make money by developing and patenting unique molecules as drugs. Patents in the U.S. typically last seven years but are often extended through questionable means.

Compounds that occur in nature are generally not patentable. And no pharma company would go through clinical trials with a non-patentable drug. Historically, patentable drugs are where drugmakers have made their profits. 

Today, however, Big Pharma has a major problem. It’s terrified of the cannabis plant… and the cannabis legalization movement sweeping the globe. 

The cannabis plant is a treasure trove of more than 100 bioactive molecules called cannabinoids. They all affect our bodies in different ways and can be used to treat different conditions. They work especially well together, in what is called the “entourage effect.” Cannabis has a staggering number of potential medical uses. No other plant comes close. 

Cannabis threatens nearly every aspect of Big Pharma’s business model. It’s already disrupting the way we treat pain, sleep disorders, neurological problems, depression, epilepsy, Parkinson’s disease and even autism. 

Studies show that in states where marijuana is legalized, doctors write far fewer opioid prescriptions. In fact, a 2018 study showed that hospitalization rates for opioid painkiller dependence and abuse decreased 23% after states legalized medical marijuana. 

Another study showed that 45% of patients given medical marijuana stopped taking prescription benzodiazepines (such as Xanax) for anxiety and pain. Lead researcher Neil Smith explains the amazing results:

When conducting this type of research, experts are typically encouraged by an efficacy rate in the neighborhood of 10%. To see 45% effectiveness demonstrates that the medical cannabis industry is at a real watershed moment.

These studies (and others) show that when people are given an option, they often choose cannabis over prescription drugs. As awareness and acceptance continue to grow, these numbers should continue to rise. It’s a nightmare for Big Pharma companies.

The therapeutic applications of cannabis are truly breathtaking, and we’re just beginning to understand how significant they really are. 

Replacing Dangerous and Addictive Drugs

Cannabis critics often point to its side effects. And it is true that cannabis has the potential to be abused by a small percentage of users. This is primarily an issue when marijuana is smoked, because smoking marijuana causes the user’s THC levels to spike dramatically for an hour or two and then quickly drop off. Smoking is primarily a recreational use of cannabis and can cause psychological problems in a small number of users. (Compared with alcohol, its side effects are extremely mild, in my opinion.)

But when cannabis-based medicine is taken orally, cannabinoid levels stay relatively steady for up to eight hours and provide the maximum medical benefit without a rushed high.

Critics of medical marijuana don’t often address the difference between medical and recreational use. Used responsibly, cannabis is arguably the safest medicine in the world. The lethal dose of marijuana is estimated to be the equivalent of smoking 20,000 joints. So in order to overdose, a cannabis user would have to consume approximately 1,500 pounds of the drug in 15 minutes. 

And for the prescription drugs cannabis can replace, there’s absolutely no comparison. Let’s look at epilepsy, for example. Epileptic patients have limited treatment options. Severe cases are often treated with benzodiazepine sedatives, such as Xanax or Ativan. These drugs are extremely addictive. The withdrawal when users stop taking them can be so severe it can actually kill.

Children with epilepsy are regularly prescribed these dangerous drugs because there are no other good options. Parents often report that these benzos turn their kids into virtual “zombies.” However, in states where cannabis has been legalized, many of these children are doing incredibly well using marijuana-based medicines. 

The best known medical use of cannabis is pain relief. It is incredibly effective at treating even severe chronic pain and inflammation. Here marijuana competes directly with prescription painkillers such as Oxycontin and fentanyl, as well as over-the-counter drugs like Tylenol and Advil. 

Nearly everyone knows someone who has become addicted to opioids. And as I mentioned earlier, we already know that when cannabis is legalized in a state, the number of painkiller prescriptions decreases dramatically.

In 2015, more than 33,000 people died from opioid overdoses. And countless others suffered from addiction. I believe cannabis is the answer to this growing opioid problem. 

Clearly the pharmaceutical industry is terrified of cannabis. So it’s trying to suppress cannabis legalization and outcompete medical marijuana with its own version of the drug. 

Insys Therapeutics, for example, has openly lobbied to keep cannabis illegal. Meanwhile it’s under criminal investigation for bribing doctors to prescribe its highly addictive form of fentanyl, a dangerous painkiller. Two former executives have already pleaded guilty.

At the same time, Insys is trying to get its own synthetic cannabis drug approved by the FDA.

It’s madness, but I’m not surprised. I predict a flood of synthetic cannabinoids to flow from the pharmaceutical industry over the coming years. 

But I seriously doubt that any single synthetic molecule will outperform cannabis’s natural “entourage effect.” That effect comes from more than a hundred different cannabinoids, plus terpenes and other bioactive compounds found in the whole cannabis flower.

This is why I don’t own any Big Pharma stocks. 

I think their business models are mostly unsustainable and cannabis is about to grab a huge piece of their market. So I’ll continue to seek out the best medical cannabis investments I can find.

In the next few weeks I’ll be sending out multiple new cannabis recommendations. 

These are publicly traded companies, which are a little different for First Stage Investor. But they’re nothing new to me. I’ve been investing in cannabis stocks since 2015, and I know the market well. 

The market is still underestimating the impact cannabis will have on medicine. Investors finally “get” recreational, but they still don’t get medical.

 We’re going to take advantage of this. Stay tuned. ■

Building Crypto’s Infrastructure

Building Crypto’s Infrastructure Brick by Brick

By Vin Narayanan, Senior Managing Editor, First Stage Investor

Spring is here. The weather outside is finally heating up. And the crypto markets are as well.

As of this writing, here’s how the First Stage Investor crypto portfolio has performed this year (and this year only):

Our portfolio is up significantly this year. And it’s an important reminder of several things:

1. It’s incredibly important to buy the dips in the market. Psychologically, buying crypto during a bear market is incredibly difficult to do. But if you’re able to pull the trigger, that’s where you get the most value and profit potential.
2. The First Stage Investor portfolio is built for the long run. There are a lot of bad crypto projects out there. And during bear markets, those projects fail – and don’t come back. We saw this play out in this most recent bear market. And it will happen again in future bear markets. That’s why picking the right coins for the long term is so critical.
3. Our long “crypto winter” might finally be over.
4. Our investment thesis is fundamentally sound. And part of that thesis – institutional money entering crypto – is slowly coming to fruition. 

More Tortoise Than Hare

Last year, we were expecting a flood of institutional money to enter the crypto market and lift it to new heights. Institutional investors, we reasoned, were locked out of 2017’s market boom because of regulatory and infrastructure concerns. There was pent-up demand. 

Plus, crypto was a good way to diversify their portfolios. It provided a natural hedge against the existing economy – a commodity that’s in short supply these days. And it gave big investors exposure to an asset class with the potential for explosive growth. Even if institutional investors bought just a small amount of crypto, the potential rewards would be tremendous.

It was a risk-reward calculation they couldn’t ignore. And we were right. There was significant pent-up demand for crypto. Institutional investors wanted to buy crypto. 

2018 threw institutional investors a curveball, though. It had nothing to do with the bear market. Big investors loved that. They could buy into the market at lower prices. But everyone was expecting regulators to give institutional investors the freedom to invest in crypto. The crypto markets were now a well-functioning, proven commodity. And VanEck, a company with a rock-solid reputation and long history of offering great exchange-traded fund (ETF) products, wanted to launch a bitcoin ETF. 

It was a great proposal. Regulatory approval should have been automatic. And institutional investors would finally have had their vehicle to invest in crypto. But the SEC dragged its feet. And dragged its feet some more. Then the government shut down, forcing the proposal to be withdrawn. It’s been resubmitted. But the SEC is still slow-walking it.

The crypto industry and institutional investors didn’t let what amounts to economic malpractice dampen their enthusiasm. Instead, they began building out the infrastructure for institutional investors on their own. It was hard work. It took some time. But we’re finally seeing the results.

Fidelity, which has $2.46 trillion (trillion!) in assets under management (AUM), has opened a crypto trading desk for “select” customers (read: high rollers). Right now, Fidelity’s custody solution is just for bitcoin. The investment giant plans on adding more coins in the future. Now imagine if Fidelity put just 2% of its AUM into crypto. That would be $49.2 billion. 

As of this writing, the market cap for all cryptos is $171.4 billion. Just 2% of Fidelity’s AUM represents more than 25% of crypto’s market cap. And Fidelity is only the fifth-largest wealth management firm in the world!

We recommend that all investors put 1% to 3% of their investment portfolios into crypto. The risk-reward proposition is incredible. And as good as it is for retail investors, it’s even better for institutional ones. There’s almost no (relative) risk and an incredible upside.

Other institutional investors understand this as well. That’s why the endowment funds at Harvard, Yale, Stanford, MIT and the University of Michigan have all made investments in crypto or crypto projects. Intercontinental Exchange, the parent company of the New York Stock Exchange, is building out its own crypto trading platform. Legendary venture capital firm Andreessen Horowitz has given up on being a venture capitalist. Instead, it’s going to focus mostly on investing big in crypto. 

And this is just the tip of the iceberg. It’s a slow-moving process, to be sure. More tortoise than hare. But steady progress is being made. Institutional money is going to lift the crypto markets to new heights. It’s just taking a bit longer than we expected. ■

Finding the Sweet Spot

IPO Day, or “Insignificant Profit Opportunity” Day

By Andy Gordon, Co-Founder, First Stage Investor

On April 18, two companies debuted on public stock exchanges: Zoom on the Nasdaq and Pinterest on the New York Stock Exchange. Both companies did better than expected. Zoom finished the day 72% higher than its opening IPO price. Pinterest closed 28% higher. I followed the day’s events on CNBC. “A great day,” I heard from several commentators. It was indeed a great day… for a few dozen people. But what CNBC didn’t say is that these two widely celebrated events didn’t benefit the vast majority of investors in these companies.

Sure, the founders and early employees of these companies had cause to celebrate. Venture capital firms and a few scattered angel investors were elated. And late-stage pre-IPO investors were also smiling (including investors in Pinterest’s last raise who began the day underwater but ended it in the black). But the stark truth is that all this hoopla was for a small subset of the 1%.

IPO prices are reserved for institutional investors. In theory, you could try to buy shares in the opening hours of day one, but good luck with that. Institutional investors hog the front of the line. If you had tried to buy Zoom or Pinterest when they IPO’d, you would have missed out on the low prices at the start of trading and paid a substantial premium later in the day, making them far less attractive. Welcome to IPO day.

“Insignificant Profit Opportunity” Day

The entire IPO process is designed to exclude everyday investors. It’s not your day to celebrate – unless you can channel the joy of people who
are making money from opportunities unavailable to you. 

If you feel horrible about this, don’t. IPO day is one of the most overhyped investing events on the planet. I know this because I’ve spent the past 20 years exploring perhaps the most important question any serious investor faces…

What is the investment sweet spot for minimizing risk and maximizing returns?

My search began with this simple premise: It must be when the perceived risk is much higher than the actual risk and the perceived rewards (returns) are much lower than the actual rewards.

So let’s get one thing straight right away: This doesn’t happen on IPO day. My research indicates IPO day conditions are just the opposite. Risks are underappreciated, and profit potential is breathlessly exaggerated. The joke, as it turns out, is on IPO day investors.

Wall Street’s hype machine mutes negative sentiment on IPO day. There’s no better illustration of this than the Zoom and Pinterest IPO coverage. At least Zoom is turning a profit. But its IPO price was 24 times its trailing sales – much too high. Consider that when Microsoft went public, its IPO price was four times trailing sales.

Pinterest doesn’t even make money. It lost $62.9 million last year. It’s had 11 years to figure out how to make a profit and hasn’t succeeded. And going public doesn’t automatically create a pathway to profitability. But since this was IPO day, I heard nothing but optimism: “Its revenues are climbing, and its losses are shrinking. It doesn’t make a profit, but it’ll figure things out.”

This is not logic. It’s a leap of faith. Other reasons why the joke is on IPO day investors…

Hypergrowth happens before the IPO. In 1999, it took companies around four years to IPO. Now it takes 10 to 12 years. These are the hypergrowth years, when revenues go from $100 million a year to more than $1 billion a year. The extra six to eight years these companies stay private fundamentally change the risk-reward ratio. The top startups double their revenues every year. Even at the next tier down, companies still grow between 50% and 100%. By the time these companies IPO, investors have missed out on between 300% (4X) and 800% (9X) of growth. 

And because valuation keeps up with or often far outstrips revenue growth, post-IPO investors could easily miss out on more than 1,000%.

The company’s business model is still unproven. How can a company generating millions or billions in revenue not have a proven business? BECAUSE IT STILL HASN’T FIGURED OUT HOW TO MAKE A PROFIT. These companies can have serious question marks. 

Look no further than Uber, the startup hoping for an $84 billion IPO valuation (or more). It’s huge, fast-growing, global… and losing money hand over fist. About 25% of its revenue comes from just five cities, including London and São Paulo. Several governments are determined to crack down on its freewheeling ways. And it faces serious legal questions about whether it can continue to treat its drivers as contractors instead of employees. 

Uber’s risk profile isn’t all that unusual. These days, startups planning to IPO face serious risks and reduced growth prospects. The risk-reward ratio has changed dramatically in the past 20 years. 

Price matters. Let’s consider price-to-sales ratios. These metrics essentially reflect how much investors are willing to pay per $1 of sales by comparing the company’s stock price with its revenue. A low ratio generally indicates a company that’s undervalued. A high ratio generally indicates a company that’s overvalued. 

Google’s price-to-sales ratio is 2.27. Amazon’s is 3.93. Both companies make money, and their business models are proven. They have established track records of profit and growth. And on the basis of comparing price to sales, they’re markedly cheaper than Snap (59.3 IPO price-to-sales), Twitter (22.2), Alibaba (19.9) and Pinterest (16.3).

But to be fair, you really need to compare price-to-sales ratios in similar sectors. Otherwise, the comparisons break down. In this instance, Google compares favorably with Twitter, Snap and Pinterest. All four generate revenue through advertising. Pinterest is about seven times more expensive. Twitter is nearly 10 times more expensive. And Snap is simply exorbitant.

Looking at the two e-commerce giants, we see Alibaba is about five times more expensive than Amazon. Price matters. And IPO prices are extremely inflated.

And the Sweet Spot Is…

Once a company goes public, it’s too late. That includes day one of trading, when unbridled optimism drowns out any realistic discussion of risks and downsides. I would invest earlier, when these companies are still private. Working backward from IPO day, I see it this way…

The pre-IPO stage sweet spot varies from startup to startup. But the earlier, the better. 

Investing early demands that investors pay close attention to the risks early-stage startups face. But taking on risk is part of the pre-IPO investing playbook. There are always more risks when you have fewer data points. And if some big risks aren’t resolved by IPO day, they’re going to loom just as large, if not larger, post-IPO. But the more risk, the lower the price. The earlier you invest, the more attractive your risk-reward ratio becomes.

I like investing in the earlier stages. Both upside and downside scenarios are more challenging to wrap your arms around, and they require a more rigorous vetting process than later-stage companies. 

And the price is certainly right. ■

Portfolio Update

Portfolio Update: BrewDog USA

By Andy Gordon, Co-Founder, First Stage Investor

BrewDog USA, our craft beer portfolio holding, is raising again on BankRoll. It’s aiming to collect at least $10 million with a max goal of $40 million. Though the company admits even that’s likely not enough:

We do not expect to be able to satisfy our cash requirements through sales and the proceeds from this Offering alone, and therefore we anticipate we may attempt to raise additional capital through the sale of additional securities in additional offerings, or through other methods…

Shares are $50 and are available on the BankRoll Ventures site. 

BrewDog is still expanding its physical presence in Columbus, Ohio, where it built a 100,000-square-foot brewery that houses a taproom (called DogTap), garden, visitor center and restaurant. It’s currently building a “craft beer hotel” with rooms overlooking the brewhouse. 

In 2018, it opened a bar in Columbus’ Short North neighborhood. It plans to open another Columbus bar within a few months. And the company expects to use the money from its current offering to open more bars across the U.S. 

BrewDog currently sells its beer in eight states, Ohio being its biggest market. It’s targeting five more states (see chart below).

Somehow, Maryland (where I live and work) has been left out of its marketing plans so far. (I, for one, think that’s a big mistake!)

As one would expect at this early stage, the company is still racking up losses. In 2017, the latest year the company has provided financials for, losses amounted to just under $8 million. All that really signifies is the company is proceeding full speed ahead with its ambitious vision and big expansion plans. BrewDog is about where it should be in terms of how much it makes ($4.9 million in 2017) and expenses (nearly $12 million). It’s also where it should be in terms of its U.S. distribution and physical buildout. 

BrewDog has one of the biggest upsides of all our portfolio companies. And it’s making steady progress toward realizing that upside. ■

Portfolio Update: Napa Valley Distillery

By Andy Gordon, Co-Founder, First Stage Investor

Nearly two years ago, Napa Valley Distillery (NVD) offered investors the chance to earn 50% in interest. It was a great deal because NVD’s business was firmly established, with growing revenues and profit. But even if NVD’s profits disappeared, you’d still get your interest payments because investors’ money would come off the very top before expenses and taxes – 10% lopped off gross revenues. 

NVD is a family owned and operated micro craft distillery producing small-batch and limited-release spirits. It has more than 35 labels in all.

At the time of the raise, NVD had a tasting salon and tasting bar but no restaurant. Salons and tasting bars aren’t allowed to serve cocktails, beer or wine unless they’re part of an event the company is hosting. But restaurants can serve cocktails, beer and wine anytime. And having a restaurant would let NVD offer a new cocktail and food pairing service – all of which would generate lots more revenue. So the company was raising money to open a restaurant on-site. 

NVD ended up raising $620,000 back in 2017. That year it had revenues of $1.8 million. In 2018, it reported revenues of $2.4 million. With the restaurant expected to debut by the end of June or early July, NVD founder and CEO Arthur Hartunian expects revenues to climb to $3 million this year.

So what exactly was the deal investors got? 

NVD is paying about $240,000 a year in interest to investors. It owes them $620,000. In 2.5 years or so, it will pay off its entire debt. By that time, investors will have made between 15% and 18.5% compound interest a year on their loans. 

When I first made the recommendation, I said investors could expect to earn 10% to 15% annual interest on the high end. And the most realistic scenario would give investors a 15% interest rate for what I described as “a relatively low-risk loan.”

I was pretty much right (it happens now and then), though not everything went according to plan. Construction on the kitchen and restaurant was delayed. Arthur thought California might drop its requirement of a kitchen and restaurant to sell alcoholic beverages at any time of the day, so he put the construction plans on hold. But the change never happened.

And by not using the loan money right away, Arthur opened the door to the one scenario I’m sure he wanted to avoid. He began a lengthy period of paying off the loan with existing revenues (that he was generating anyway), putting a drag on his ability to spend and grow. 

He’s now looking for ways to remedy the situation. One option he’s considering is giving investors the ability to convert their loans to equity. 

Whatever he decides, Arthur wants to make sure that “his investors are taken care of.”

Thank you, Arthur. That’s all I ask for. ■

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