Traditional Venture Capital investing historically has focused on software-driven technology, leaving a gap for hardware-driven companies. In this week’s episode, co-hosts Bob Fraser and Ben Fraser interview Robert Cote who shares his unique approach to venture capital by monetizing intellectual property. Robert is a foremost IP lawyer who discusses the ins and outs of this unique approach to venture investing. Tune in now!
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Transcription
Ben Fraser: Hello, Future Billionaires! Welcome back to another episode of the podcast. We’ve got a very unique one today. A lot of times we will bring on experts in not just real estate, but also private equity and venture capital. And so today, Bob, we talked with Robert Cody, and what do you talk about?
Bob Fraser: So this guy has a unique approach to venture capital.
We’ve all heard about venture capital. We’ve talked about venture debt. Here’s a new one, venture revenue stream.
Ben Fraser: Yes. So tune in now to hear how he focuses on companies with ip, intellectual property, and is able to create an asset and then cash flow from that asset. Very cool model if I wanna check it out.
And as always, we gotta give him a very big disclaimer because he and his firm are raising capital. So you need to do your own due diligence. Us bringing him onto the podcast is not a recommendation by any means, and you have to do your own due diligence. But if it’s interesting, you feel free to reach.
And we are just curious and want to bring this cool model to you guys and hope you enjoy the episode.
Hello, Invest Like a Billionaire Podcast listeners! Welcome back to another episode. I am Ben Frazier, your co-host joined by Bob Frazier. And today we have Robert Cody, who is the founder and C E O of Cody Capital, and is bringing a very unique perspective on investing in innovative technologies. Right?
So we’ve talked a lot. Venture capital private equity. Investing in this podcast is something that our listeners are very interested in, right? We’re all heavy into real estate. And Robert is through his 25 year history has created some pretty cool models of investing that are a little bit different than traditional venture capital and really focused on intellectual property.
So we’re gonna dive into it. It’s a very fascinating little niche here. Robert, thanks so much for joining us on this podcast. You’re welcome. Give us a little bit of background on, on you. You’ve been doing this for, I believe, 25 years pr previously at your prior law firm, you’re a top IP lawyer, break down.
What is intellectual property for those, like us that are, maybe newer to the subject. And you know what’s so fascinating about this industry?
Robert Cote: I spent 25 years investing in companies that develop breakthrough innovations or what you can call, I. It’s the thing we hear about being stolen by China and others.
It’s the actual technology, whether you call it a breakthrough innovation IP or technology, that’s what we’re talking about. And so I help companies that develop breakthrough innovation scale. The use of their technology, their ip, and I used a revenue sharing approach as opposed to an equity model.
One, to help these companies own more of their business and reap more of the reward. And one to be paid to wait instead of waiting 10 years to see an outcome that may in many cases for venture capital outcome actually be paid to wait and then still participate in the outcome. And I realized, At my law firm where I was partnering with companies that had developed these breakthrough innovations, I could do a lot more good today when there’s a, when there’s a huge cry out there to bring advanced manufacturing back to America by stepping outside of my traditional practice and developing a mission I’ll call it an army, Cody’s army, around going out and actually funding many of.
Kind of hardware companies building real physical products based on breakthrough innovations. So we give this country a chance to rebuild its manufacturing base in a way that it can be rebuilt. The old stuff’s not coming back with a model that incentivizes these entrepreneurs to really do the hard work to build that business, which again, is a revenue sharing.
and essentially that’s my background in what I’m doing today and I’d love to answer any further questions.
Bob Fraser: just, I’m gonna break this down. So let’s make it super simple. So intellectual property is patents and technology, these kind of things. So it’s basically you create a breakthrough, you protect that by by getting patents and other things.
But, so let’s say you have this. Breakthrough technology. And so you’re an IP attorney by background, which means you’re the guy that goes and figures out how to help companies protect us. That’s the background of a basic IP
attorney.
Robert Cote: For a basic IP attorney. But I stepped beyond that.
understand.
Bob Fraser: I’m just breaking it down for our listeners. Okay. So what you did that for a while. And then what you’ve done is figured out how, lot of these companies, these potentially real big breakthroughs, right? Like you were talking about the guys that invented P C R, which is which is the genetic testing thing.
Is that right
Robert Cote: To, it’s the way to amplify DNA n a and be able to see it. You can develop treatments, detect diseases. It’s something that won the Nobel Prize actually so
Bob Fraser: huge, I massive. So this is an example. Something. So they basically got this little golden goose that they figured out how to do something no one else could do.
And now they wanna release it to the world. So they would hire an IP attorney to protect it. But what you go is one step beyond that. So you figured out how to, as an investor bring capital to the, to these companies through revenue sharing agreements. So that was they, when they release this technology or manufacture something that you actually get a piece of the revenue is that?
Correct.
Robert Cote: Yes.
Bob Fraser: So it’s very interesting and you made a point very quickly but I want to expand on this. So it’s like venture capital, but very different than venture capital. . So I actually ran a VCD company early in my career and they do what’s called the equity model, right?
They actually put in money, into your company and take ownership in the company, and that’s one model. But it is very expensive, as you mentioned, , you give up a ton of your equity, and then as an investor, it’s also not always great because, as you pointed out, again, super rapidly is. You gotta wait for an exit.
So let’s say you’re waiting 10 years for an I P o or 15 years, or who knows what, right? And or let’s say there isn’t an exit, the market crashes or something else happens and there’s no exit. So you’ve got this am massive investment that, the payday is a long ways out there versus a revenue sharing model where you’ve basically contracted to share revenues and you have cash flows from sales.
So as they make sales, you. , you have revenue, so you get a revenue stream and
Robert Cote: Yeah, I want, I correct. I wanted to, the model has proven to be much more. Acceptable to investors, even every everyday investors, if you can create a model that’s income producing from the asset that you’re investing in heck yeah.
That’s really like real property. It doesn’t like cash flow, , right? Correct. And that’s critical because a lot of people see, and rightly equity models tend to be lottery tickets. I may, I wait 10 years, I may or may not see. Exactly a return and mostly venture capital is not returning what you expect.
They would return. In fact, performance is pretty poor. I wanted to change the game by having an asset that has a lot of value to it, to protect you and to create a cash flow stream so you’re paid to wait. That beats what you would get in a real property investment zone. It makes total
Bob Fraser: sense. Makes total sense.
So it’s better from an investor’s point of view because hey, who doesn’t like cash flow? It’s also better from a a company point of view, right? This, because they don’t have to give up the company and like control of the company and. Deal with, potential board members and EQU and dilution issues and that things.
So it’s can be much more attractive to people. Say, Hey, I’ll just li I’ll just pay a royalty
Robert Cote: stream on this. And the companies love it for maybe three reasons. One, one of the. Challenges these companies face is they’re building their bus business. They’ve entered markets, they’re generating revenue, they have something nobody else has.
So revenues can be durable, but to get the customer to sign the contracts in that pipeline, they wanna see financial stability. So we develop a program with enough capital support so the market knows they can deliver on that contract and we’ll sign. So we actually take these companies out of a catch 22 situation that’s holding back a lot of growth.
Bob Fraser: Primarily balance sheet. You give them a stronger balance sheet and
Robert Cote: that, that kind of thing. Exactly. And then we gate capital in against milestones. Could be contract based. Could be some, f d a approval of a drug, ahead of revenue, the revenues will follow.
We consider it sacrosanct that the cash flows will be there and the revenues will be durable. So it’s very important to know that the engine in the car, not just the team driving the car is truly different and people are willing to pay.
Bob Fraser: So these companies that may partner with you? Yeah. It’s very difficult to get a giant contract.
I know this for a fact, right? To get a giant to have a customer, get a customer contract. If the customer’s not sure you can produce it manufacture it. So they wanna know you have financial backing, you have wherewithal that, that, you’ve got a big shark, so to speak, behind you who can write big checks, that kind of thing.
And. And so you’re funding you’re creating a big a funding, a balance sheets, boost booster for them and a backing that lets them go sell more and then gating that with performance criteria. I love that. That’s a tremendous model. And now one other point that you made that I think is super relevant, and that is that the difference with venture capital. So venture capital focuses almost exclusively on high tech, right? And right. And, those kind of things. And it’s, it, and there’s a gap in lower tech. So let’s say someone who’s manufacturing or has a, has, an a, It’s a product that doesn’t scale as readily a software, which is ultimately scalable.
So there’s a big gap. And this actually fits. So venture capitalists will not invest a lot of times in low tech or lower tech companies. And this model actually works for lower
Robert Cote: tech companies or manufacturers? I think we better clarify. So these are high tech companies, both groups.
I think the better distinction is venture capital after the.com bo boom. , you know how it works. They build their funds around what’s hot, and that was software digitizing the world with software, moving businesses online. And so that’s where many of the funds have found their home. And it’s where you build your track records.
So venture capital, while we’re moving manufacturing offshore, moved over and hardware building. High tech, physical products, real products that need to be manufacturing manufactured. They were moving over to software, digital products, much lower capital requirements, easier to model, and now their track records were built.
Built on that premise. It’s hard to shift gears, so now that. The world has shifted back to investing in breakthrough innovations that can change how we manufacture products, make them more sustainable, more cir circular, reuse their waste. We’re actually creating models that are higher growth and higher.
Higher profitability through efficiency. So green actually is an illusion. It’s not just good for the environment. Today many physical product companies with breakthrough innovations are turning how we make products into advanced manufacturing. That’s sustainable and circular. But more importantly, high profit, high growth.
It’s truly high tech. In fact, it’s more high tech than. That engine in the car is difficult to replicate, takes many years to copy, and so you have high barriers to entry to competitors. So if you pick right, you’ve got a cash cow, if I want to use a cute word for it. over in the software world many competitors.
Even if I pick the best software company, Uber, I’m gonna deal with Burger King and McDonald’s, Lyft, and I’m gonna have a lot of competition. And what venture capital has suffered with is, yes, I can go round around and pump up, pump and dump. I like to call it the value of these companies. So I’m always showing great paper returns.
But if you look at the end result, 10 years out, Those returns aren’t there because they can’t liquidate those investments. Too many competitors have emerged and there are too many options for consumers and of course for buyers, if you’re looking to sell that business or take it public. So I wanna draw a distinction.
I would say that software is low tech, more incremental improvements and easily replicated. And I would say that hardware or physical products that are based on breakthrough are the highest tech of all. Okay. So
Bob Fraser: hardest. Are you filling a gap that is not being filled by traditional venture capital?
Correct. But there’s people that, there’s companies that cannot get traditional VC, but that qualify
Robert Cote: for your model. Correct. Because venture capital has shied away over 20 years. from making physical products, I’ll call it hardware people who manufacture something, right? And at the same time, we moved manufacturing offshore, which compounded the problem, right?
They moved over tos where a guy behind a desk. Can code something up and hit hoppy and it’s instantly replicated. So you don’t need all those assets. So you’re definitely
Bob Fraser: filling a gap. That was the point I was trying to make. Yeah. That there’s a gap that, that the traditional vc they’re never gonna fund and.
and in, in man manufacturing for sure, they just, there’s very few, very little VC investment in manufacturing type businesses that produce, cuz they’re more difficult to scale rapidly and software is ultimately scalable as you point
Robert Cote: out, and there’s probably another point.
So while it’s very challenging to get venture capital today, if you’re building a hardware business, meaning real physical products that need to be manufacture, when you get that capital if you can, it comes at a very high price. The equity models for these companies when they’re early revenue, if they need 30 to 50 million, which is typically the range that somebody who makes something needs to scale to justify customers signing that contract that you can build out the capacity to produce, meaning manufacturing, equipment, production lines, to get that capital you.
Have a 50 million need, you may have five or 10 million of revenue and be worth 50 million or a hundred million in evaluation so that 50 million is coming in. and they’re gonna take a half or more of your company’s equity. And that’s a real problem for these companies.
Bob Fraser: Yeah. And most entrepreneurs, that’s the thing that’s the most precious to them.
You’ve ever watched an episode of Shark Tank, right? How many deals blew up over valuation issues, which is these entrepreneurs, this is my baby. I don’t want to give up all my equity, but that’s just the market. That’s a fact. . And it’s the same, we’ve actually talked about venture debt and Right.
And venture lending, which is very similar in some ways. It doesn’t have revenue stream. It doesn’t have as much upside as you, you have but it’s preferable to a lot of the companies that don’t wanna give up all their equity. They’d rather land.
But, so this model has a blend of Yeah. Cash flow and some security. Plus you actually get a fair amount of upside because you’re typically I would imagine you’re doing this on revenues even, right? So yeah, you’re even protected from the bottom line, which if they, wanna go non-profit unprofitable for a while, you don’t, you’d still make money because you’re above, above the expense line.
Is that right? Right,
Robert Cote: Exactly. And we should let’s drill into the model second, and I can explain what those returns look like, but I want to hit a couple of points. . The other thing that these companies love is not only am I giving ’em the capital support they need to get customers to sign, and gating it in, so my investors are protected.
We’re not just putting a chunk of money down, we’re making a commitment. So I’m protecting my investors. I’m not diluting these companies because I’m sharing in revenues the point you just hit very well, and I’m solving a need that can’t get that capital from venture capital. . And then finally I’m doing something that they very much value, which is I’m gonna protect what they have.
I’m one of the leaders not only investing in intellectual property, but I’m one of the leaders in protecting, and that’s an art much more than a science that requires that you be able to walk, blindfold through the darkness. I like to say to be able to feel your way and only experience deep experience where you’re dealing.
Many battles on many different fronts over many years. Does one be able to, is one able to be able to craft a way to protect what you have to protect the engine in the car? And I care as an investor about the engine in the car because that’s security. I’m gonna underwrite that value and I’m going to develop a path to liquidate it cuz I know somebody.
In the market, usually multiple people want the diamond that this company holds in its pocket. So I’ve created like in real property, an asset that protects your capital. There is no protection in venture capital, equity investing. So for investors, I’m changing the risk profile. They’re secured by an asset that will get us our capital back if something goes wrong.
Bob Fraser: So you’re bringing your expertise and asset in intellectual property to bear to and you have a huge stake in the quality of that intellectual property, so you’re gonna protect that. Makes total sense. Talk
Ben Fraser: a little bit about that. Cause I think that is a unique aspect as a differentiator from traditional vc.
and something as real estate investors li like us, that, we always come back to the collateral, right? Ultimately you have collateral. So in a liquidations scenario where you’ve done a revenue share agreement, but that only works if the company’s generating revenue. If they, go bankrupt or the technology ist accepted.
What, what’s , I’m sure it’s probably different for every company, but what’s the value that you can extract from the IP itself? If you peel away the company that created
Robert Cote: it, so I’m gonna use the word brick and mortar assets, we’re actually securing the brick and mortar assets of the company.
So let me step out and explain what that means. So if I come up with an innovation, it actually creates cast gs of innovation, meaning many different ideas or invention. as I figure out how I’m going to build a product, there’s a lot of challenges. So you tend to have a large portfolio of innovations.
Those are protected by patent rights or trade secrets. You keep it secret if people can’t. understand what you’re doing by looking at your product or your equipment and you patent it when they can because it’s your only way to protect what you have. So there are a couple of different ways to do it, and so I’m valuing not only the actual portfolio of technology or IP and the rights that protected to make sure that the buyer knows he will have that monopoly he’s paying.
protection is really critical in the world. You don’t want people copying it. You lose the benefits. So secondly, I’m valuing the physical equipment that I’m funding, the plants and equipment that I’m helping capitalize to build the new product. And so both the ideas and how to implement them as well as the physical equip.
Give a buyer a turnkey solution so they can get in the business if something were to go wrong. So I like to say, if you think about it, it’s an IP property and it’s brick and mortar based, physical based. It’s real property based in a lot of ways. And I want in investors on this and listeners to understand we’re not talking about some intangible idea that I can’t grab with my.
So it’s hugely
Ben Fraser: a combination of the idea, but also physical assets that are used to scale the technology. Can we,
Bob Fraser: We’ve been talking conceptually, which I love, but can we get into a couple just real examples, like a real company that really did this and the actual deal that was made.
And if you need to not mention the exact name of the company or something, that’s fine. But the real deal, how it really worked out for everybody involved. And just go through, let’s just break this down real practic.
Robert Cote: So there are a lot of elements to that. So you can bring me on the straight narrow if I go off, off.
But the, I try the model has developed to be simple. I want to be your partner. So I don’t want to be in a heavy negotiation over what’s the value of your business and how much equity, it’s counter to that partnership, right? And it can break down a relationship. Can you give us
Bob Fraser: an example of just a
Robert Cote: particular example?
So I want people to appreciate. The model. Let’s take an example. So let’s take a company that’s developed a brand new breakthrough called nano carbo. Okay? And imagine that nanocar is like a grain of sand at a billionth of an inch, and I can control the structure of that grain of sand at a billion of an inch.
And I can put billions of those grains of sand in a coating and I can coat them on a window, and you can’t. , but every one of those grains of sand is not only blocking the heat from your building like existing windows in new construction, but instead of reflecting it away, it’s converting it every grain of sand into electricity.
So imagine a world where I can coat every building and turn it into a solar panel that is a coating you can’t see with your eyes. Imagine the change we could bring in the world renewable. and solar energy can be available everywhere. That’s So is this a real company? Yes, a real company. Okay, so tell me the deal.
Tell me the deal you yeah. So I’m gonna get to the model now. So what I tell companies is give me a five year revenue plan. Simple. We’ll worry about discounting that plan in a minute, but gimme a five year revenue plan. And I wanna figure out what revenue royalty, or what percentage of revenue, what revenue.
which is the way it works, will get me back a hundred percent of that capital in five years. Correct.
Bob Fraser: Now remember, 20% per year at ish.
Robert Cote: Correct. That’s the beauty of it. Once you get comfortable that I can underwrite that IP asset and like a piece of real property, protect your capital, you can look at that as a true yield every day, every year on your money.
That’s the magic of the. and the way we structure it and we keep it pretty simple. I’m not negotiating valuations. Give me a five year revenue right now. The art here is you will typically get one revenue projection if you’re a venture capitalist, which , right? , which he’s motivated to see because he’s gonna put a multiple on it based on comps, and he needs to double his money every round.
So he’s in on the. You follow, Robert? I
Bob Fraser: think I’ve read, 500 business plans in my days and I think I can count on one hand the number of entrepreneurs that ever met their revenue projections.
Robert Cote: Exactly. . So now here’s the art of it. We are not in the business of taking anybody’s ip. We are not repo men.
In fact, if I’ve gotta do that, I consider my business o over right Reputation. I’m unlocking an asset, the engine in the car that has value, that would bring many more investors into what was considered a lottery ticket business and make it look more like real property investing. And that’s the art of this.
And I want people to appreciate that. That’s security. We hold in the asset. I’m not just exercising that willy-nilly, but it really sobers up a company. In discounting that revenue trajectory, once they know that the diamond in their pocket is at risk, so you’ll see that revenue trajectory or that plan come down by 50% or more, and we model our share of revenue on that high confidence revenue plan that puts the asset at risk, not the pie in the sky plan that gets these hump and dump valuations that look good on paper, but never get realized in an.
Yeah. Very
Ben Fraser: cool. And so when a company’s like deciding to potentially work with you , do they already have some of this IP protected or is it something where you’re really coming with a value add with obviously your background expertise and helping them really create a strong, fortress
Robert Cote: around that?
So I use the line again. You have, when you’ve done this many years, you learn to walk blind through the darkness that yet, . And what I’m gonna say there is that 25 years of doing what I did, investing in and protecting takes you through so many wars and battles that you become the IP pre you become the predator in the IP circle of life.
And you want the predator in the IP circle of life because he knows how to capture the market. He knows how to capture what you own. And the answer to your question is usually. The CEO is worried about building the business. He believes that his business is like the field of dreams. If you build it, they will come.
What? He doesn’t realize that only a guy like me who spent so many years helping companies to build industries with breakthrough innovation, what I know is that if you build it, they will look to steal it and you better protect it, right? So the answer is, I come in and provide an invaluable service to figure out how to better protect what you have.
Because we’re gonna take the engine in the car and we’re gonna sell our own cars, and then we’re gonna scale the use of that. With manufacturers around the world that can sell their cars too. And we can grow this business faster, create more value for investors, and have an asset that’s protecting, that grows in value with every partnership around the world.
Much, much better than betting on the guy who’s driving the car. The team, the one team, I’m betting on many teams now, but the key to it is understanding how to. that asset because you are sharing it. And that’s the art of IP investing versus venture capital investing. So how
Ben Fraser: do you protect it internationally?
Because in America we have great IP protection laws, abroad, they’re not as strong in, in fact, it’s common practice to steal intellectual property, right? So how are helping protect companies that want to expand internationally or need to expand internationally to hit their revenue project?
Robert Cote: So that’s a big question, , but I’ll try to give a simple answer. It’s a big question. So I always tell companies if you can keep it secret. Yep. Okay. So if you can sell half the recipe, Or a license, half the recipe, right?
Bob Fraser: Coca-Cola right, is not pined. It’s better to have a trade secret, which there you go.
Robert Cote: Exactly. And you can either keep it secret, which is often a challenge to keep it completely secret like Coca-Cola does. , or you can sell half the cake and provide the inputs for the rest of the cake so that half the secrets are on this side of the pond, or in a secure location that you can trust.
That’s really important. That’s one way if you’re selling a physical product, people are pretty smart at reverse engineering, and it’s not just China. Everybody’s got a competitive basketball team and every team wants to. and it tends to be human nature to figure out and learn from what others are doing, rightly or wrongly, right?
So you have to understand that if they can reverse engineer and now you need to get in the game of patenting. So that’s the other aspect, to hit a second area, and that’s an art in and of itself because you need to patent in markets where you have effective enforce. The US Germany believe it or not, you’re gonna love this.
China has built one of the, has built a state-of-the-art legal system to protect intellectual property rights for Chinese companies and in company around the world. And you’d laugh at that and say, what? W t F, how could that be? When you need to license your companies into the American market and global markets, you better have strong protections in China cuz they want to come in your market.
So your patent minefield is holding them out of China and now you can legally license your way through cross licensing into America, American market. European market. So even China has got in the patent game, they file at a. patent applications at four times. What Americans do today, they’re truly in the game of patenting what they have, and it’s an economic weapon now legally put in place that helps get them into market so they don’t have to fight their way in.
Interesting. I think that people wouldn’t appreciate China would actually be protecting intellectual property.
Ben Fraser: That’s really interesting. So how do you, like, when you’re looking at the right companies to invest in and to create a structure like this in your fund or otherwise, what do you look for?
Because there’s gotta be an element of, maybe if you go too early stage or pre-revenue, you’re more banking on the come that doesn’t really suit your model as well as maybe someone that’s got some existing proven market. , but needs to scale, needs help. Really creating a fortress, surround their IP and leveraging some of the background.
What do you look for and your ideal, target companies?
Robert Cote: So I look for a company that has a product that implements innovations, ip and I wanna make sure that those innovations, that IP. Are highly differentiated, meaning there’s nobody else that consult. Something that provides to customers the value proposition, because in the end, it’s all about value.
I want that value demonstrated in a pipeline, both pre-sales and a pipeline that I can validate to make sure that actually people see that value. Just like the business plan you may get from those 500 startups that you’ve looked at You, you know that what people tell you needs to be validated to some degree.
I need to trust the customers to tell me they appreciate the value. So you’re underwriting a contract base as well, so you wanna see a real contract base and that demonstrates the value of this intellectual property. So you get comfortable that the revenues will be durable cuz you’re scaling out to meet demand.
You wanna make sure somebody’s gonna buy on the other end of that scale. And that’s pretty critical. And you wanna make sure the pipeline is validated cuz you wanna give ’em that larger pool of money that will be gated in over let’s say 18 months, 24 months. You wanna make sure many customers will buy.
So we can scale the company more quickly that catch 22 of having the customer, but not being able to demonstrate the guys who have to check the box, can you do it? That’s a real struggle for many of these companies to build physical products I’m solving. , so hopefully that answers the.
Ben Fraser: Yeah, that does.
I, it’s interesting too, going back to the Shark Tank comment earlier, you see some of these deals being made where they’re not actually asking for equity. They’d rather just get a royalty or a revenue share. And when you do that, you think about the benefit.
Bob Fraser: You should call it Mr.
Wonderful Investing , Mr. Wonderful.
Robert Cote: It’s, people do make the reference every time I tell them I have a revenue share model.
Ben Fraser: But benefit is you don’t. The operational risk, right? You’re just right. Getting paid on the
Bob Fraser: top line there is some operational risk, your sales risk, but not bottom
Ben Fraser: line risk, which is not bottom line, but, which is great.
The flip side of that, actually it’s interesting cause I was talking with a guy the other day and he’s, been scaling his business with, through this partnership affiliate agreement where he has this kind of revenue share. Just based off revenue minus ad spend. But he’s now having to incur additional costs on, fulfillment of his of his product, that he didn’t anticipate early on as they’ve scale is up quite a bit and now the incentives are misaligned. Or he doesn’t wanna keep scaling because that, 30% of the top line or whatever he is getting is now way more expensive than it was early on. So do you ever find that as you go longer in this cycle with A company that early on, they needed the capital, so they’re willing to give up more.
But now does it create any, disincentives down the line because their cost structure is greater than they anticipated.
Bob Fraser: And to add on to that, an equity investor looks very negative on a royalty arrangement or a revenue sharing arrangement because, that’s, again, you’re going you’re taking from the top line, right?
So that’s you’re getting the sweet nectar,
Robert Cote: You’re gonna have to, just to make comment on that when you’re in the hardware side of the house, which is where the gaping hole is in capital availability. , you’re also versus software where venture capital sits over in this hardware house where you’re building real products.
Based on breakthrough innovations to get capital in is heavily diluted, as we mentioned earlier. So I actually, we model out what a revenue share would look like over five years, we presume an exit within five years. And we actually compare the outcome for existing investors, equity investors. to the, share of the pie that we’re getting along the way in and in the exit.
And you can see essentially we’re probably taking half of what a venture capitalist would take. And so the company reaps much, much more of the reward, both the people building it, who you wanna incentivize, as well as existing investors. . And so when you realize as a, an existing investor building this business and you get to market and you have this capital problem, here comes Cody with a way to not dilute you and you can see that it’s actually economically better for you counter to what you were thinking would be the case.
Interesting.
Ben Fraser: So what is the planned exit generally at the five year timeframe? Is there a buy-sell agreement at a certain valuation? Is it the company? Plans to sell. What’s generally the expectation on an
Robert Cote: exit? So we tend to model five years. Again it’s like the business plan that you’re handled or the pipeline that you’re trying to underwrite.
You never know what’s real and what’s. Not, and everything in my life and in every startup I’ve ever worked with always takes longer than we think, right? Always . So I tend to use a healthy five year run. I think for anybody with something breakthrough that’s a timeframe and wish they can really show well, right?
They can really scale this business. And so we model three, we model five years to get our money back, which is a 20% return per year. and then we ensure that we’re getting another turn, a preference, A one X. So we’re getting two X total at that exit in five years. Okay? And we take a share of the exit based on looking at that revenue in year five and your profitability, putting in a value on the business and figuring out what percentage will give me another turn now.
You’re building this business, I’m still getting a percentage of everything above that. So I’m getting one x along the way. One x off the top is a preference cuz I’m a downside protector, right? I’m building this investment model from a perspective of protecting the downside so I can bring in millions of people to help many more of these companies grow and not make this lottery.
So I want the asset to be protected. I want ’em to get the cash flow, and I want them to be looking at a very high probability of a two x on their money over five years gross. Of course, I get a share of the splits, right? But it’s a two x return and then we’re still sharing in a percentage, the same percentage of the exit to buy out any continuing revenue.
I tend to model getting a three x gross, and if the company does better, you know we do better. But a three x gross and a two x to my investors over five years. Is the way that I model this. Any questions on that? But the there really,
Bob Fraser: you don’t control the accent, right? And you don’t, you can’t guarantee an accent.
You can’t drive an exit. So this could be up into perpetuity, right? That this thing goes. Is, and there’s nothing you can do about it, but hey, there’s worse things than giving cash flow into perpetuity.
Robert Cote: And I’m gonna hit a couple of points that I think you guys will love as well, which are addons to what you just said.
And that is, now think about the dimension. I’ve added another dimension to an exit. I’ve added a cash flow stream. Venture capital is equity. They can’t trade. They gotta wait 10 years and hope for the best. Usually it’s not a good. here I am betting on real differentiated properties that are cash flowing.
I’ve underwrite, underwritten the contract base, so I know the cash flows are durable and. I’m letting the company choose. No longer are you forced to exit cuz my fund needs a return. Really valuable to the company and I’m stepping down my royalty in perpetuity. I’m always trying to make sure in perpetuity I’m taking off the top so I’m not subject to the cost structure politics at the board level so that I’m getting that 20% return on my money in perpetuity.
Or I can sell that stream to many funds that buy royalty streams today, including insurance companies who want to have that durable stream. It’s very common in new drug discoveries that create royalties when the drug is sold. Those drug royalties tend to be sold to many different funds, insurance companies, et cetera.
So I’ve added for my investors a new dimension that we can choose to exit at year five if we want, or we can stay in the game, sell it off.
Bob Fraser: Awesome. Cool.
Ben Fraser: Very. . Awesome. Robert I think we’ve hit time, but thank you so much for coming on the podcast and sharing this very unique model. I’m sure listeners will find this very interesting.
So what’s the best way for folks to find out more about what you guys are doing, if there’s some interest?
Robert Cote: So I would say you can go to our website, https://www.cotecapital.com/, and that’s https://www.cotecapital.com/ or to our IP capital fund, which is how you can invest with us, either in the fund or in individual deals that you’ll see there all breakthrough innovations that you’ll find attractive.
And that offering page is https://invest.cotecapital.com/. So either way to learn more, we are hosting live Q&A to do more of a deep dive on some of the topics we covered. and I would love to see many more investors join my mission and help bring advanced manufacturing back to America with a model like real property that they’re familiar with, asset back and cash flowing.
So
Ben Fraser: Awesome. Thank you. Thanks so much, Robert. Appreciate you coming on.
Robert Cote: You’re welcome. Thank you, gentlemen. Bye-Bye.
