Berman - Lessons from the Lemonade Stand: A Common Sense Primer on Investing

A Common Sense Primer on Investing

by

James Berman

2012 James Berman

For Carrie and Sasha

Many people helped with Lemonade, as it came to be known. Im grateful to my talented assistants, Sadia Bruce and Kelly Zekas, who spent so many hours editing and proofreading. Araminta Atherton designed a terrific cover. My good friend Ethan Herschenfeld provided invaluable feedback. My wife Carrie is my eternal love and support in every way. Finally, I would like to thank my parents for their devotion and for teaching me that money doesnt just grow on trees, in lemon groves or elsewhere.

Lessons from the Lemonade Stand (Lemonade) provides educational information on investing. All readers should take care to understand the risks, costs, mechanics, and consequences of investing. None of the content in this book is intended to be (nor should be interpreted as) a solicitation to buy or sell securities.

Past performance does not guarantee future results. Any forward-looking statement is inherently uncertain and cannot be relied upon as a statement of actual performance. Investing can result in serious loss.

Although all content is derived from data believed to be reliable, accuracy cannot be guaranteed. James Berman, JBGlobal.com LLC, and their employees assume no liability whatsoever for any investment losses as a result of readers following the advice in Lemonade. Lemonade is not intended to provide personalized investment advice. Readers should consider consulting an investment advisor before making any actual investment. This book is not intended to provide accounting or legal advice. Tax rules and laws regarding investment change regularly and are specific to the individual. As a result, the general tax rules mentioned in this book should not be relied upon. Readers should consult an accountant for tax advice and a lawyer for legal advice.

James Berman is an investor in Insight Guru Inc, the parent company of Trefis, both personally and through the venture fund he subadvises.

2012 James Berman

All rights reserved. No part of this publication may be reproduced, distributed or transmitted in any form or by any means, including photocopying, recording, or other electronic or mechanical methods, without the prior written permission of the publisher, except in the case of brief quotations embodied in critical reviews and certain other noncommercial uses permitted by copyright law. For permission request, write to

This eco-friendly manuscript is published exclusively as an e-book.

1) Every topic in the investment world can be broken down to the basic concept of supply and demand.

2) If someone claims an investment is risk-free, run the other way.

3) Bigger returns mean bigger risks.

4) Hedging may help, but theres always a cost to it.

5) As Warren Buffett says, If youre smart, you dont need leverage; if youre dumb, itll ruin you.

6) You may not be able to count on your stocks, but you can always count on your taxes.

7) By the time you invest in a foreign country, it shouldnt be foreign to you.

8) Owning a home is (still) the best investment of all.

9) Investing without work is gambling: treat the market like roulette, and youll land on zero.

10) Counterintuition, not intuition, is the investors best friend.

Simplicity, indeed, is the master key to financial success.

- John Bogle

Investment is a common sense topic not quite as common as tying your shoes or brushing your teeth. Yet we learned about it soon after we mastered those feats: when we opened our first lemonade stand.

If you were a young entrepreneur, you probably had a lemonade stand or maybe a bake sale or whatnot. I had my first business with my friend Justin: we sold lemonade, iced tea, and homemade peanut butter in front of my apartment building. You get the idea.

The investment world sounds complicated, but it can all be broken down to basic concepts. The most important is supply and demand, a fancy phrase for selling and buying which is just another way to describe what goes on at lemonade stands across America on any summer day.

This leads to Lemonade Law #1:

Dont feel bad if you never had a lemonade stand. Ive only chosen the lemonade stand for its common touch. But the idea is flexible, and you can plug in any other business. This book grew out of a perceived need a need to explain investment topics in simple ways. Theres too much confusion surrounding investing. The talking heads toss around phrases like credit spreads and equity dilution and out goes the viewers attention. Here, investment terms are introduced in bolded italics so that you can separate the lingo from the plain talk.

In the true spirit of a primer, this book is introductory. Its neither comprehensive, nor does it offer legal or accounting advice. It barely scratches the surface of most concepts but hopefully provides the tools to understand any concept. If it does whats intended, it will allow you to apply lemonade logic to your money. Buyer beware: This book is unlikely to make you rich in and of itself. If all else fails, you could go back to running a lemonade stand. Youd certainly have the best on your block!

Investing is fun, exciting and dangerous if you dont do any work.

- Peter Lynch

Meet Lucinda, who has just launched Lucinda Lemonade Inc. in the quaint, tidy town of Lemonville.

To open a lemonade stand requires capital that is, money. Maybe a buck or two here buys the lemons, and one or two there buys the sugar. Theres also a dip into the piggy bank for pitchers, along with crayons and paper for a sign. Rent is not a problem for most lemonade stand owners. The start-up capital the money required to get going is minimal.

Lets assume for the moment that Lucindas lemonade stand is doing a brisk business, and she wants to expand her operation, perhaps by setting up a second stand on Main Street. She runs into a small problem in her exciting expansion: she needs more money.

Lucinda considers going to a bank for a loan but worries they would never lend money to her tiny business. She has the idea of raising money from a few friends by selling pieces of this profitable and growing business. If Lucinda decides to sell a piece of the lemonade business, shes selling stock or if you want to be particularly highbrow about it, equity. If she divides the business into tenths and sells one-tenth of the business to her neighbor Liam, shes sold one share of stock.

The process goes something like this: Lucinda sells a piece of the business that is one share of stock for $10. Two things are now different. One is that Lucindas business has $10 in the piggy bank that it didnt have before (enough to buy new signs and a table and pay her new assistant). The other is that Liam now owns a piece of the company. That means that hes entitled to one-tenth of the value of Lucindas business going forward, whether that value goes up or down.

Keep in mind that Liam and Lucindas deal is a private one. In other words, the share in Lucinda Lemonade was not traded on a stock exchange; instead, Liam and Lucinda negotiated privately since Lucinda Lemonade is still a private (not publicly traded) company. This is known as a private equity deal.

Now lets turn to Liam, who is Lucindas first